CAF-05

Financial Accounting
and Reporting II

Vol. II

Practice Manual Examination

Questions & Answers

Book Contains Translations of

QURANIC AYATS & AHADITHS,
Therefore, Handle Carefully.
 Table of Contents
Chapter Topic Page No.

1 IFRS-15 Revenue 1
2 IFRS-15 Appendix Examples 31
3 IFRS-15 Summary of Revenue 50
4 IAS-10 & 37 58
5 Summary of IAS-10 & 37 107
6 IFRIC-1 Complete 114
7 IFRS-9 Complete 125
8 IFRS-9 Flow Chart 153
9 Summary of IFRS-9 154
10 IAS-41 Complete 157
11 Number Ltd. (Test IAS-41) 173
12 Final Accounts Part 2 176
13 Final Accounts Part 3 (IAS-1) Theory 220
14 IFRS-8 Complete 230
15 IFRS 8 Extra Practice 241
16 Lease Part 2 244
17 Lease Part 3 284
18 Summary of Lease 289
19 Ethics 294
20 IAS-38 310
21 Summary of IAS-38 338
22 SIC 32 Complete 346
23 IAS-16 & IAS-12 351
24 Spring 2020 358
25 Autum 2020 371
26 Spring 2021 384
27 Autumn 2021 397
28 Spring 2022 404
29 Autumn 2022 419
30 Spring 2023 430
31 Autumn 2023 445
 “Pray Salah (Namaz) and give peace to your soul and heart.”

REVENUE FROM CONTRACTS WITH CUSTOMERS

(IFRS 15)
IFRS replaced IAS 18 and IAS 11.
Income : increase in economic benefits during an accounting period in the form of inflow of assets or
decrease of liabilities that result in increase of equity , other than those relating to contribution from equity
participants.
Revenue: Income arising in the course of an entity’s ordinary activities.
Customer: is a party that has contracted with an entity to obtain the goods or services that are an output of
the entity’s ordinary activities.
Core Principle of IFRS 15: is that an entity recognises revenue to reflect the transfer of goods or
services to customers in an amount that reflects the consideration to which the entity expects to be entitled
in exchange for those goods or services.
Transfer of goods or services occur when the customer obtains control of goods.
Control is obtained when the customers has the ability to direct the use of and obtain substantially all
remaining benefits from the asset (asset in this IFRS 15 covers both goods and services). (Goods may be
tangible or intangible).
Five step model [Para 2 of IFRS Part A1]
Applying the above core principle involves following a five step model as follows:
Step 1: Identify the Contract with a Customer:
Step 2: Identify the separate performance Obligations in the Contract:
Step 3: Determine the Transaction Price:
Step 4: Allocate the transaction price to each performance obligation (based on standalone prices)
Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation.
Example: On 1 Dec. 2001, Wasim receives an order from a customer for a computer as well as 12 months
technical support. Wasim delivers the computer (and thus control) to the customer on same date. The
computer sells for 30,000 and technical support for 12,000 per annum. The customer paid 42,000 upfront.
Discuss how revenue should be recognized for this transaction during the year ended 31.12.2001.
Solution:
Below is how five steps to be applied in this transaction:
Step 1: Identify the Contract with a Customer: there is an agreement between Wasim and its customer
for goods and services.
Step 2: Identify the performance Obligations in the Contract: there are two performance obligations in
the contract;
• Computer; and
• Technical support
Step 3: Determine the Transaction Price: it is 42,000
Step 4: Allocate the transaction price to each performance obligation based on standalone prices: no
need for any allocation as the transaction price and standalone price is same (will be discussed later).
Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation: control over the
computer has passed to the customer on 1 December 2001, therefore revenue of 30,000 should be
recognized on that date. The technical support is provided over time so revenue should be recognized
over time. During the year ended 31 December 2001, revenue of 1,000 (12,000 x 1/12) should be
recognized related to technical support.

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 “Being able to pray Fajr is a blessing that is not guaranteed to everyone.”

Example:
On 01.01.2016 Mobilink gives a bundle offer to a customer as follows:
• A free hand set on 01.01.2016; plus
• 12 months network services for Rs. 100 per month (means total revenue is 100 x 12 = 1200)
Let’s assume standalone prices if goods and services are sold separately, are:
Handset = 300
Network services (80 x 12) = 960
Total 1,260
Transaction date is 1.01.2016
Required: Explain how to account for the revenue in the above scenario.
Further explanation of five step model
(1) Step 1: Identify the Contract with a Customer:
A contract is an agreement between two or more parties that creates enforceable rights and
obligations. Contract may be written or oral (or as per business practices; e.g. an invoice).
(2) Step 2: Identify the performance Obligations in the Contract:
A contract includes promises to transfer goods or services to a customer. E.g. a promise to deliver a
good or service.
(3) Step 3: Determine the Transaction Price:
The transaction price is the amount of consideration in a contract to which an entity expects to be
entitled in exchange for transferring promised goods or services to a customer.
Transaction price is also adjusted for the effects of time value of money if the contract includes a
significant financing component. In addition, transaction price is also adjusted for any consideration
payable to the customer (further discussion later on)

Time value of money:

Revenue is the market price less any trade discount allowed.
If a sale is a cash sale, the revenue is the immediate proceeds of the sale.
If a sale is a normal credit sale, the revenue is the expected future receipt.
However, in some cases when the payment is deferred, the cash sale price might be less than the amount of
cash that will eventually be received.
The difference between the total sale value and the cash price of the consideration is recognised as interest
income. However this adjustment is only required if the period between transfer of goods and receipt of cash
is equal to or more than one year. (or if any other information is available)

Example: Deferred consideration

An enterprise sells a machine on 1 January 2015. The terms of sale are that the enterprise will receive Rs. 5
million on 31 December 2016 (2 years later).

An appropriate discount rate is 6%.

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 “Prayer is your free wireless connection to reach Allah.”

Example: Sale on extended credit terms

On 30 June 2021 Hashim Limited sells goods to a customer on extended credit terms. The customer is
required to pay Rs. 1 000, in full and final settlement, on 30 June 2022. The cash sales price is Rs. 909
(present value using a discount rate of 10%).
The financial year-end is 31 December.

Required:
Provide all related journal entries in Hashim Limited’s general journal

Example: sale on extended credit terms over 2 years

Shahid Limited sold a plant to a customer on 1 October 2021 for Rs 300,000 payable at the end of 30
September 2023. A market related interest rate is 10%.

Required:
Provide all journal entries in Shahid Limited’s general journal for each year ended 31 December.

Example:
A customer purchases an item, on 1 January 2021, to be paid for over a period of 3 years:
End of year 2021 40 000
End of year 2022 50 000
End of year 2023 29 700
The present value of these payments (using a discount rate of 10%) amounts to
100 000.
The year end is 31 December.

Required:
Show the related journal entries in the books of seller for the year ended 31 December 2021, 2022 and
2023.
(4) Step 4: If there are more than one performance obligations in the contract; then allocate the
transaction price to each performance obligation on the basis of relative stand-alone selling prices of
each distinct good or services, promised in the contract.
Stand Alone Price means a price at which an entity would sell a promised good or service separately to a
customer (means market price if a product is sold separately) (without bulk discount).
Transaction Price means amount of consideration to which an entity expects to be entitled in exchange for
transferring promised goods or services to a customer; excluding amount collected on behalf of third parties
e.g. amount collected for owner or sales tax collected on behalf of government.
Collection of Revenue by Agent
Estate Agent Limited provides a service to a client whereby it collects monthly rentals of 15,000 on the last
day of each month. The agent is entitled to a commission calculated at 10% of the rental and the remainder
is paid over to the property owner on the first day of the next month.
Required:
Provide the journal entries to show the collection of the rental and the revenue earned in the accounting
records of Estate Agent Limited.
(5) Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation.
An entity recognises revenue when (or as) it satisfies a performance obligation by transferring a promised
good or service to a customer (which is when the customer obtains control of that good or service). The
amount of revenue recognised is the amount allocated to the satisfied performance obligation; as a result of
allocation of transaction price in step 4.
• A performance obligation may be satisfied at a point in time; or
• A performance obligation may be satisfied over a period of time.

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 “We don’t pray to exist! We exist to Pray!”

Detailed discussion of IFRS 15:

Identify the Contract [Para 9 of IFRS Part A1]
An entity shall account for a contract with customer only when all of the following criteria are met:
(a) The parties to the contract have approved the contract (in writing or orally etc) and are committed to
perform their respective obligations under the contract.
(b) Entity can identify each party’s rights (e.g goods and cash)
(c) Entity can identify the payment terms (e.g payment is to be made in 15 days)
(d) Contract has commercial substance. [An exchange of goods lack commercial substance when non-
monetary exchange occurs between entities in the same line of business to facilitate sales to
customers e.g. a contract between two oil companies that agree to an exchange of oil to fulfil demand
from their customers in different specified locations on a timely basis][it means contract will have
commercial substance if risks, timing or amount of the entity’s future cash flows is expected to change
as a result of contract]; and
Example 1
Two shopkeepers are independently operating mobile shops in different cities of Pakistan i.e. Lahore and
Karachi. The mobile orders are placed by customers online and shopkeepers than deliver the mobile using
courier service.
The shopkeeper in Lahore has received an online order from a customer in Karachi. The mobile ordered is
not there in stock at Lahore therefore he requested the shopkeeper in Karachi to deliver mobile to his
customer in Karachi and in exchange in future he will deliver same mobile for Karachi shopkeeper for his
customer in Lahore.
The exchange transaction has no commercial substance because amount of entity's future cash flows is not
expected, to change as a result of the contract.
(e) It is probable that entity will collect the consideration to which it will be entitled in exchange for the
goods or services that will be transferred to the customer. (by considering the customer,s ability to pay the
amount of consideration when it is due)

Question from above can be: criteria to be fulfilled before general IFRS 15 model is applied
Treatment of consideration received; if contract does not meet the criteria for the identification of the
contract: [para 15 of part A]
When a contract does not meet the above criteria and entity receives a consideration from the customer, the
entity shall recognise the consideration received as revenue only when either of the following events has
occurred:
(a) The entity has no remaining obligation to transfer goods or services and all or substantially all of
consideration has been received and is non-refundable; or
(b) The contract has been terminated and consideration is non-refundable.
Example 2
Mr. Anjum agreed on March 1, 2016 to sell 5 cutting machines to Dawlance. Due to some deficiency in
drafting the agreement each party's rights cannot be identified. On March 31, 2016 Mr. Anjum delivered the
goods and these were accepted by Dawlance. After 10 days of delivery i.e. April 10, 2016 Dawlance made
the full payment and the payment is non-refundable.
When should Anjum record the revenue?
Answer:
As Mr. Anjum cannot identify each party's rights .so revenue recognition should be delayed until the entity's
(Anjum's) performance is complete and substantially all of the consideration (cash) in the arrangement has
been collected and is non-refundable.
Therefore Mr. Anjum should record the revenue on April 10, 2016, as it is the date on which performance is
complete and non-refundable payment is received.

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 “Salah is the key to all happiness and success.”

Example 3:
A CA firm agreed to provide consultancy services to a leading school. A non-refundable advance of Rs.
50,000 is received at the time of agreement on January 1, 2012. The final payment terms were not clear as
per agreement. On 15 January 201 2 the contract was terminated.
When should CA firm record the revenue?
Answer
If a contract does not meet these criteria, revenue is recorded when the contract has been terminated and
the consideration received is nonrefundable.
Therefore revenue should be recorded on 15 January 2012.
An entity shall recognise the consideration received as a liability until one of the events above occurs.

Does the contract exist if either of the party can terminate it? [Para 12 of IFRS Part A1]
A contract does not exist if each party (either seller or buyer) has the unilateral enforceable right to terminate
a wholly unperformed contract without compensating the other party.
A Contract will be wholly unperformed if the following criteria is met:
(a) Entity has not yet transferred any good or services, and
(b) Entity has not yet received or entitle to receive any consideration.
Example 3A
A shopkeeper agreed to deliver 30 computers to Mr. Umer within 3 months’ time. As per the agreement
shopkeeper can cancel the contract any time before delivering the computers. In case of cancellation
shopkeeper is not required to pay any penalty to Umer. Does the contract exist?
Solution:
A contract does not exist if each party (either buyer or seller) has an enforceable right to terminate a wholly
unperformed contract without compensating the other party.
As shopkeeper can cancel contract without compensating Umer so contract does not exist.
Combination of contracts (what are the situations in which two or more contracts can be combined
as a single contract) [Para 17 of IFRS Part A1]
The entity must combine two or more contracts entered into at or near the same time with the same
customer (or related party of customer e.g. parent or subsidiary) and treat them as a single contract if one or
more of the following conditions are present:
1. The contracts are negotiated as a package with a single commercial objective.
2. The amount of consideration to be paid in one contract depends on the price or performance of the other
contract; or
3. The goods or services promised in the contracts are a single performance obligation.
Example 4:
Builder Co. enters into 2 separate agreements with customer X.
• Agreement 1: Deliver bricks to Customer X For Rs. 100,000
• Agreement 2: Build a wall for customer X for Rs. 7,000
Normal price of constructing wall is Rs. 30,000.
Analysis
The two agreements should be combined and considered as a one contract because contracts are
negotiated with a single commercial objective of building a wall. The price of two agreements is
interdependent. Builder Co. is probably charging high price for bricks to compensate for the discounted
(lower) price for building the wall.

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 “Doctors can treat you, but only ALLAH can heal you”

Example 5:
X Limited enters into two separate contracts to transfer Products A and B to Y Limited. However, payment
for the delivery of Product A is conditional on the delivery of Product B.
Analysis
As the consideration to be paid in one contract depends on the performance of the other contract so both
contracts will be combined.
Example 6:
Software Company A enters into a contract to sell software to Customer B. Three days later, in a separate
contract, Software Company A agrees to provide consulting services to significantly customize the software
to function in Customer B's IT environment. Customer B is unable to use the software until the customization
services are complete.
Analysis
Software Company A determines that the two contracts are combined because they were entered into at or
nearly the same time with the same customer, and the goods or services in the contracts are a "single
performance obligation". Software Company A is providing a significant service of integrating the software
and consulting services into the combined item for which the customer has contracted. In addition, the
software will be significantly customized by the consulting services.
Contract Modification [Para 18 , 20 AND 21 of IFRS Part A1]
A contract modification is a change in scope or price (or both) of a contract that is approved by parties to the
contract. E.g. changes in design, quantity, timing or method of performance.

Examples include:
• Adding a swimming pool to a building
• Increase in number of items to be supplied
• Extending an IT service contract (e.g providing software and afterwards its installation)
When a contract modification be considered as a separate contract: [Para 20 of IFRS Part A1]
An entity shall account for a contract modification as a separate contract if both the following conditions are
present:
(a) Scope of contract increases because of addition of goods or services; and
(b) The price of the contract increases by an amount of consideration that reflects the entity’s standalone
selling prices (market price) of additional goods or services.
Example:
ABC Ltd promises to sell 120 products to a customer for Rs.12, 000 (Rs.100 per product). The products are
transferred to the customer over a six-month period. The entity transfers control of each product at a point in
time (means at delivery). After the entity has transferred control of 60 products to the customer, the contract
is modified to require the delivery of an additional 30 products (a total of 150 identical products) to the
customer. The additional 30 products were not included in the initial contract. The price of the additional 30
products is 95 per product.
Required:
Compute the amount to be recognized as Revenue assuming as if the price of additional products reflects
the stand-alone selling?

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 “Allah is enough”

Solution: Additional products for a price that reflects the stand-alone selling price
When the contract is modified, the price of the contract modification for the additional 30 products is an
additional Rs.2, 850 or Rs.95 per product. The pricing for the additional products reflects the stand-alone
selling price of the products at the time of the contract modification and the additional products are distinct
from the original products.
The contract modification for the additional 30 products is, in effect, a new and separate contract for future
products that does not affect the accounting for the existing contract. The entity recognizes revenue of
Rs.100 per product for the 120 products in the original contract and Rs.95 per product for the 30 products in
the new contract.
If contract modification is not treated as a separate contract [Para 21 of IFRS Part A1]
If contract modification is not treated as a separate contract because both the above conditions are not met;
then;
(a) If remaining goods or services are distinct from previous goods or services transferred; then an entity
shall account for the contract modification as if it were a termination of existing contract and creation
of a new contract.

Example: [Additional products for a price that does not reflect the stand alone selling price]
ABC Ltd promises to sell 120 products to a customer for Rs.12, 000 (Rs.100 per product). The products are
transferred to the customer over a six-month period. The entity transfers control of each product at a point in
time (means at delivery). After the entity has transferred control of 60 products to the customer, the contract
is modified to require the delivery of an additional 30 products (a total of 150 identical products) to the
customer. The additional 30 products were not included in the initial contract

During the process of negotiating the purchase of an additional 30 products, the parties agree on a price of
Rs.80 per product.
In accounting for the sale of the additional 30 products, the entity determines that the negotiated price of
Rs.80 per product does not reflect the stand-alone selling price of the additional products.
Consequently, the contract modification is not accounted for as a separate contract. The entity accounts for
the modification as a termination of the original contract and the creation of a new contract.
Consequently, the amount recognized as revenue for each of the remaining products is a blended price of
Rs.93.33 {[(Rs.100 × 60 products not yet transferred under the original contract) + (Rs.80 × 30 products to
be transferred under the contract modification)] ÷ 90 remaining products}.
(b) If remaining goods or services are not distinct; then an entity shall account for the contract
modification as if it were part of the existing contract. (if goods are not distinct the it means old
contract is going on)
Example: A contract to construct a house for a customer, considered to be a single performance obligation.
At the inception the entity expects the following:
Transaction price: 1,000,000
Expected costs: 800,000
Expected profit: 200,000
By the end of the first year, the entity has satisfied 50 percent of its performance obligation on the basis of
cost incurred i.e 400,000. Therefore the amounts recognized for the first year would be:
Revenue: 500,000
Costs: 400,000
Profit: 100,000
At the end of the first year, parties agree to change the floor plan of the house. As a result, the contract
revenue and the expected costs increase by 100,000 and 75,000 respectively. This 100,000 does not reflect
standalone price.
The entity concludes that the remaining goods and services to be provided under the modified contract are
not distinct (because no new asset)
Consequently, the entity accounts for the contract modification as if it were part of the original contract.
How to account for the revenue for the first year?
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Solution:
The entity will update its measure of progress.
400,000 / 875,000 x 1,100,000 = 502,857
The entity would recognize additional revenue of 2,857 (502,857 - 500,000) at the end of first year.
[B] Identifying the Performance Obligations: [Para 22 of IFRS Part A1]
At the inception of contract, an entity shall assess the goods or services promised in a contract with
customer and shall identify as a performance obligation each promise to transfer to the customer either:
(a) a good or service or a bundle of goods or services that is distinct; or
(b) A series of goods or services that are substantially the same and have the same pattern of transfer to
customers (e.g. monthly maintenance services, health club or payroll processing services)
Definition of distinct good or service:[para 27 of part A 1]
A good or service is distinct if both the following criteria are met:
(a) Customer can benefit from the good or service either on its own or together with other resources that
are readily available to customer; and
(b) Entity’s promise to transfer the good or service to the customer is separately identifiable from other
promises in the contract.
Explanation of (a) above: If a good or service is regularly sold separately; this would indicate that customers
generally can benefit from the good or service on its own or in combination with other available resources.

Example:
Retailer Co sells a washing machine for Rs, 1,000. Retailer Co also provides the following free 'gifts':
• Free service and maintenance for 3 years
• 1kg of washing powder every month for the next 18 months
• A discount voucher for a 50% discount if next purchase is made in the next 6 months.

Required: How many performance obligations are in the contract?

Solution:
There are 4 performance obligations as all of the goods or services are distinct because the customer can
benefit from the good or service on its own and the entity's promise to transfer the good or service is
separately identifiable from other promises in the contract:
Following are the performance obligations:
• Washing machine (satisfied at a point in time)
• Service and maintenance over the next 3 years means 36 months (satisfied over time)
• 18kg washing powder over the next 18 months (satisfied over time)
• Discount voucher (satisfied at a point in time when customer will make future purchases or time
period is elapsed which ever is earlier)

Example:
A software house has agreed with Dawlance appliances that it will deliver a software and will also provide
support service and software updates.
Analysis
There are 3 performance obligations as customer can benefit from each service independently and promises
of entity are separately identifiable. (i.e. 1) software; 2) support service; and 3) software updates)

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 “Have fear of Allah wherever you are”
Example:
Mr. Y subscribes to a 12 months magazine subscription and receives a free watch. How many performance
obligations are in the contract?
Solution
There are two performance obligations
• 12 months magazine subscription, and
• A watch
Revenue will be allocated to each of performance obligation based on their standalone selling price.

If promised good or service is not distinct, an entity must combine that good or service with other promised
good or service until it identifies a bundle of goods or services that is distinct. In some cases, this would
result in entity accounting for all goods or services promised in a contract as a single performance obligation.
Example:
A property consultant agreed with Mr. Asif that "he will deliver a house to Mr. Asif within 1 year". If we go
deep down the contract we see that consultant is promising to:
• Create map
• Prepare foundation
• Construct walls
• Construct roof
• Paint the house

Analysis
Though customer can take benefit from each good or service on its own but promises are not separately
identifiable in the contract, so all of the above services are not distinct and the delivery of house will be
considered as single performance" obligation, (various inputs produce a combined output.)

Not distinct goods or services [IFRS 15: 29 & 30]

Factors that indicate that two or more promises to transfer goods or services to a customer are not
separately identifiable include the following:
• the entity provides a significant service of integrating the goods or services with other goods or services
promised in the contract into a bundle of goods or services that represent the combined output (e.g.
software and installation)
• one or more of the goods or services significantly modifies or customises, one or more of the other
goods or services promised in the contract.(Example below)
• the goods or services are highly interdependent or highly interrelated (Q.4 Brilliant Limited)

Example: [Based on IFRS 15 Illustrative Example 11]

An entity, a software developer, enters into a contract with a customer to transfer a software licence, perform
an installation service and provide unspecified software updates and technical support (online and
telephone) for a two-year period.
The contract specifies that, as part of the installation service, the software is to be substantially customised
to add significant new functionality to enable the software to interface with other customised software
applications used by the customer.
The entity sells the licence, installation service and technical support separately. The customised installation
service can be provided by other entities. The software remains functional without the updates and the
technical support.

Required: Identify performance obligations.

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ANSWER:
The software licence and the customised installation service are not distinct. The entity identifies three
performance obligations in the contract for the following goods or services:
• customized installation service (that includes the software license); [because of para 2 above]
• software updates; and
• technical support.

[Example 11 from part b original standard para IE 49,51,52,54,55,56 and 57]

Revenue recognition from sales of goods with after sale service agreement:
When the selling price of a product includes an identifiable amount for subsequent servicing, that amount is
deferred and recognised as revenue over the period during which the service is performed. The amount
deferred should be sufficient to cover both the cost of servicing and a reasonable profit.

Example: Servicing in selling price

X Plc sells a new system to a client and invoices Rs.800, 000.

This price includes after-sales support for the next 2 years with an estimated cost Rs. 35,000 each year.
The normal gross profit margin for such support is 17.5%. How should the revenue be recognised?

Analysis:
The Rs. 800,000 must be split between the amount received for the system and the amount received for
providing the service.
The amount for the system would be recognised in the usual way (on delivery or acceptance by the client).
The revenue for providing the service is deferred and recognised over the period of service.
The revenue for providing the service is calculated to cover the costs and provide a margin of 17.5%.

Rs.
Revenue deferred (after sales support)
2 years x Rs.35,000/0.825 84,848
Revenue for sale of system 715,152
Total revenue 800,000

Examples of promised Goods and Services Include: [Para 26 of IFRS Part A1]
(a) Sale of goods produced by an entity (e.g., inventory of a manufacturer);
(b) Resale of goods purchased by an entity (e.g. trading business);
(c) Performing agreed – upon tasks for a customer (e.g. customization of software);
(d) Providing agency services to principal (agent providing services).
(e) Constructing, manufacturing or developing an asset on behalf of a customer (house or building);
(f) Granting licences (Franchises) etc.
(g) Granting options to purchase additional goods/services like giving discount vouchers (will be
discussed in examples)
Satisfaction of Performance Obligations [Para 31 of IFRS Part A1]
An entity shall recognise revenue when (or as) the entity satisfies a performance obligation by transferring a
good or service (i.e. an asset) to a customer. An asset is transferred when (or as) the customer obtains
control of the asset.
A customer obtains control of an asset when it can direct the use of and obtain substantially all the
remaining benefits from it. Control included the ability to prevent other entities from directing the use of and
obtaining the benefits from an asset.

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 “When things are too hard to handle, retreat & count your blessings instead.”

Indicators of Transfer of Control Includes: [Para 38 of IFRS Part A1]

(1) The entity has right to payment for asset (means right to receive is established)
(2) The customer has the legal title. (If however entity retains the legal title solely as a protection
against customers failure to pay; still it means control has been transferred by entity to customer at
the time of delivery of asset). [Example is sale on instalment basis].
(3) The entity has transferred physical possession of asset. However, physical transfer may not
always concide with control of an asset. For example; consignment arrangements (sale or return
basis), a customer or consignee may have physical asset that the entity controls. Conversely, in some
bill – and – hold arrangements, an entity may have physical possession of an asset that a customer
controls.
(4) The customer has the significant risks and rewards of ownership of an asset.
(5) The customer has accepted the asset;
Measuring progress towards complete satisfaction of a performance obligation [this discussion is
applicable when performance obligation is satisfied over time]. [Para 41 of IFRS Part A1]
An entity shall recognise revenue over time by measuring the progress towards complete satisfaction of that
performance obligation.
When goods or services are transferred continuously, a revenue recognition method that best depicts the
entity’s performance should be applied.
Methods for measuring progress
There are two types of Methods:
(a) Output Methods; and
(b) Input Methods
Output Methods: [Para B15 of IFRS Part A1]
These methods recognise revenue on the basis of direct measurement of the value to customer of goods or
services transferred to date relative to the remaining goods or services promised under the contract. e.g.:
(a) Surveys of Performance completed to date;
(b) Units produced as a percentage of total units to be produced; or
(c) Units delivered as a percentage of total units to be delivered
(d) Contract milestone reached.
Input Methods: [Para B18 of IFRS Part A1]
These methods recognise revenue on the basis of the entity’s efforts or inputs to the satisfaction of a
performance obligation relative to the total expected inputs to the satisfaction of that performance obligation.
e.g.
(a) Resources consumed as a percentage of total resources to be used;
(b) Labour hours used as a percentage of total labour hours to be used;
(c) Machine hours used as a percentage of total machine hours to be used;
(d) Cost incurred as a percentage of total cost to be incurred.
Example: Providing a service
X Plc is engaged on a contract to develop new computer software for a customer. The contract has not been
completed by the reporting date (31 December 2015). X Plc is reasonably certain of its progress towards
complete satisfaction of performance obligation.
The total revenue from the contract will be Rs. 700,000 and total costs are expected to be Rs. 400,000.
Costs of Rs. 150,000 have been incurred to date.
X plc measure percentage completion by comparing costs incurred to date against total expected costs.
What revenue should be recognised for the year ended 31 December 2015?
----------( 11 )----------
Analysis:

Revenue in the current period should be recognised at Rs. 262,500 (Rs.700, 000 x
150,000/400,000).

Costs of Rs. 150,000 should also be recognised as cost of sales.

Measurement:
When a performance obligation is satisfied (rather than right to receive is established); an entity shall
recognise as revenue the amount of the transaction price that is allocated to that performance obligation.
Determining the Transaction Price: [Para 47 of IFRS Part A1]
Transaction Price means amount of consideration to which an entity expects to be entitled in exchange for
transferring promised goods or services to a customer; excluding amount collected on behalf of third parties
e.g. amount collected for owner or sales tax collected on behalf of government.
Transaction price can be a fixed consideration, variable consideration or consideration other than cash (e.g.
shares or any other fixed asset)
Factors to be considered while determining transaction price: [Para 48 of IFRS Part A1]
When determining the transaction price, an entity shall consider the effects of all of the followings:
(a) Variable consideration;
(b) Constraining estimates of Variable consideration;
(c) Existence of significant financing components;
(d) Non-Cash consideration; and
(e) Consideration payable to customers.
Variable Consideration:
Amount of consideration can vary because of discounts, refunds, incentives etc.

Constraining estimates of Variable consideration:

An entity shall include in the transaction price some or all of the amount of variable consideration estimated
by applying the expected value or most likely method only to the extent that it is highly probable that a
significant reversal in amount of cumulative revenue recognised will not occur when uncertainties associated
with variable consideration is subsequently resolved.
Methods of estimating the variable consideration: [Para 53 of IFRS Part A1]
An entity shall estimate an amount of variable consideration by using either of the following methods:
(a) Expected value method.
(b) Most likely method.

Example:
Tayyab Co. enters into a contract to build an oil rig for Rs. 100 million.
If the oil rig is not completed on time there will be a Rs. 20 million penalty.
Tayyab Co. has built similar oil rigs before and there is 90% chance that the oil rig will be completed on time
What is the transaction price?
Answer
Expected value method: [100 x 90% + 80 x 10% = 98 million]
Most likely method:
Two possible outcomes:
Rs. 100 m if completed on time
Rs. 80m if not completed on time
Therefore, transaction price is Rs. 100 m as there is 90% chance that the oil rig will be completed on time.

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 “One who remembers ALLAH is never Alone”

Existence of Significant Financing Component:

In determining the transaction price, an entity shall adjust the promised amount of consideration for the
effects of time value of money if the timing of payments agreed to by the parties to the contract provides the
customer or entity with a significant benefit of financing.
Example:
An entity received an advance of 150,000 on 01.01.2015 against goods to be delivered on 31.12.2016.
Interest rate is 6% per annum.
Solution:
Recognize a contract liability for 150,000 payment at the contract inception.
Cash 150,000
Contract liability 150,000
During two years from the contract inception until the transfer of product, recognise the interest expense on
150,000 at 6 percent for two years.
Interest expense 9,000
Contract liability 9,000
150,000 x 6% = 9,000
Interest expense 9,540
Contract liability 9,540
159,000 x 6% = 9,540
Recognize revenue on the transfer of goods
Contract liability 168,540
Revenue 168,540
Non-Cash consideration: [Para 66 of IFRS Part A1]
To determine the transaction price for the contracts in which a customer promises consideration in a form
other than cash, an entity shall measure the non-cash consideration at fair value which is at the time of
earning of revenue.(Non-cash considerations includes shares, vehicles, machine etc).
Example 15:
An Entity A decides to take a contract to perform consulting service that would normally be valued at Rs.
50,000. Entity A determines that the service is a single performance obligation. Entity A agrees to receive
1,000 shares of customer (Company B). Both accept the contract on Jan. 1, 2014, when shares are valued
at Rs. 50 a share. On Feb. 1, 2014, Entity A completes the services, when shares are valued at Rs. 52 a
share.
Answer
We-will record the revenue of Rs. 52,000 (52 x 1,000).
Consideration Payable to a Customer [Para 70-72 of IFRS Part A1]
Consideration payable to a customer includes cash amounts that an entity paid or expected to pay to a
customer.
• An entity shall account for consideration payable to a customer as a reduction of the transaction price
(means deduct from revenue).
• If however, payment to a customer is in exchange for goods or services that are transferred by
customer to entity then simply record the purchase of those goods or services (separately)
Example 16:
JJ enters into a contract with Metro cash n carry.
Metro Commits to buy at least Rs, 20m of items over the next 12 months. The terms of the contract require
JJ to make a payment of Rs. 1 m to compensate the Metro for changes that it will need to make to its retail
stores to accommodate the products.
How much revenue should be recognised by JJ?

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 “Take every day as a chance to become a better Muslim.”
Answer:
The Rs. 1 m paid to the Metro is a reduction of the transaction price and a revenue of Rs. 19m will be
recorded on satisfaction of performance obligation. (Means over the 12 months)
Allocating transaction Price to performance obligations [Para 73-75 of IFRS Part A1] (This problem
will arise if more than one performance obligation in a contract)
An entity shall allocate the transaction price to each performance obligation identified in the contract on a
relative standalone selling prices.
Stand-alone Price; means a price at which an entity would sell a promised good or service separately to a
customer.
Example:
Entity enters into a contract for sale of new car and a 3 year service contract for Rs. 26,000. The standalone
selling price of car is Rs. 24,000 and that of services is Rs. 3,000.

Performance
Standalone price Allocated transaction price Revenue
obligations
23,111
Car 24,000 23,111
(24,000/27,000 × 26,000)
2,889
Service Contract 3,000 963/ year
(3,000/27,000 × 26,000)
27,000 26,000

Example:
A retailer sells a customer a computer-and-printer package for Rs. 900. The retailer has determined that
there are two separate performance obligations and regularly sells the printer for Rs. 300 and the computer
for Rs. 700.
Required:
Allocate the price to separate performance obligations.

Solution:
There are two performance obligations in the given transaction.

Performance obligations Standalone price Allocated transaction price

Printer 300 270 (300/1,000 × 900)
Computer 700 630 (700/1,000 × 900)
1,000 900
In this transaction, there is an inherent discount of Rs. 100 which does not relate to specific performance
obligation and is therefore allocated to all performance obligations on a relative stand-alone selling price
basis.
Methods of estimating the stand alone price if it is not available: [Para 79 of IFRS Part A1]
If stand-alone selling price is not available (may be because entity do not sell the goods or services
separately) then estimate it by using any of the following method:
(a) Adjusted Market Assessment Approach: means price at which same goods or services are sold
separately by other competitors (suppliers) in the market.
(b) Expected Cost plus Approach: Estimate the cost and then add appropriate profit.
(c) Residual Approach: An entity may estimate the stand-alone selling price by reference to the total
transaction price less the sum of the observable standalone selling prices of other goods or services
promised in the contract.

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Example (Marketing assessment approach)
A manufacturer produced and sold to customer a table and a computer for Rs. 13,000. The standalone price
of table is Rs. 5,000 and standalone price of .our computer is not available. In most recent customer surveys
our computer has been given a rating of 3 out of 5 points as against 4 out of 5 points to competitor’s
computer. The standalone selling price of competitor computer is Rs. 12,000.
Analysis
There are two performance obligations in the given transaction.

Performance obligations Standalone price Allocated transaction price

Table 5,000 4,643 (5,000/14,000 × 13,000)
Computer 9,000* 8,357 (9,000/14,000 × 13,000)
14,000 13,000

12,000/4 × 5 = 15,000 (price of that computer which has a rating of 5 out of 5, so our computer has a price
of 15,000 × 3/5 = 9,000)
Example (Expected Cost plus Approach): Sohail sells a machine and one year free technical support for
100,000. It usually sells the machine for 95,000 but does not sell technical support for this machine as a
standalone product. Other support services offered by the Sohail attract mark up of 50%. It is expected that
the technical support would cost 20,000.
How much of the transaction price should be allocated to the machine and to the technical support?
Solution:
The selling price of the machine is 95,000 based on observable prices. There is no observable selling price
of the technical support. Therefore, the stand alone selling price needs to be estimated. One approach of
doing this is the expected cost plus margin approach. Based on this, the selling price of the service would be
30,000 (20,000 x 150%).
The total standalone selling prices of the machine and support are 125,000 (95,000 + 30,000). However,
total consideration receivable is only 100,000. This means customer is receiving a discount of 25,000.
IFRS 15 says that the entity must consider that whether the discount relates to the whole bundle or to a
particular performance obligation. In the absence of the information, it is assumed that it relates to the whole
bundle.

The transaction price will be allocated as follows:

Performance obligation Standalone price Allocation of transaction price
Machine 95,000 76,000 (95,000/125,000 x
100,000)
Services 30,000 24,000 (30,000/125,000 x
100,000)
Total 125,000 100,000
The revenue will be recognized when (or as) the performance obligation is satisfied.
Example (Residual approach)
A manufacturer produced and sold a customer a computer, printer and a scanner package for Rs. 1,250. He
has determined that these are three separate performance obligations and regularly sells the printer for Rs.
300; the computer for Rs. 700. This is the first time: manufacturer is going to sell scanner, hence there is no
sale price identified for scanner as stand-alone price.
Required:
Allocate the price to separate performance obligations.

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Solution:
There are three performance obligations in the given transaction.

Performance obligation Transaction Price

Printer 300
Computer 700
Scanner (Balancing) 250
1,250

OTHER ASPECTS OF IFRS 15

Contract costs
Costs might be incurred in obtaining a contract and in fulfilling that contract.
Incremental costs of obtaining a contract [Para 91-94 of IFRS Part A1]
The incremental costs of obtaining a contract are those costs that would not have been incurred if the
contract had not been obtained (or that are incurred as a direct consequence of obtaining the contract)
The incremental costs of obtaining a contract with a customer are recognised as an asset if the entity
expects to recover those costs.
Costs to obtain a contract that would have been incurred regardless of whether the contract was obtained
are expensed as incurred (unless they can be recovered from the customer regardless of whether the
contract is obtained).

Example: Incremental costs of obtaining a contract

X Limited wins a competitive bid to provide consulting services to a new customer.
X Limited incurred the following costs to obtain the contract:

Commissions to sales employees for winning the contract 10,000

External legal fees for due diligence 15,000
(consultancy services of bid preparation)
Travel costs to deliver proposal 25,000
Total costs incurred 50,000

Analysis
The commission to sales employees is incremental to obtaining the contract and should be capitalised as a
contract asset.
The external legal fees and the travelling cost are not incremental to obtaining the contract because they
have been incurred regardless of whether X Limited obtained the contract or not.
An entity may recognise the incremental costs of obtaining a contract as an expense when incurred if the
amortisation period of the asset is one year or less.
Example: Incremental costs of obtaining a contract when contract life is up to 1 year
A salesperson earns a 5% commission on winning a contract that was signed during January 2021. The
products will be delivered in the current year only. How should the entity account for the commission paid to
its employee?
Analysis:The commission will be expensed as incurred since the commission relates to a contract that is
upto 1 year.
Presentation
An unconditional right to consideration is presented as a receivable.

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 “Fear Allah because of his punishment. Love Allah because he is full of mercy

Example:
X Limited enters into a contract to transfer Products A and B to Y Limited in exchange for Rs. 1,000.
Product A is to be delivered on 28 February.
Product B is to be delivered on 31 March.
The promises to transfer Products A and B are identified as separate performance obligations. Rs.400 is
allocated to Product A and Rs.600 to Product B.

X Limited recognises revenue and recognises its unconditional right to the consideration when control of
each product transfers to Y Limited (control is normally transferred when the goods are delivered).
Solution:
The following entries would be required to reflect the progress of the contract.
Contract progress

28 February: X Limited transfers Product A to Y Limited.

At 28 February Dr (Rs.) Cr (Rs.)

Receivables 400
Revenue 400
31 March: X Limited transfers Product B to Y Limited
31 March
Receivables 600
Revenue 600

Contract assets
A supplier might transfer goods or services to a customer before the customer pays consideration or before
payment is due.
A contract asset is a supplier’s right to consideration in exchange for goods or services that it has
transferred to a customer [in other words, an amount for which an entity has recognized the revenue
because performance obligation is satisfied but for which right to receive is not yet unconditional]
A contract asset is reclassified as a receivable when the supplier’s right to consideration becomes
unconditional.
Example:
X Limited enters into a contract to transfer Products A and B to Y Limited in exchange for Rs. 1,000.
Product A is to be delivered on 28 February.
Product B is to be delivered on 31 March.

The promises to transfer Products A and B are identified as separate performance obligations. Rs.400 is
allocated to Product A and Rs.600 to Product B (based on relative standalone prices)
Revenue is recognised when control of each product transfers to Y Limited.
Payment for the delivery of Product A is conditional on the delivery of Product B. (i.e. the consideration of
Rs. 1,000 is due only after X Limited has transferred both Products A and B to Y Limited). This means that X
Limited does not have a right to consideration that is unconditional (a receivable) until both Products A and
B are transferred to Y Limited.

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 “Fill your heart with Emaan and it will become the most peaceful place on earth.”

Solution:

Contract progress
The following accounting entries would be necessary:

28 February: X Limited transfers Product A to Y Limited

X Plc does not have an unconditional right to receive the Rs.400 so the amount is recognised as a contract
asset.

At 28 February

Contract asset 400

Revenue 400
31 March: X Limited transfers Product B to Y Limited

X Limited now has an unconditional right to receive the full Rs. 1,000. The Rs.400 previously recognised as
a contract asset is reclassified as a receivable and the Rs.600 for the transfer of product B is also
recognised as receivable.

31 March Dr (Rs.) Cr (Rs.)

Receivable / Cash 1,000

Contract asset 400

Revenue 600

Contract liabilities (advance from customers or unearned income)

A contract might require payment in advance or allow the entity a right to an amount of consideration that is
unconditional (i.e. a receivable), before it transfers a good or service to the customer.

In these cases, the entity presents the contract as a contract liability when the payment is made or the
payment is due (whichever is earlier).

Other Aspects of IFRS 15

Consignment Arrangements [sale or return basis] [Para B77 of IFRS Part A1]
When an entity delivers a product to another party (such as a dealer or a distributor) for sale to end
customers, the entity shall evaluate whether that other party has obtained control of the product at that point
in time. In consignment sales, an entity shall not recognise revenue upon delivery of a product because
control is not normally transferred at that date.
In such a situation, revenue is recognised by the entity when the goods are sold by dealer to customer, or
time period of return is expired (if any) whichever is earlier [Para B78 (a)]

Bill & Hold Arrangements: [Para B 79 to 81 of IFRS Part A1]

It means a contract under which an entity bills a customer for a product but the entity retains the physical
possession of the product until it is transferred to a customer at a point in time in future.
For example; a customer may request an entity to enter into such a contract because of a customer’s lack of
available space for the product or because of delays in the customer’s production schedules.
In such cases, customer is considered to have obtained the control of a product, even though product
remains in the entity’s physical possession. Consequently entity is only providing custodial services over the
customer’s asset. If entity is charging some fee for custodial services then transaction price needs be
allocated to two performance obligations; i.e.
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 “Faith is Trusting GOD even when you don’t understand his plan.”
(a) Control of goods ; and
(b) Custodial services.
Revenue from goods is recognised when control of goods is transferred. Revenue from custodial services is
recognised as the services are rendered.
Example:
Clearance entered into following sale transaction during the year:
On 31.12.2001, clearance sells the machine plus spare parts to Ehsan for 500,000. The value of the
machine was 480,000, with the value of the spare parts being 20,000. Clarence delivered the machine on 31
December, but was asked to hold the spare parts by Ehsan, due to Clarence‘s warehouse being in close
proximity to Ehsan’s factory. Clarence expects to hold spare parts for 2-4 years. The parts are kept
separately in a warehouse, cannot be used or sold by the Clarence, and are ready for immediate shipment
at Ehsan’s request. Clarence agreed to the transaction as holding costs would be insignificant.
Discuss how the above transactions should be accounted for.

Solution:
This is a bill and hold arrangement. Even though Clarence retains physical possession of goods, Ehsan
retains control. This can be seen in the fact that Clarence cannot use or sell the goods, and must ship them
upon the Ehsan’s request.
In the above arrangement, there are probably three performance obligations. These will be the promise to
provide the machine, the spare parts and the custodial services over holding the spare parts.
The performance obligation over promising to provide the machine and spare parts appear to be met on
31.12.2001, so the full 500,000 revenue should be recorded. If the custodial service of holding the spare
parts is deemed to be part of the transaction price, this would be split out and recognized over the expected
period of holding the spare parts.

Extra Practice Question

Q.1 On 1 October 2017, Galaxy Telecommunications (GT) entered into a contract with a bank for supplying
20 smart phones to the bank staff with unlimited use of mobile network for one year. The contract price per
smart phone is Rs. 34,650 and the price is payable in full within 10 days from the date of contract. At the end
of the contract, the phones will not be returned to GT.
The entire amount received as per contract was credited by GT to advance from customers account. The
smart phones were delivered on 1 November 2017.
If sold separately, GT charges Rs. 18,000 for a smart phone and a monthly fee of Rs. 1,800 for unlimited
use of mobile network.

Required:
Prepare adjusting entry for the year ended 31 December 2017 in accordance with IFRS 15 ‘Revenue from
Contracts with Customers’.
(04)

Q.2 (a) List the five steps involved in recognizing revenue under IFRS 15 ‘Revenue from Contracts with
Customers’. (03)

(b) On 1 June 2018 Ravi Limited (RL) delivered 500 units of one of its products to Bravo Limited (BL) at Rs.
200 per unit. BL immediately paid the amount and obtained control upon delivery. BL is allowed to return
unused units within 30 days and receive a full refund. RL’s cost of the product is Rs. 150 per unit and it uses
perpetual system for recording inventory transactions.

On 30 June 2018, BL returned 20 units.

Required:
Prepare necessary journal entries in the books of RL on 1 June 2018 and 30 June 2018 under each of the
following independent situations:
i. Based upon historical data, RL estimates that 5% units will be returned on expiry of 30 days. (05)
ii. The product is new and RL has no relevant historical evidence of product returns or other available
market evidence. (04)
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 If the heart becomes hardened, the eye becomes dry.

Q.3 Pluto Limited (PL) sells industrial chemicals at following standalone prices:

Rupees
Products
(per carton)
C-1 100,000
C-2 90,000
C-3 110,000
PL regularly sells a carton each of C-2 and C-3 together for Rs. 170,000.
Required:
Calculate the selling price to be allocated to each product, in case PL offers to sell one carton of each
product for a total price of Rs. 260,000.
(05)

Q. 4 BRILLIANT LIMITED
Brilliant Limited (BL) manufactures and sells plastic card printing machines with laminators. A machine-
specific card printing software is provided as a must part of the printing machine. BL also sells plastic cards
imported from Thailand.
BL agreed to supply the following to, Proud Learners (PL), a country-wide school network:
• 15 Card printing machines – Available in ready stock
• 8 Laminators – Would require 30 days to deliver
• 100,000 Plastic cards – Available in ready stock

A lump sum price of Rs.9.2 million for the total contract has been agreed between BL and school network.
Cost and list prices of the goods per item are:

Item List Price (Rs.) Cost (Rs.)

Card printing machines 800,000 400,000
Laminators (combined) 200,000
Plastic cards 12 5
BL does not sell printing machine without laminator. However, in order to get this order BL went against its
policy. There is another supplier of imported card printing machine of almost similar specification. This
supplier sells the machine at Rs.750,000.
In most recent customers’ surveys printing machine of BL has been given 7 out of 10 points as against 9 out of
10 given to competitors’ imported machine. There is no supplier of laminator in the market.

Required: Identify performance obligations and allocate the transaction price to the identified performance
obligations.

A. 4 BRILLIANT LIMITED
Identification of performance obligations:
There are three performance obligations:
1. Transfer of 15 Plastic card printing machines and its software
2. Transfer of 8 Laminators
3. Transfer of 100,000 plastic cards

As printing machine and software both are highly dependent to each other and inter-related, therefore in the
context of this contract, this is a combined output to PL. Therefore, software is not a separate performance
obligation.
The total transaction price as per the contract is Rs.9.2 million.
On the basis of available information, the stand-alone prices of each item will be estimated using the
following approaches:

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 “The Quran is for ourselves, not our Shelves.”

1) Plastic card printing machines and its software:

In the absence of observable stand-alone price, we may use ‘adjusted market assessment’ approach. The
competitor’s machine is sold at Rs.750,000 which is similar (not identical) to BL’s machine. As per given
information, we may use customers’ rating for adjustment of competitors’ price that worked out as follows:
Rupees
Competitors’ price 750,000
Adjusted price of BL machine (750,000/9 x 7) 583,333

Total price (15 x 583,333) 8,750,000

2) Laminators:
There is neither observable stand-alone price nor any comparable competitors’ product available in the
market in which BL operates. In this case, we may use ‘expected cost plus a margin approach’. The
estimated stand-alone price is worked out as follows:

Expected cost to BL 200,000

Margin estimated (800,000 -
600,000(400,000+200,000))/800,000 = 25% 66,667 (200/75 x 25)

266,667
Total price (8 x 266,667) 2,133,336
Note: Residual approach cannot be used as sum of
standalone price of machine and cards is more than
transaction price.
3)Plastic cards:
Observable stand-alone price is available Total price
(100,000 x 12)

1,200,000

Total of stand-alone prices is:

Plastic card printing machines and its software 8,750,000
Laminators 2,133,336
Plastic cards 1,200,000
Total 12,083,336

Allocation of Rs.9,200,000 (transaction price) will be based on relative stand-alone prices, as the difference
of Rs.2,883,336 between stand-alone price and transaction price is not specific to any performance
obligation, so no additional problem.
Std. Alone Price Transaction price
Plastic card printing machines and its software 8,750,000 6,662,067
Laminators 2,133,336 1,624,278

Plastic cards 1,200,000 913,655

Total 12,083,336 9,200,000

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Q.5 Thursday Enterprise (TE) is a supplier of product Zee and has provided you the following information:

(a) On 1 August 2018, TE entered into a six months contract with customer Alpha for sale of Zee for Rs. 250
per unit, under the following terms and conditions:
• if Alpha purchases more than 5,000 units during the contract period, the price per unit would be
retrospectively reduced to Rs. 215 per unit.
• TE’s unconditional right to receive consideration would be established upon:

1. Completion of quality control procedures by Alpha for the first order. The procedure would
take a week after receiving the goods.
2. Placement of order by Alpha for subsequent orders.

At the inception of the contract, TE concludes that Alpha’s purchases will not exceed the 5,000 units
threshold for the discount.

Alpha placed the following orders:

Delivery date
Order date Units Payment date
(Transfer of control)
10 August 2018 3,000 28 August 2018 12 September 2018
25 December 2018 4,000 15 January 2019 10 January 2019 (10)

(b) On 1 February 2019, TE entered into a six months contract with another customer Beta for sale of Zee
for Rs. 250 per unit, under the following terms and conditions:
• If the Beta purchases more than 15,000 units during the contract period, the price per unit would be
retrospectively reduced to Rs. 215 per unit.
• TE’s unconditional right to receive consideration would be established upon delivery of goods to
Beta.

At the inception of the contract, TE concludes that Beta will meet 15,000 units threshold for the discount.
Beta placed the following orders:

Delivery date
Order date Units Payment date
(Transfer of control)
14 February 2019 10,000 28 February 2019 20 March 2019
1 June 2019 8,000 15 July 2019 18 July 2019

Required:
In respect of the above contracts, prepare journal entries to be recorded in the books of TE for the years
ended 31 December 2018 and 2019.
(05)

(Entries without date will not be awarded any marks)

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 “The Greatest thing a Friend can do for you is bring you closer to ALLAH.”

Further practice
1. PARVEZ UNITED
The following transaction took place at Parvez Limited (PL).
On 31 March PL's car manufacturing division consigned several vehicles to independent dealers for sale
to third parties. The sales price to the dealer is PL's list price at the date of sale to third parties. If a
vehicle is unsold after six months, the dealer has a right to return the vehicle to PL within next fifteen
days.
Required
Discuss how the above transactions should be accounted for in the books of accounts of Parvez Limited.

2. Car World

Car World sells new cars on deferred payment basis whereby 40% deposit is received on sale and the
balance payment is received at the end of two years. The appropriate discount rate is 10%.
On 1 July 20X4 a car was sold to a customer for Rs. 2,000,000.
Required: Prepare necessary journal entries to record the above transaction in the books of Car World
for the years ended 30 June 2015 and 30 June 2016.

3. Saleem Engineering (SE)

Question: Saleem Engineering (SE) is a supplier of various types of industrial machines. It also provides
services for the maintenance of these machines.
Following transactions were carried out by SE during the year ended 30 June 2016:
i. Five machines were sold on a lay away basis to one of its frequent customers. Three out of a total of five
installments had been received till the year end.
ii. A service contract for maintenance of a machine for a period of one year was signed and SE received a
non-refundable annual fee amounting to Rs. 45,000 as advance on 15 April 2016.
Required:
Discuss when it will be appropriate for SE to recognise revenue in each of the above situations.

4. RECOGNITION OF REVENUE
(i) Karim Industries Limited (KIL) has sold a machine on credit to Yawar Engineering (YE). The machine
would be used by YE if it is able to secure a contract for providing services to AMZ & Company. KIL
has agreed that the machine may be returned at 90% of the price, if YE fail to secure the contract.
(ii) Asif Electronics (AE) is about to sell a new type of food factory. Since customer demand is high, AE
is taking advance against orders. The selling price has been fixed at Rs. 7,000 per unit and so far 175
customers have paid the initial 25% deposit which is non-refundable.
(iii) Nazir Engineering Limited (NEL) entered into a contract for the provision of services over a period of
two years. The total contract price was Rs. 25 million and NEL had initially expected to earn a profit
of Rs. 5 million on the contract. However, the contract had not progressed as expected. In the first
year, costs of Rs. 12 million were incurred. Management is not sure of the ultimate outcome but
believes that at least the costs on the contract would be recovered from the customer.

Required: State how revenue should be recognised in the above cases.

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 “ALLAH makes the impossible, Possible”

ANSWERS
1 PARVEZ LIMTED
Consignment inventories
There is a contract for sale of cars between Pervez Limited (PL) and dealer containing confirmation
of respective rights and obligations, payment terms, commercial substance and probability of
collection of price.
There is only one performance obligation, namely, the transfer of cars to the dealer.
As per contract, the transaction price, would be list price on the date of sale during the six month
period. Thereafter, though not specifically mentioned, after the lapse of fifteen days the list price
applicable on sixteenth day would be the transaction price of the unsold cars not returned.
Since there is only one performance obligation, the question of allocation of transaction price does
not arise.
PL will recognize revenue upon satisfaction of performance obligation. Performance obligation would
be satisfied once the dealer has sold any cars to third parties during the six month period. Thereafter,
if the dealer does not return the unsold cars within fifteen days, the performance obligation would be
considered as satisfied on sixteenth day.
On 31 March 2017 the vehicles should remain in inventories in PL books of accounts. (until sold by
dealer).
2.

Debit (Rs.) Credit (Rs.)

Date Particulars --------- Rupees ---------
1/7/2014 Cash (40%×2,000,000) 800,000
Accounts receivable (bal) 991,735
Revenue (W-1) 1,791,736
30/6/15 Accounts receivable (10% × 991,736) 99,174
Interest income 99,174
30/6/16 Accounts receivable (991375+99174) x 10% 109,091
Interest income 109,091
30/6/16 Cash 1,200,000
Account Receivables 1,200,000

W-1: Present value of future payments Rupees

-2 1,791,736
PV=800,000+1,200,000 (1+0.1)

3.
Part (i)
Revenue from lay away sales is recognised when the goods are delivered against full payment.
However, if the SE’s historical experience (i.e. one of its frequent customers) shows that most lay away
transactions are converted into sales, then it can recognise revenue when it receives a significant deposit,
provided that the goods are on hand, identified and ready for delivery. Since the customer has paid
significant part of instalments (3 out of 5 instalments), the five industrial machines are on hand, identifiable
and ready for delivery, the revenue is recognized in full.
Part (ii)
Although the fee is non refundable, it shall be presented as contract liability and recognise revenue over
time.

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4.
(i) The completion of the sale transaction is uncertain because it is contingent upon purchaser (YE)
securing the contract with another company (AMZ & Company). Therefore, KIL should not recognize
any revenue when the customer will secure the contract.
(ii) Revenue should be recognized when the food factory is delivered to the customer. Until then no
revenue should be recognized and the 25% deposit should be treated as a contract liability.
Advance may be transferred to revenue if customer do not claim the product and AE has no
remaining obligation under the contract.
(iii) If the outcome of a service transaction cannot be estimated reliably, revenue should only be
recognized to the extent that expenses incurred are recoverable from the customer. Thus revenue
to the extent of Rs. 12 million may be recognized in the first year.

Performance obligations satisfied over time [IFRS 15: 35]

An entity transfers control of a good or service over time and, therefore, satisfies a performance obligation
and recognises revenue over time, if one of the following criteria is met:

Criteria Example
the customer simultaneously receives and Routine or recurring services such as a cleaning service
consumes the benefits provided by the or software debugging services or teaching/training
entity’s performance as the entity performs; services. [e.g. services of lawyers and teachers] [Example
2 and 4]
the entity’s performance creates or providing interior designing and painting services, wood
enhances an asset that the customer work or electricity work at a customer’s premises.
controls as the asset is created or
enhanced; or
the entity’s performance does not create an a customized machinery is being developed for a
asset with an alternative use to the entity customer and contract specifically prevents the entity to
and the entity has an enforceable right to direct/transfer this machinery to another customer. Also,
payment for performance completed to the customer has no right to terminate the contract unless
date. the entity fails to perform its obligations. [construction by
contractor] [Example 3 case B][question 2 spring 2022]

If a performance obligation is not satisfied over time, an entity satisfies the performance obligation
at a point in time.
Accounting for settlement discounts
Settlement discounts (also known as prompt payment discounts or cash discounts) are offered to credit
customers to encourage early payment of their account. It is not guaranteed that customers will take
advantage of settlement discounts at the point of sale as it is dependent upon whether or not credit
customer pays within the timeframe allowed for settlement discount.

While applying IFRS 15 five step approach, the third step requires an entity to 'Determine the transaction
price', which is the amount to which an entity expects to be entitled in exchange for the transfer of goods and
services. An entity is required to consider the terms of the contract and its customary business practices to
determine the transaction price. IFRS 15 does not distinguish between trade discount and settlement
discount.

When settlement discounts are offered, the expected consideration is variable as the amount the entity will
actually receive is dependent upon the customer choice as to whether it will take advantage of the discount.
Where a contract contains elements of variable consideration, the entity should estimate the amount of
variable consideration to which it will be entitled under the contract.

The variable consideration is only included in the transaction price if, and to the extent that, it is highly
probable that its inclusion will not result in a significant revenue reversal in the future when the uncertainty
has been subsequently resolved.

----------( 25 )----------
When a business makes a sale, it does not know whether the customer will take advantage of the settlement
discount or not, therefore, this is dealt in following ways:
(a) Record the revenue for the full amount if the customer is not expected to pay early:
(i) If customer does not pay early as expected, the full amount will be received as recorded already.
(ii) If customer pays early and is entitled to discount, recognise the reduction in revenue by the amount
of discount. Reduction in revenue may be recorded by debiting the ‘revenue’ account directly or by
debiting ‘discount allowed’ account which is eventually deducted from sales revenue (similar to sales
returns).
(b) Record the revenue for reduced (net of discount) amount if the customer is expected to pay early:
(i) If customer pays early as expected, the net amount will be received as recorded already.
(ii) If customer does not pay early as expected, treat the additional amount received as revenue from
original sales transaction.

Example: M Limited
Question: M Limited (ML) sold goods of Rs. 10,000 to Z Traders (ZT) on 8th August 2021 to be paid on
31st August 2021. However, if ZT pays within 10 days, it will be entitled to 4% cash discount and will have to
pay only Rs. 9,600.
Required:
How the above transactions alongwith following independent scenarios will be treated in the books of ML on
8th August and on the date of payment:
(a) ML expected that ZT will not pay within 10 days and ZT actually paid on 31st August.
(b) ML expected that ZT will not pay within 10 days but ZT actually paid on 17th August.
(c) ML expected that ZT will pay within 10 days and ZT actually paid on 17th August.
(d) ML expected that ZT will pay within 10 days but ZT actually paid on 31st August.

Answer:
Part (a)
Debit Credit
Date Particulars
Rs. Rs.
8th August ZT: Receivables 10,000
Revenue 10,000
31st August Cash/Bank 10,000
ZT: Receivables 10,000
Part (b)
8th August ZT: Receivables 10,000
Revenue 10,000
17th August Cash/Bank 9,600
Revenue / Discount allowed* 400
ZT: Receivables 10,000
*Discount allowed account will be deducted from Revenue in statement of comprehensive income.

Part (c)
8th August ZT: Receivables 9,600
Revenue 9,600
17th August Cash/Bank 9,600
ZT: Receivables 9,600

Part (d)
Debit Credit
Date Particulars
Rs. Rs.
8th August ZT: Receivables 9,600
Revenue 9,600
31st August Cash/Bank 10,000
ZT: Receivables 9,600
Revenue 400
----------( 26 )----------
As the above example highlights, applying IFRS 15 has a significant impact on the reported revenue.
Offering settlement discounts will result in lower revenue being recognised, when the discount is accepted.
This will result in lower gross profit margins and net profit margins. Before IFRS 15, entities used to report
discount allowed in operating expenses which did not affect gross profit margins.

Buyers’ Perspective
Example: Z Limited
Question: M Enterprises (ME) sold goods of Rs. 10,000 to Z Limited (ZL) on 8th August 2021 to be paid on
31st August 2021. However, if ZL pays within 10 days, it will be entitled to 4% cash discount and will have to
pay only Rs. 9,600.

Required:
How the above transactions alongwith following independent scenarios will be treated in the books of ZL on
8th August and on the date of payment:
(a) ZL did not take advantage of settlement discount terms and paid on 31st August.
(b) ZL took advantage of settlement discount and paid on 17th August.

Answer:
Part (a)
Debit Credit
Date Particulars
Rs. Rs.
8th August Purchases 10,000
ME: Trade payables 10,000
31st August ME: Trade payables 10,000
Cash / Bank 10,000

8th August Purchases 10,000

ME: Trade payables 10,000
17th August ME: Trade payables 10,000
Purchases / Discount received* 400
Cash / Bank 9,600

Part (b)
*Discount received account will be deducted from purchases in statement of comprehensive income.
Example: A Limited and S Limited
Question: A Limited (AL) bought and obtained control of goods from S Limited (SL) on 1 st July 2021. The
parties have agreed to fixed contract price of Rs. 880,000 to be paid on 30 th June 2022. The normal credit
period is 15 to 30 days in the relevant industry. SL offers same goods for Rs. 800,000 if paid within normal
credit period.
AL and SL have year-end of 30th June.
Required:
Pass journal entries to record the above transaction in the books of AL and SL.

Answer:
Books of AL
Debit Credit
Date Particulars
Rs. Rs.
01-Jul-2021 Purchases 800,000
SL: Trade payables 800,000
30-Jun-2022 SL: Trade payables 800,000
Interest expense 80,000
Cash / Bank 880,000

----------( 27 )----------
 Books of SL
Debit Credit
Date Particulars
Rs. Rs.
01-Jul-2021 AL: Trade receivables 800,000
Revenue (sale of goods) 800,000
30-Jun-2022 Cash /Bank 880,000
Finance income 80,000
AL: Trade receivables 800,000

Q.
Financial statements of Trich Mir Limited (TML) for the year ended 31 December 2019 are under
preparation. While reviewing revenues from contract with customers, following matters have been identified:
(i) On 1 October 2019, TML sold Machine C to Chan Limited for Rs. 25 million. As per the contract,
payment would be made after 2 years. The accountant recognised sales revenue of Rs. 25 million upon
delivery on 1 October 2019. Further, commission paid to sales employees for winning the contract of
Rs. 1.6 million was capitalised and is being amortised over 2 years period. Applicable discount rate is
10% per annum.
(ii) TML entered into a contract to manufacture a specialised machine for Dhan Limited at a price of Rs. 30
million. The contract meets the criteria of recognition of revenue over time. At the year end, the
machine was 60% complete and it was estimated that a further cost of Rs. 10 million would be incurred.
Cost of Rs. 15 million incurred till year end has been included in closing inventory and receipts of Rs.
11 million have been credited to revenues.
(iii) TML entered into a contract to sell one unit of Machine A and Machine B for a total price of Rs. 16
million. Machine A was delivered in December 2019 to the customer while Machine B was delivered in
January 2020. The consideration of Rs. 16 million is due only after TML transfers both the machines to
the customer. TML sells machines A and B at standalone prices of Rs. 12 million and Rs. 8 million
respectively. The accountant recognised receivable and revenue of Rs. 12 million upon delivery of
Machine A.

Required:
Prepare correcting entries for the year ended 31 December 2019 in accordance with IFRS 15 ‘Revenue
from Contracts with Customers’. (14)

Q.
(a) Stupa Limited (SL) sells electrical products at following standalone prices:
Products Rupees

E-1 30,000
E-2 30,000
E-3 50,000
Required:
Calculate transaction price to be allocated to each product under each of the following
independent situations:
(i) SL offered to sell one unit of each of the above products for Rs. 90,000. SL regularly
sells one unit each of E-2 and E-3 together for Rs. 70,000. (04)
(ii) SL offered to sell one unit of E-1 and two units of E-3 for Rs. 104,000. (02)

(b) On 1 October 2018, Kushan Construction Limited (KCL) entered into a contract to construct a
commercial building for a customer for Rs. 50 million and a bonus of Rs. 10 million if the building
is completed on or before 31 December 2019.
Till 30 June 2019, KCL expected that the building will be completed within time at a total cost of
Rs. 40 million. However, due to bad weather and time involved in regulatory approvals, the
building was completed on 28 February 2020 at a total cost of Rs. 42 million of which Rs. 26
million was incurred till 30 June 2019.

----------( 28 )----------
 Required:
Compute profit to be recognized for the years ended 30 June 2019 and 2020, if:
(i) Performance obligation under the contract is satisfied over time. (04)
(ii) Performance obligation under the contract is satisfied at a point in time. (01)

Q. On 1 January 2021, Covaxin Telecom (CT) announced a new annual promotional package for its
customers. The package comprises of a mobile phone, full year unlimited on-net calls and 1,000 minutes per
month on other networks. Package price is Rs. 11,550 per quarter payable in advance on the first day of
each quarter. At the end of the contract, the phone would not be returned to CT.
On the first day of the promotional announcement, CT sold 1,000 packages. Based on the data available
with CT, it is expected that each customer would utilize 10,000 minutes of other networks with quarterly
break-up as under:
Quarter ending Minutes
31 March 2021 2,700
30 June 2021 2,000
30 September 2021 2,900
31 December 2021 2,400
The mobile phone has a retail value of Rs. 34,000, if sold separately. A monthly subscription for unlimited on-net
calls is Rs. 500 while every call on other networks is charged at Rs. 1.5 per minute, if billed separately.

Required:
Compute the quarterly revenue to be recognized for the quarters ending 31 March 2021 and 30 June 2021. (08)

A:
QUARTER WISE REVENUE:
Standalone prices Transaction price Allocation
Mobile phone 34,000 28,560 per package (34,000/55,000 x
46,200)
On-net calls 6,000 5,040 per package (6,000/55,000 x
(12 x 500) 46,200)
Other network calls 15,000 12,600 per package (15,000/55,000 x
(10,000 x 1.5) 46,200)
Total 55,000 46,200
(11,550 x 4)

First Quarter revenue:

a) Mobile Phone:
100% revenue related to mobile phones should be recognize upon delivery in first quarter, so:
28,560 x 1,000 packages = 28,560,000
b) On-net calls:
5,040 x 1,000 packages x 3/12 = 1,260,000 [As information of actual network usage is not
available so assumed as equal usage in each quarter]
c) Other Mobile calls:
12,600/10,000 x 2,700(minutes in first quarter) x 1,000 packages = 3,402,000
Total Revenue = 33,222,000 (28,560,000 + 1,260,000 + 3,402,000)

Second Quarter Revenue:

a) Mobile phone = NIL
b) 5,040 x 1,000 packages x 3/12 = 1,260,000
c) 12,600/10,000 x 2,000 x 1,000 = 2,520,000

Total revenue = 3,780,000 (1,260,000 + 2,520,000)

----------( 29 )----------
Q.5
Financial statements of Parodia Motors Limited (PML) for the year ended 30 June 2021 are under
preparation. While reviewing revenues from contract with customers, following matters have been identified:
(i) On 1 November 2020, PML sold Car-A to Alpha Limited (AL) for Rs. 5 million. As per the contract, Rs.
1 million would be paid immediately and the balance would be paid after 2 years. The accountant has
recognized revenue to the extent of the cost of Car-A i.e. Rs. 3.5 million and remaining revenue would
be recognized upon receipt of balance from AL.
(ii) On 1 January 2021, PML entered into six months’ contract with Beta Limited (BL) to sell Car-B for Rs.
3.5 million per unit. As per the contract, if BL purchases more than 10 units during the contract period,
the price will be retrospectively reduced to Rs. 3.4 million per unit. At the inception of the contract, PML
concluded that BL will meet the threshold for the discount. BL purchased 11th unit of Car-B on 28 June
2021 for which no revenue has been recorded. BL has made payments of all units except 11th unit
which will be settled in July 2021.
(iii) On 1 February 2021, PML sold Car-C to Gamma Limited (GL) for Rs. 3 million and recognized the
entire amount as revenue. PML also provided GL a Rs. 0.2 million discount voucher for any future
purchases of spare parts within one year. There is 80% likelihood that GL will redeem the discount
voucher and will purchase spare parts within one year. By the end of the year, no spare parts were
purchased by GL. PML normally sells Car-C for Rs. 3 million with no discount voucher.
(iv) On 20 February 2021, PML sold Car-D to Delta Limited (DL) with one-year free maintenance services
at a lumpsum payment of Rs. 3.6 million. Payment was made on 1 March 2021 upon delivery of Car-D
to DL. The revenue of Rs. 1.2 million (i.e. 4/12 of Rs. 3.6 million) has been recognized. PML normally
sells Car-D and annual maintenance services separately for Rs. 3.5 million and Rs. 0.3 million
respectively.

Discount rate of 12% per annum may be used wherever required.

Required:
Prepare correcting entries for the year ended 30 June 2021 in accordance with IFRS 15 ‘Revenue from
Contracts with Customers’. (16)

----------( 30 )----------
 Take time to utilize time for the one who made time.

Examples of IFRS 15 Revenue from Contracts with Customers

Example 1 Modification of a contract for goods [Example 5 of IFRS Part B]

An entity promises to sell 120 products to a customer for 12,000 (100 per product). The products are
transferred to the customer over a six-month period. The entity transfers control of each product at a point in
time. After the entity has transferred control of 60 products to the customer, the contract is modified to
require the delivery of an additional 30 products (a total of 150 identical products) to the customer. The
additional 30 products were not included in the initial contract.
Case A – Additional product for a price that reflects the stand-alone selling price
When the contract is modified, the price of the contract modification for the additional 30 products is an
additional 2,850 or 95 per product. The pricing for the additional products reflects the stand-alone selling
price of the products at the time of the contract modification and the additional products are distinct from the
original products.
In accordance with IFRS 15, the contract modification for the additional 30 products is in effect, a new and
separate contract for future products that does not affect the accounting for the existing contract. The entity
recognises revenue of 100 per product for the 120 products in the original contract and 95 per product for
the 30 products in the new contracts (as and when the control is transferred)
Case B – Additional products for a price that does not reflect the stand-alone selling price.
During the process of negotiating the purchase of an additional 30 products, the parties initially agree on a
price of 80 per product. However, the customer discovers that the initial 60 products transferred to the
customer contained minor defects that were unique to those delivered products. The entity promises a
partial credit of 15 per product to compensate the customer for the poor quality of those products. The entity
and the customer agree to incorporate the credit of 900 (15 credit × 60 products) into the price that the entity
charges for the additional 30 products. Consequently, the contract modification specifies that the price of the
additional 30 products is 1,500 or 50 per product. That price comprises the agreed-upon price for the
additional 30 products of 2,400, or 80 per product, less the credit of 900.
At the time of modification, the entity recognises the 900 as a reduction of the transaction price and,
therefore, as a reduction of revenue for the initial 60 products transferred. In accounting for the sale of the
additional 30 products, the entity determines that the negotiated price of 80 per product does not reflect the
stand-alone selling price of the additional products. Consequently, the contract modification does not meet
the conditions of IFRS 15 to be accounted for as a separate contract. Because the remaining products to be
delivered are distinct from those already transferred, the entity accounts for the modification as a termination
of the original contract and the creation of a new contract.
Consequently, the amount recognised as revenue for each of the remaining products is a blended price of
93.33 ([(100 × 60 products not yet transferred under the original contract) + (80 × 30 products to be
transferred under the contract modification)] ÷ 90 remaining products}.

Example 2 Customer simultaneously receives and consumes the benefits [Example 13 of IFRS Part
B]
An entity enters into a contract to provide monthly payroll processing services to a customer for one year.
The promised payroll processing services are accounted for as a single performance obligation. The
performance obligation is satisfied over time in accordance with IFRS 15 because the customer
simultaneously receives and consumes the benefits of the entity’s performance in processing each payroll
transaction as and when each transaction is processed. The entity recognises revenue over time by
measuring its progress towards complete satisfaction of that performance obligation by using any of the
methods available in IFRS 15.
Example 3 – Assessing whether a performance obligation is satisfied at a point in time or over time
[Example 17 of IFRS Part B]
An entity is developing a multi-unit residential complex. A customer enters into a binding sales contract with
the entity for a specified unit that is under construction. Each unit has similar floor plan and is of a similar
size, but other attributes of the units are different (for example, the location of the unit within the complex).

----------( 31 )----------
 Delay anything but Prayer

Case A – Entity does not have an enforceable right to payment for performance completed to date
The customer pays a deposit upon entering into the contract and the deposit is refundable only if the entity
fails to complete construction of the unit in accordance with the contract. The remainder of the contract price
is payable on completion of the contract when the customer obtains physical possession of the unit. If the
customer defaults on the contract before completion of the unit, the entity only has the right to retain the
deposit.
At contract inception, the entity determines whether its promise to construct and transfer the unit to the
customer is a performance obligation satisfied over time. The entity determines that it does not have an
enforceable right to payment for performance completed to date because, until construction of the unit is
complete, the entity only has a right to the deposit paid by the customer. Because the entity does not have a
right to payment for work completed to date, the entity’s performance obligation is not a performance
obligation satisfied over time. Instead, the entity accounts for the sale of the unit as a performance obligation
satisfied at a point in time [means when performance obligation is satisfied and unit is transferred]
Case B – Entity has an enforceable right to payment for performance completed to date
The customer pays a non-refundable deposit upon entering into the contract and will make progress
payments during construction of the unit. The contract has substantive terms that precludes (restricts) the
entity from being able to direct the unit to another customer. In addition, the customer does not have the
right to terminate the contract unless the entity fails to perform as promised. If the customer defaults on its
obligations by failing to make the promised progress payments as and when they are due, the entity would
have a right to all of the consideration promised in the contract if it completes the construction of the unit.
The courts have previously upheld similar rights that entitle developers to require the customer to perform,
subject to the entity meeting its obligations under the contract.
At contract inception, the entity determines whether its promise to construct and transfer the unit to the
customer is a performance obligation satisfied over time. The entity determines that the asset (unit) created
by the entity’s performance does not have an alternative use to the entity because the contract precludes
the entity from transferring the specified unit to another customer.
The entity also has a right to payment for performance completed to date. This is because if the customer
were to default on its obligations, the entity would have an enforceable right to all of the consideration
promised under the contract if it continues to perform as promised (as per previous court decisions).
Therefore the terms of the contract and the practices in the legal jurisdiction indicate that there is a right to
payment for performance completed to date. Consequently, the entity has a performance obligation that it
satisfies over time. To recognise revenue for that performance obligation satisfied over time, the entity
measures its progress towards complete satisfaction of its performance obligation by using any relevant
input/output method.
Case C – Entity has an enforceable right to payment for performance completed to date
The same facts as in Case B apply to Case C, except that in the event of a default by the customer, either
the entity can require the customer to perform as required under the contract or the entity can cancel the
contract in exchange for the asset under construction and an entitlement to a penalty of a proportion of the
contract price.
Despite that the entity could cancel the contract, the entity has a right to payment for performance
completed to date because the entity could also choose to enforce its rights to full payment under the
contract. Therefore the entity has a performance obligation that is satisfied over time.

Example 4 Measuring progress when making goods or services available [Example 18 of IFRS Part
B]
An entity, an owner and manager of health clubs, enters into a contract with a customer for one year of
access to any of its health clubs. The customer has unlimited use of the health clubs and promises to pay
100 per month.
The entity determines that its promise to the customer is to provide a service of making the health clubs
available for the customer to use as and when the customer wishes. This is because the extent to which the
customer uses the health clubs does not affect the amount of the remaining goods and services to which the
customer is entitled. The entity concludes that the customer simultaneously receives and consumes the
benefits of the entity’s performance as it performs by making the health clubs available. Consequently, the
entity’s performance obligation is satisfied over time.

----------( 32 )----------
The entity also determines that the customer benefits from the entity’s service of making the health clubs
available evenly throughout the year. (That is, the customer benefits from having the health clubs available,
regardless of whether the customer uses it or not.) Consequently, the entity concludes that the best
measure of progress towards complete satisfaction of the performance obligation over time is a time-based
measure and it recognises revenue on a straight-line basis throughout the year at 100 per month.
Example 5 – Penalty gives rise to variable consideration [Example 20 of IFRS Part B]
An entity enters into a contract with a customer to build an asset for 1 million. In addition, the terms of the
contract include a penalty of 100,000 if the construction is not completed within three months of a date
specified in the contract.
The entity concludes that the consideration promised in the contract includes a fixed amount of 900,000 and
a variable amount of 100,000 (which may or may be received because of charging penalty).
The entity estimates the variable consideration by using either of the following methods.
• Expected value method.
• Most likely method.
Example 6 – right of return [sale on approval basis] [Example 22 of IFRS Part B]
An entity enters into 100 contracts with customers. Each contract includes the sale of one product for 100
(100 total products × 100 = 10,000 total consideration). Cash is received when control of a product transfers.
The entity’s customary business practice is to allow a customer to return any unused product within 30 days
and receive a full refund. The entity’s cost of each product is 60.
Because the contract allows a customer to return the products, the consideration received from the customer
is variable. To estimate the variable consideration to which the entity will be entitled, the entity decides to
use the expected value method because it is the method that the entity expects to better predict the amount
of consideration to which it will be entitled. Using the expected value method, the entity estimates that 97
products will not be returned.
The entity concludes that it is highly probable that a significant reversal in the cumulative amount of revenue
recognised (ie 9,700) will not occur as the uncertainty is resolved (ie over the return period of 30 days).
The entity estimates that the costs of recovering the products will be immaterial and expects that the
returned products can be resold at a profit.
Upon transfer of control of the 100 products, the entity does not recognise revenue for the three products
that is expects to be returned. Consequently, the entity recognises the following:
(a) Revenue of 9,700 (100 × 97 products not expected to be returned);
(b) A refund liability of 300 (100 refund × 3 products expected to be returned); and
(c) An asset of 180 (60 × 3 products for its right to recover products from customers on settling the refund
liability).
Example 7 – Significant financing component and right of return [Example 26 of IFRS Part B]
An entity sells a product to a customer for 121 that is payable 2 years after right of return is expired. The
customer obtains control of the product at contract inception. The contract permits the customer to return the
product within 90 days. The product is new and the entity has no relevant historical evidence of product
returns or other available market evidence.
The cash selling price of the product is 100, which represents the amount that the customer would pay upon
delivery for the same product sold under otherwise identical terms and conditions as at contract inception.
The entity’s cost of the product is 80.
The entity does not recognise revenue when control of the product transfers to the customer. This is
because the existence of the right of return and the lack of relevant historical evidence means that the entity
cannot conclude that it is highly probable that a significant reversal in the amount of cumulative revenue
recognised will not occur. Consequently, revenue is recognised after three months when the right of return
lapses.
The contract includes a significant financing component. This is evident from the difference between the
amount of promised consideration of 121 and the cash selling price of 100 at the date that the goods are
transferred to the customer.
The contract includes an implicit interest rate of 10 per cent (ie the interest rate that over 2 years discounts
the promised consideration of 121 to the cash selling 33
----------( price of 100).
)----------
 Allah has time to listen: Do you have time to Pray?

Accounting entries:
(a) When the product is transferred to the customer.
Stock with customer 80
Inventory 80
(b) When the right of return lapses (the product is not returned):
Receivable 100
Revenue 100
Cost of sales 80
Stock with customer 80
Until the entity receives the cash payment from the customer, interest revenue would be recognised on time
basis.
Example 8 – Advance payment and assessment of discount rate [Example 29 of IFRS Part B]
An entity enters into a contract with a customer to sell an asset. Control of the asset will transfer to the
customer in two years (ie the performance obligation will be satisfied at a point in time). The contract
includes two alternative payment options: payment of 5,000 in two years when the customer obtains control
of the asset or payment of 4,000 when the contract is signed. The customer elects to pay 4,000 when the
contract is signed.
The entity concludes that the contract contains a significant financing component because of the length of
time between when the customer pays for the asset and when the entity transfers the asset to the customer,
as well as the prevailing interest rates in the market.
The interest rate implicit in the transaction is 11.8 per cent, which is the interest rate necessary to make the
two alternative payment options economically equivalent. However, the entity determines that the rate that
should be used in adjusting the promised consideration is six per cent, which is the entity’s incremental
borrowing rate.
The following journal entries illustrate how the entity would account for the significant financing component:
(a) Recognise a contract liability for the 4,000 payment received at contract inception:
Cash 4,000
Contract liability 4,000
(b) During the two years from contract inception until the transfer of the asset, the entity adjusts the
promised amount of consideration and accretes (increase) the contract liability by recognising interest
on 4,000 at six per cent for two years:
At the end of first year:
Interest expense 240
Contract liability 240
4,000 contract liability × (6 per cent interest) = 240
At the end of second year:
Interest expense 254
Contract liability 254
[4,000 + 240 contract liability] × (6 per cent interest) = 254

(c) Recognise revenue for the transfer of the asset (at the end of two years):
Contract liability 4,494
Revenue 4,494

----------( 34 )----------
Example 9 – Entitlement to non-cash consideration [Example 31 of IFRS Part B]
An entity enters into a contract with a customer to provide a weekly service for one year. The contract is
signed on 1 January 20X1 and work begins immediately. The entity concludes that the service is a single
performance obligation This is because the entity is providing a series of distinct services that are
substantially the same and have the same pattern of transfer. Therefore it is a performance obligation
satisfied over time and progress is measured by using time basis.
In exchange for the service, the customer promises 100 shares per week of service (a total of 5,200 shares
for the contract). The terms in the contract require that the shares must be paid upon the successful
completion of each week of service.
The entity measures its progress towards complete satisfaction of the performance obligation as each week
of service is complete. To determine the transaction price (and the amount of revenue to be recognised), the
entity measures the fair value of 100 shares that are received upon completion of each weekly service
(means at the end of each week as 100 x Fair value per share).

Example 10 – Consideration payable to a customer [Example 32 of IFRS Part B]

An entity that manufactures consumer goods enters into a one-year contract to sell goods to a customer that
is a large global chain of retail stores. The customer commits to buy at least Rs. 15 million of products during
the year. The contract also requires the entity to make a non-refundable payment of Rs. 1.5 million to the
customer at the inception of the contract. The Rs.1.5 million payment will compensate the customer for the
changes it needs to make to its shelving to a accommodate the entity’s products.
The entity concludes that the payment to the customer is not in exchange for a distinct good or service that
transfers to the entity. This is because the entity does not obtain control of any rights to the customer’s
shelves. Consequently, the entity determines that the 1.5 million payment is a reduction of the transaction
price.
Suppose during the first month, the entity transferred goods amounting to sale value of 2 million therefore, in
the first month in which the entity transfers goods to the customer, the entity recognises revenue of 1.8
million. (2 million ÷ 15 million x 13.5).
Example 11 – Allocation methodology [Example 33 of IFRS Part B]
An entity enters into a contract with a customer to sell Products A, B and C in exchange for 100. The entity
will satisfy the performance obligations for each of the products at different points in time. The entity
regularly sells product A separately and therefore the stand-alone selling price is directly observable. The
stand-alone selling prices of products B and C are not directly observable.
Because the stand-alone selling prices for Products B and C are not directly observable, the entity must
estimate them. To estimate the stand-alone selling prices, the entity uses the adjusted market assessment
approach for Product B and the expected cost plus margin approach for Product C. The entity estimates the
stand-alone selling prices as follows:
Stand-alone
Product Method
selling price

Product A 50 Directly observable

Product B 25 Adjusted market assessment approach
Product C 75 Expected cost plus a margin approach
Total 150

The customer receives a discount for purchasing the bundle of goods because the sum of the stand-alone
selling prices (150) exceeds the promised consideration (100). The entity considers whether it has
observable evidence about the performance obligation to which the entire discount belongs and concludes
that it does not. Consequently, the discount is allocated proportionately across Products A, B and C. The
discount, and therefore the transaction price, is allocated as follows:

----------( 35 )----------
 A Muslim in sujood is stronger than a king on his throne

Product Allocated transaction price

Product A 33 (50 ÷ 150 × 100)

Product B 17 (25 ÷ 150 × 100)
Product C 50 (75 ÷ 150 × 100)
Total 100

Example 12 – Allocating a discount [Example 34 of IFRS Part B]

An entity regularly sells Products A, B and C individually, thereby establishing the following stand-alone
selling prices:
Product Stand-alone selling price

Product A 40
Product B 55
Product C 45
Total 140

In addition, the entity regularly sells Products B and C together for 60

Case A – Allocating a discount to one or more performance obligations
The entity enters into a contract with a customer to sell Products A, B and C in exchange for 100. The entity
will satisfy the performance obligations for each of the products at different points in time.
The contract includes a discount of 40 on the overall transaction, which would be allocated proportionately to
all three performance obligations when allocating the transaction price using the relative stand-alone selling
price method. However, because the entity regularly sells Products B and C together for 60 and Product A
for 40, it has evidence that the entire discount should be allocated to the promises to transfer Products B
and C.
If the entity transfers control of Products B and C at the same point in time, then the entity could, as a
practical matter, account for the transfer of those products as a single performance obligation. That is, the
entity could allocate 60 of the transaction price to the single performance obligation and recognise revenue
of 60 when Products B and C simultaneously transfer to the customer.
As the contract requires the entity to transfer control of Products B and C at different points in time, then the
allocated amount of 60 is individually allocated to the promises to transfer Product B (stand-alone selling
price of 55) and Product C (stand-alone selling price of 45) as follows:

Product Allocated transaction price

Product B 33 (55 / 100 total stand-alone selling price × 60)

Product C 27 (45 / 100 total stand-alone selling price × 60)
Total 60

Case B – Residual approach is appropriate

The entity enters into a contract with a customer to sell Products A, B and C as described in Case A. The
contract also includes a promise to transfer product D. Total consideration in the contract is 130. The stand-
alone selling price for Product D is highly variable because the entity sells Product D to different customers
for a broad range of amounts (from 15 to 45). Consequently, the entity decides to estimate the stand-alone
selling price of Product D using the residual approach.
Before estimating the stand-alone selling price of Product D using the residual approach, the entity
determines whether any discount should be ----------(
allocated36 to )----------
the other performance obligations in the contract.
 Sometimes, All it takes is just one prayer to change everything.

As in Case A, because the entity regularly sells Products B and C together for 60 and Product A for 40, it
has observable evidence that 100 should be allocated to those three products and a 40 discount should be
allocated to the promises to transfer Products B and C. Using the residual approach, the entity estimates the
stand-alone selling price of Product D to be 30 as follows:

Product Stand-alone selling price Method

Product A 40 Directly observable

Products B and C [100 - 40] 60 Directly observable with
discount
Product D (bal) 30 Residual approach
Total 130

The entity observes that the resulting 30 allocated to Product D is within the range of its observable selling
prices (15 – 45). Therefore, the resulting allocation (see above table) is consistent with the allocation
objective.

Case C – Residual approach is inappropriate

The same facts as in Case B apply to Case C except the transaction price is 105 instead of 130.
Consequently, the application of the residual approach would result in a stand-alone selling price of 5 for
Product D (105 transaction price less 100 allocated to Products A, B and C). The entity concludes that 5
would not faithfully depict the amount of consideration to which the entity expects to be entitled in exchange
for satisfying its performance obligation to transfer Product D, because 5 does not approximate the stand-
alone selling price of Product D, which ranges from 15 – 45. In this case, entity should use any other method
to estimate standalone price of product D.

Example 13 – Incremental costs of obtaining a contract [Example 36 of IFRS Part B]

An entity, a provider of consulting services, wins a competitive bid to provide consulting services to a new
customer. The entity incurred the following costs to obtain the contract:

External legal fees for due diligence 15,000

Travel costs to deliver proposal 25,000
Commissions to sales employees as a result of obtaining the contract 10,000
Total costs incurred 50,000

The entity recognises an asset for the 10,000 incremental costs of obtaining the contract arising from the
commissions to sales employees because the entity expects to recover those costs through future fees for
the consulting services.
The entity observes that the external legal fees and travel costs would have been incurred regardless of
whether the contract was obtained. Therefore those costs are recognised as expenses when incurred.

Example 14 – Contract liability and receivable [Example 38 of IFRS Part B]

Case A – Cancellable contract
On 1 January 2019, an entity enters into a cancellable contract to transfer a product to a customer on 31
March 2019. The contract requires the customer to pay consideration of 1,000 in advance on 31 January
20X9. The customer pays the consideration on 1 March 2019. The entity transfers the product on 31 March
2019. The following journal entries illustrate how the entity accounts for the contract:
(a) The entity receives cash of 1,000 on 1 March 2019 (cash is received in advance of performance):
Cash 1,000
Contract liability 1,000
----------( 37 )----------
(b) The entity satisfies the performance obligation on 31 March 2019:
Contract liability 1,000
Revenue 1,000
Case B – Non-cancellable contract
The same facts as in Case A apply to Case B except that the contract is non-cancellable. The following
journal entries illustrate how the entity accounts for the contract:
(a) The amount of consideration is due on 31 January 2019 (which is when the entity recognises a
receivable because it has an unconditional right to consideration):
Receivable 1,000
Contract liability 1,000
(b) The entity receives the cash on 1 March 2019:
Cash 1,000
Receivable 1,000
(c) The entity satisfies the performance obligation on 31 March 2019:
Contract liability 1,000
Revenue 1,000
Example 15 – Contract asset recognized for the entity’s performance [Example 39 of IFRS Part B]
On 1 January 2018, and entity enters into a contract to transfer Products A and B to a customer in exchange
for 1,000. The contract requires Product A to be delivered first and states that payment for the delivery of
Product A is conditional on the delivery of Product B. In other words, the consideration of 1,000 is due only
after the entity has transferred both Products A and B to the customer. Consequently, the entity does not
have a right to consideration that is unconditional (a receivable) until both Products A and B are transferred
to the customer.
The entity identifies the promises to transfer Products A and B as performance obligations and allocates 400
to the performance obligation to transfer product A and 600 to the performance obligation to transfer Product
B on the basis of their relative stand-alone selling prices. The entity recognises revenue for each respective
performance obligation when control of the product transfers to the customer.

The entity satisfies the performance obligation to transfer Product A:

Contract asset 400
Revenue 400
The entity satisfies the performance obligation to transfer product B and to recognise the unconditional right
to consideration:
Receivable 1,000
Contract asset 400
Revenue 600
Example 16 – Receivable recognised for the entity’s performance [Example 40 of IFRS Part B]
An entity enters into a contract with a customer on 1 January 2019 to transfer products to the customer for
150 per product. If the customer purchases more than 1 million products in a calendar year, the contract
indicates that the price per unit is retrospectively reduced to 125 per product.
Consideration is due when control of the products transfer to the customer. Therefore, the entity has an
unconditional right to consideration (ie a receivable) for 150 per product until the retrospective price
reduction applies (ie after 1 million products are shipped).
In determining the transaction price, the entity concludes at contract inception that the customer will meet
the 1 million products threshold and therefore estimates that the transaction price is 125 per product.
Consequently, upon the first shipment to the customer of 100 products the entity recognises the following:
Receivable (150 x 100) 15,000
Revenue (125 x 100) ----------( 38 )---------- 12,500
 “Don’t pray only when you need something. Pray always because you love Allah.”

Payable to customer (25 x 100) 2,500

(a) 150 per product × 100 products.
(b) 125 transaction price per product × 100 products.
The refund liability (means payable to customer) represents a refund of 25 per product, which is expected to
be provided to the customer for the volume-based rebate (ie the difference between the 150 price stated in
the contract that the entity has an unconditional right to receive and the 125 estimated transaction price).
Example 17 – Option that provides the customer with a material right to future products (discount
voucher) [Example 49 of IFRS Part B]
An entity enters into a contract for the sale of Product A for 100. As part of the contract, the entity gives the
customer a 40 per cent discount voucher for any future purchases up to 100 in the next 30 days. The entity
intends to offer a 10 per cent discount on all sales during the next 30 days as part of a seasonal promotion.
The 10 per cent discount cannot be used in addition to the 40 per cent discount voucher. The standalone
price of product A is 100.
Because all customers will receive a 10 per cent discount on purchases during the next 30 days, the only
discount that provides the customer with a material right is the discount that is incremental to that 10 per
cent (i.e. the additional 30 per cent discount). The entity accounts for the promise to provide the incremental
discount as a performance obligation in the contract for the sale of product A [means there are two
performance obligations; i.e Product A and goods against discount voucher]
To estimate the stand-alone selling price of the discount voucher, the entity estimates an 80 per cent
likelihood that a customer will redeem the voucher and that a customer will, on average, purchase
Rs.50 of additional products. Consequently, the entity’s estimated stand-alone selling price of the discount
voucher is 12 (50 average purchase price of additional products × 30 per cent incremental discount × 80 per
cent likelihood of exercising the option). The stand-alone selling prices of product A and the discount
voucher and the resulting allocation of the 100 transaction price are as follows:
Performance obligation Stand-alone
selling price

Product A 100
Discount voucher 12
Total 112

Product Allocated transaction price

Product A 89 (100 / 112 × 100)

Discount voucher 11 (12 / 112 × 100)
Total 100

The entity allocates 89 to Product A and recognises revenue for Product A when control transfers. The entity
allocates 11 to the discount voucher and recognises revenue for the voucher when the customer redeems it
for goods or services or when it expires [means suppose if customer does not take the goods against the
discount voucher within the agreed time period].
Example 18 – Customer loyalty programme [Example 52 of IFRS Part B]
An entity has a customer loyalty programme that rewards a customer with one customer loyalty point for
every Rs.10 of purchases. Each point is redeemable for a Rs.1 discount on any future purchases of the
entity’s products. During a reporting period, customers purchase products for 100,000 and earn 10,000
points that are redeemable for future purchases. The consideration is fixed and the stand-alone selling price
of the purchased products is 100,000. The entity expects 9,500 points to be redeemed. The entity estimates
a stand-alone selling price (totalling Rs.9,500) on the basis of the likelihood of redemption
The points provide a material right to customers that they would not receive without entering into a contract.
Consequently, the entity concludes that the promise to provide points to the customer is a performance
obligation. The entity allocates the transaction price (100,000) to the product and the points on a relative
stand-alone selling price basis as follows:
----------( 39 )----------
 “If you only pray when you’re in trouble… you’re in trouble.”

Product 100,000 91,324 [100,000 × (100,000 stand-alone selling price / 109,500)]

Points 9,500 8,676 [100,000 × (9,500 stand-alone selling price / 109,500)]
109,500 100,000
At the end of the first reporting period, suppose 4,500 points have been redeemed and the entity continues
to expect 9,500 points to be redeemed in total. The entity recognises revenue for the loyalty points of 4,110
[(4,500 points / 9,500 points) × 8,676] and recognises a contract liability of 4,566 (8,676 – 4,110) for the
unredeemed points at the end of the first reporting period.
At the end of the second reporting period, suppose 8,500 points have been redeemed cumulatively. The
entity updates its estimate of the points that will be redeemed and now expects that 9,700 points will be
redeemed. The entity recognises revenue for the loyalty points of 3,493 [(8,500 total points redeemed /
9,700 total points expected to be redeemed ) × 8,676 initial allocation] – 4,110 recognised in the first
reporting period). The contract liability balance is 1,073 (8,676 initial allocation – 7,603 of cumulative
revenue recognised).
Example 19 – Bill-and-hold arrangement [Example 63 of IFRS Part B]
An entity enters into a contract with a customer on 1 January 2018 for the sale of a machine and spare
parts. The manufacturing lead time for the machine and spare parts is two years.
Upon completion of manufacturing, the entity demonstrates that the machine and spare parts meet the
agreed-upon specifications in the contract. The promises to transfer the machine and spare parts are distinct
and result in two performance obligations that each will be satisfied at a point in time. On 31 December
2019, the customer pays for the machine and spare parts, but only takes physical possession of the
machine. Although the customer inspects and accepts the spare parts, the customer requests that the spare
parts be stored at the entity’s warehouse because of its close proximity to the customer’s factory. The
customer has legal title to the spare parts and the parts can be identified as belonging to the customer.
Furthermore, the entity stores the spare parts in a separate section of is warehouse and the parts are ready
for immediate shipment at the customer’s request. The entity expects to hold the spare parts for two to four
years and the entity does not have the ability to use the spare parts or direct them to another customer.
The entity identifies the promise to provide custodial services as a performance obligation because it is a
service provided to the customer and it is distinct from the machine and spare parts. Consequently, the
entity accounts for three performance obligations in the contract (the promises to provide the machine, the
spare parts and the custodial services). The transaction price is allocated to the three performance
obligations and revenue is recognised when (or as) control transfers to the customer.
Control of the machine transfers to the customer on 31 December 2019 when the customer takes physical
possession. The entity assesses the indicators of transfer of control to determine the point in time at which
control of the spare parts transfers to the customer, noting that the entity has received payment, the
customer has legal title to the spare parts and the customer has inspected and accepted the spare parts.
The entity recognises revenue for the spare parts on 31.12.2019 when control transfers to the customer.

Example 20—Volume discount incentive [Example 24 of IFRS Part B]

An entity enters into a contract with a customer on 1 January 2018 to sell Product A for 100 per unit. If the
customer purchases more than 1,000 units of Product A in a calendar year, the contract specifies that the
price per unit is retrospectively reduced to 90 per unit. Consequently, the consideration in the contract is
variable.

For the first quarter ended 31 March 2018, the entity sells 75 units of Product A to the customer. The entity
estimates that the customer’s purchases will not exceed the 1,000-unit threshold required for the volume
discount in the calendar year.
The entity determines that it has significant experience with this product and with the purchasing pattern of
the customer. Thus, the entity concludes that it is highly probable that a significant reversal in the
cumulative amount of revenue recognised (i.e. 100 per unit) will not occur when the uncertainty is resolved
(ie when the total amount of purchases is known). Consequently, the entity recognises revenue of 7,500
(75 units × 100 per unit) for the quarter ended 31 March 2018.
In May 2018, the entity’s customer acquires another company and in the second quarter ended 30 June
2018 the entity sells an additional 500 units of Product A to the customer. In the light of the new fact, the
entity estimates that the customer’s purchases will exceed the 1,000-unit threshold for the calendar year and
therefore it will be required to retrospectively reduce the price per unit to 90.
Consequently, the entity recognises revenue of 44,250 for the quarter ended 30 June 2018. That amount is
calculated from 45,000 for the sale of 500 units (500 units × 90 per unit) less the change in transaction price
of 750 (75 units × 10 price reduction) for the reduction of revenue relating to units sold for the quarter ended
31 March 2018.
----------( 40 )----------
Practice questions:
Example: [Based on IFRS 15 Illustrative Example 22]

An entity enters into 100 contracts on 31 December 2017 with customers. Each contract includes the sale of
one product for Rs.100 (100 total products × Rs. 100 = Rs. 10,000 total consideration).

Cash is received when control of a product transfers. The entity’s customary business practice is to allow a
customer to return any unused product within 30 days and receive a full refund. The entity’s cost of each
product is Rs. 60.

Using the expected value method, the entity estimates that 97 products will not be returned.

The entity estimates that the costs of recovering the products will be immaterial and expects that the
returned products can be resold at a profit.

Required: Journal entries (entity uses perpetual inventory system) if:

a) 3 products are returned on January 30, 2018
b) 2 products are returned on January 30, 2018
c) 4 products are returned on January 30,2018

Answer:
The journal entries on 31 December 2017 shall be same in all scenarios based on entity’s expectation of 97
products not to be returned:

Date Particulars Debit Rs. Credit Rs.

31-Dec-17 Bank (100 x Rs. 100) 10,000
Revenue (97 x Rs. 100) 9,700
Refund liability (3 x Rs. 100) 300
Cost of Sales (97 x Rs. 60) 5,820
Goods with customer (3 x Rs. 60) 180
Inventory (100 x Rs. 60) 6,000

On 30th January 2018, the adjustment shall be made when actual returns are confirmed:

Date Particulars Debit Rs. Credit Rs.

Part (a) if 3 products are returned
30-Jan-18 Refund liability (3 x Rs.100) 300
Bank 300
Inventory 180
Goods with customer 180
Part (b) if 2 products are returned
30-Jan-18 Refund liability (3 x Rs.100) 300
Cash (2 x Rs.100) 200
Revenue (1 x Rs.100) 100
Inventory 120
COS 60
Goods with customer 180
Part (c) if 4 products are returned
30-Jan-18 Refund liability (3 x Rs.100) 300
Revenue 100
Cash (4 x Rs.100) 400
Inventory 240
COS 60
Goods with customer 180

----------( 41 )----------
⯈ Example: [Based on IFRS 15 Illustrative Example 26]

An entity sells a product to a customer for Rs. 121 on 3 October 2017 that is payable 24 months after lapse
of return period of 90 days. The product is new and the entity has no relevant historical evidence of product
returns or other available market evidence. Therefore, the entity concludes that risk and rewards (and
control) will transfer to customer on expiry of return period.

The cash selling price of the product is Rs. 100 and the cost of inventory is Rs. 80. The entity has year-end
of December 31. The contract includes an implicit interest of 10%.

Required: Comment on when to recognise revenue and prepare the journal entries for the contract.

⯈ ANSWER:

The entity does not recognise revenue when control of the product transfers to the customer. This is
because the existence of the right of return and the lack of relevant historical evidence means that the entity
cannot conclude that it is highly probable that a significant reversal in the amount of cumulative revenue
recognised will not occur.

Date Particulars Debit Rs. Credit Rs.

3 Oct 2017 Stock with customer 3rd party 80
Inventory 80
1 Jan 2017 Receivable 100
Revenue 100
1 Jan 2017 Cost of sales 80
Stock with customer 3rd party 80
31 Dec 2018 Receivable 10
Interest income [Rs. 100 x 10%] 10
31 Dec 2019 Receivable 11
Interest income [Rs. 110 x 10%] 11
31 Dec 2019 Bank 121
Receivable 121

⯈ Example: [Based on IFRS 15 Illustrative Example 32]

An entity enters into a one-year contract to sell goods to a customer that is a large global chain of retail
stores. The customer commits to buy at least Rs. 15 million of products during the year.
The contract also requires the entity to make a non-refundable payment of Rs. 1.5 million to the customer at
the inception of the contract (1 Jan 2018) for the changes it needs to make to its shelving to accommodate
the entity’s products.
By 30th June 2018, Rs. 6 million goods were invoiced.
By 31st December 2018, remaining Rs. 9 million goods were invoiced.
Required: Journal entries.
ANSWER:

Consideration paid to customer is 10% of total invoice value (i.e. Rs. 1.5m / 15m).

Date Particulars Debit Rs. Credit Rs.

1 Jan 2018 Advance to customer 1,500,000
Bank 1,500,000
30 Jun 2018 Bank/Receivable 6,000,000
Revenue (6/15 x 13.5) 5,400,000
Advance to customer 600,000
31 Dec Bank/Receivable 9,000,000
2018
Revenue (9/15 x 13.5) 8,100,000
Advance to customer. 900,000

----------( 42 )----------
⯈ Example: [Based on IFRS 15 Illustrative Example 17A]
An entity is developing a multi-unit residential complex. A customer enters into a binding sales contract with
the entity for a specified unit that is under construction. Each unit has a similar floor plan and is of a similar
size, but other attributes of the units are different (for example, the location of the unit within the complex).
The contract inception is 1 January 2018. The price of one unit is Rs. 3,000,000. The expected date of
completion and possession transfer is 31 December 2019. The entity year end is December 31. The
construction is 60% complete by 31 December 2018.
• The customer pays a 10% deposit on 1 January 2018, refundable only if the entity fails to complete
the construction.
• The remainder of the contract price is payable on completion of the contract when the customer
obtains physical possession of the unit.
• If the customer defaults on the contract before completion of the unit, the entity only has the right to
retain the deposit.
Note: Ignore financing component & ignore accounting for contract costs.
Required: Journal entries for all of the following independent situations:
i. The unit is completed and possession is transferred on due date.
ii. The entity allocated the unit to another customer on 1 March 2018.
iii. The entity completes the unit but customer defaults (the entity plans to sell unit to another
customer).

Answer:
The entity does not have an enforceable right to payment for performance completed to date because, until
construction of the unit is complete, the entity only has a right to the deposit paid by the customer.
Because the entity does not have a right to payment for work completed to date, the entity’s performance
obligation is not a performance obligation satisfied over time.
The entity shall recognised revenue at a point in time when the control is transferred on 31 December 2019.
Date Particulars Debit Rs. Credit Rs.

Journal Entry in case of (i), (ii) & (iii)

01-Jan-18 Bank 300,000
Contract liability 300,000
Part (i)
31-Dec-19 Bank 2,700,000
Contract liability 300,000
Revenue 3,000,000
Part (ii)
01-Mar-18 Contract liability 300,000
Bank/ Refund liability 300,000
Part (iii)
31-Dec-19 Contract liability 300,000
Revenue 300,000

⯈ Example: [Based on IFRS 15 Illustrative Example 17B]

An entity is developing a multi-unit residential complex. A customer enters into a binding sales contract with
the entity for a specified unit that is under construction. Each unit has a similar floor plan and is of a similar
size, but other attributes of the units are different (for example, the location of the unit within the complex).
The contract inception is 1 January 2018. The price of one unit is Rs. 3,000,000. The expected date of
completion and possession transfer is 31 December 2019. The entity year end is December 31. The
construction is 60% complete by 31 December 2018.
• The customer pays a 10% non-refundable deposit on 1 January 2018.
• The customer will make progress payments of Rs. 1,350,000 (45%) on 31 December 2018 and 2019
each.

----------( 43 )----------
• The contract has substantive terms that preclude the entity from being able to direct the unit to another
customer. In addition, the customer does not have the right to terminate the contract unless the entity
fails to perform as promised.
Note: Ignore financing component & ignore accounting for contract costs.

Required: Journal entries as the unit is completed and possession is transferred on due date in each of the
following situations.
i. If the customer defaults on its obligations by failing to make the promised progress payments as and
when they are due, the entity would have a right to all of the consideration promised in the contract if it
completes the construction of the unit. The courts have previously upheld similar rights that entitle
developers to require the customer to perform, subject to the entity meeting its obligations under the
contract.
ii. In the event of a default by the customer, either the entity can require the customer to perform as
required under the contract or the entity can cancel the contract in exchange for the asset under
construction and an entitlement to a penalty of a proportion of the contract price.
Answer:
Situation (i)
The asset (unit) created by the entity’s performance does not have an alternative use to the entity because
the contract precludes the entity from transferring the specified unit to another customer.
The entity also has a right to payment for performance completed to date. This is because if the customer
were to default on its obligations, the entity would have an enforceable right to all of the consideration
promised under the contract if it continues to perform as promised.
Therefore, the entity has a performance obligation that it satisfies over time.

Date Particulars Debit Rs. Credit

Rs.
01-Jan-18 Bank 300,000
Contract liability 300,000
31-Dec-18 Contract liability 300,000
Bank (3,000,000 x 45%) 1,350,000
Contract asset (Balancing)[not an 150,000
unconditional right]
Revenue (3,000,000 x 60%) 1,800,000
31-Dec-19 Bank [3,000,000 x 45%] 1,350,000
Contract asset 150,000
Revenue[3,000,000 – 1,800,000] 1,200,000

Situation (ii)
Despite that the entity could cancel the contract; the entity has a right to payment for performance
completed to date because the entity could also choose to enforce its rights to full payment under the
contract. Therefore, the entity has a performance obligation that it satisfies over time.
Therefore, same accounting treatment follows in both of above situations.

⯈ Example: [Based on IFRS 15 Illustrative Example 39]

On 1 January 2018, X Limited enters into a contract to transfer Products A and B to Y Limited in exchange
for Rs. 1,000. Product A & Product B are be delivered on 28 February & 31 March respectively. Control
transfers with the delivery.
The promises to transfer Products A and B are identified as separate performance obligations. Rs.400 is
allocated to Product A and Rs.600 to Product B.
Situation 1: X Limited has unconditional right to payment on delivery of each product separately.
Situation 2: Payment for the delivery of Product A is conditional on the delivery of Product B. Required:
Journal entries to record revenue.

----------( 44 )----------
⯈ ANSWER:
Situation 1: Journal entries
Date Particulars Debit Rs. Credit Rs.
28 Feb 2018 Receivables 400
Revenue 400
31 Mar 2018 Receivables 600
Revenue 600
Situation 2: Journal entries
Date Particulars Debit Rs. Credit Rs.
28 Feb 2018 Contract asset 400
Revenue 400
31 Mar 2018 Receivables 1,000
Revenue 600
Contract asset 400

⯈ Example: [Based on IFRS 15 Illustrative Example 5]

On 1 January 2021, SL promises to sell 120 products to CL for Rs. 12,000 (Rs. 100 per product). The
products are to be transferred equally on January 31 and February 28. CL paid Rs. 12,000 on inception of
contract.
On February 15, the contract is modified to require the delivery of an additional 30 products to CL on March
10 at Rs. 80 per product (Total Rs. 2,400). CL paid additional amount on modification date i.e. February 15,
2021.
The additional 30 products are distinct and reflect the stand-alone selling price of the additional products.
All products were delivered as agreed.
Required: Pass Journal entries for the above contract.

⯈ ANSWER:
Date Particulars Debit Rs. Credit Rs.
01-Jan-21 Bank 12,000
Contract liability 12,000
[120 units x Rs. 100]
31-Jan-21 Contract liability 6,000
Revenue 6,000
[60 units x Rs. 100]
15-Feb-21 Bank 2,400
Contract liability 2,400
[30 units x Rs. 80]
28-Feb-21 Contract liability 6,000
Revenue 6,000
[60 units x Rs. 100]
10-Mar-21 Contract liability 2,400
Revenue 2,400
[30 units x Rs. 80]

Example: [Based on IFRS 15 Illustrative Example 5]

On 1 January 2021, SL promises to sell 120 products to CL for Rs. 12,000 (Rs. 100 per product). The
products are to be transferred equally on January 31 and February 28. CL paid Rs. 12,000 on inception of
contract.
On February 15, the contract is modified to require the delivery of an additional 30 products to CL on March
10 at Rs. 80 per product (Total Rs. 2,400). CL paid additional amount on modification date i.e. February 15,
2021.
The additional 30 products are distinct but do not reflect the stand-alone selling price of the additional
products.
All products were delivered as agreed.
Required: Pass Journal entries for the above contract.
----------( 45 )----------
ANSWER:
Date Particulars Debit Credit
Rs. Rs.
01-Jan-21 Bank 12,000
Contract liability 12,000
[120 units x Rs. 100]
31-Jan-21 Contract liability 6,000
Revenue 6,000
[60 units x Rs. 100]
15-Feb-21 Bank 2,400
Contract liability 2,400
[30 units x Rs. 80]
28-Feb-21 Contract liability 5,600
Revenue 5,600
[(6,000 + 2,400) / 90 units x 60 units]
10-Mar-21 Contract liability 2,800
Revenue 2,800
[(6,000 + 2,400) / 90 units x 30 units]

⯈ Example: [Based on IFRS 15 Illustrative Example 5]

On 1 January 2021, SL promises to sell 120 products to CL for Rs. 12,000 (Rs. 100 per product). The
products are to be transferred equally on January 31 and February 28. CL paid Rs. 12,000 on inception of
contract.
On February 15, the contract is modified to require the delivery of an additional 30 products to CL on March
10 at Rs. 80 per product (Total Rs. 2,400). CL paid additional amount on modification date i.e. February 15,
2021.
The additional 30 products are distinct but do not reflect the stand-alone selling price of the additional
products.
It was discovered that 60 products already supplied had minor defects. SL agreed to give Rs. 900 credit to
CL for this i.e. (Rs. 15 per product × 60 products).
All products were delivered as agreed.
Required: Pass Journal entries for the above contract

----------( 46 )----------
Answer:
Date Particulars Debit Credit
Rs. Rs.
01-Jan-21 Bank 12,000
Contract liability 12,000
[120 units x Rs. 100]
31-Jan-21 Contract liability 6,000
Revenue 6,000
[60 units x Rs. 100]
15-Feb-21 Bank[2,400 - 900] 1,500
Revenue (credit for minor defects) 900
Contract liability 2,400
[30 units x Rs. 80]
28-Feb-21 Contract liability 5,600
Revenue 5,600
[(6,000 + 2,400) / 90 units x 60 units]
10-Mar-21 Contract liability 2,800
Revenue 2,800
[(6,000 + 2,400) / 90 units x 30 units]

⯈ Example: [Based on IFRS 15 Illustrative Example 5]

On 1 January 2021, SL promises to sell 120 products to CL for Rs. 12,000 (Rs. 100 per product). The
products are to be transferred equally on January 31 and February 28. CL paid Rs. 12,000 on inception of
contract.
On February 15, the contract is modified to require the delivery of an additional 30 products to CL on March
10 at Rs. 80 per product (Total Rs. 2,400). CL paid additional amount on modification date i.e. February 15,
2021.
The additional 30 products are neither distinct nor reflect the stand-alone selling price of the additional
products.
All products were delivered as agreed.
Required: Pass Journal entries for the above contract.

⯈ ANSWER:
Date Particulars Debit Rs. Credit Rs.
01-Jan-21 Bank 12,000
Contract liability 12,000
[120 units x Rs. 100]
31-Jan-21 Contract liability 6,000
Revenue 6,000
[60 units x Rs. 100]
15-Feb-21 Bank 2,400
Revenue 240
Contract liability [2,400 + 240] 2,640
[(Rs. 12,000 + 2,400) / 150 units = Rs. 96 per unit]
Adjustment = Rs. 96 x 60 = Rs. 5,760 - 6,000 = Rs. 240
28-Feb-21 Contract liability 5,760
Revenue 5,760
[60 units x Rs. 96]
10-Mar-21 Contract liability 2,880
Revenue 2,880
[30 units x Rs. 96]

----------( 47 )----------
Example:
Guitar World (GW) normally sells Machine A13 for Rs. 1.7 million. Maintenance services for such type of
machines are provided separately at Rs. 25,000 per month. Details of two contracts for sale of Machine A13
are as follows:
(i) On 1 July 2018, GW signed a contract with Energene Limited to sell Machine A13 with one year free
maintenance services at a lumpsum payment of Rs. 1.8 million. The amount was received upon delivery
of machine on 1 August 2018.
(ii) On 1 October 2018, GW sold Machine A13 to Vitalene Limited for Rs. 1.95 million. As per the contract,
payment would be made after 2 years. Maintenance services would also be provided for Rs. 25,000 per
month for two years which would be paid at the end of each month.
Required: With reference to IFRS-15 ‘Revenue from Contracts with Customers’, explain how the above
contracts should be recorded in GW’s books for year ended 31 December 2018. (Show supporting
calculations but entries are not required)
Answer:
Part (i)
The contract contains two distinct performance obligations i.e. selling the machine and providing the
maintenance services as:
• the customer can separately benefit from the machine without the maintenance services from GW
(or GW sells maintenance services separately) and
• the machine and maintenance services are separately identifiable in the contract.

Thus GW will allocate the transaction price between the two performance obligations as follows:

Stand-alone Allocation of Rs. 1,800,000

Performance obligations Rs. 000 Rs.000 Rs. 000
Machine 1,700 1,700/2,000 x 1,800 1,530
Maintenance (Rs. 25,000×12) 300 300/2,000 x 1,800 270
Total 2,000 1,800

Revenue related to sale of machine would be recognized at a point in time i.e. upon delivery on 1 August
2018. While revenue related to maintenance service would be recognized over time i.e. as the services are
rendered.
Till 31 December 2018, revenue would be recognized in respect of:
• Sale of machine Rs. 1,530,000
• Maintenance service Rs. 112,500 (i.e. Rs. 270,000 x 5/12)
Remaining amount of Rs. 157,500 (i.e. Rs. 270,000 x 7/12) would appear in liabilities as contract liability.
Part (b)(ii)
The contract contains two distinct performance obligations i.e. selling the machine and providing the
maintenance services.
The contract includes a significant financing component in respect of sale of machine which is evident from
the difference between the amount of promised consideration of Rs. 1.95 million and the cash selling price
of Rs. 1.7 million.
Revenue related to machine would be recognized upon delivery on 1 October 2018. Revenue related to
maintenance service would be recognized as the services are rendered each month.
The difference between promised consideration(i.e. 1,950,000) and cash selling price (i.e. 1,700,000) of Rs.
250,000 would be recognized as interest revenue over two years using the implicit rate of 7.1% i.e. PV of
future payments:
1.7 = 1.95 (1+i)-2 I = 7.1%
Till 31 December 2018, revenue would be recognized in respect of:
• Sale of machine Rs. 1,700,000 (on 1 October 2018)
• Maintenance service Rs. 75,000 i.e. Rs. 25,000 for 3 months
• Interest revenue Rs. 30,175 (Rs. 1.7 million × 7.1% × 3/12)

----------( 48 )----------
Example: [Based on IFRS 15 Illustrative Example 63]

An entity enters into a contract with a customer on 1 January 2018 for the sale of a machine and spare
parts. The manufacturing lead time for the machine and spare parts is two years.
Upon completion of manufacturing, the entity demonstrates that the machine and spare parts meet the
agreed-upon specifications in the contract. The promises to transfer the machine and spare parts are
distinct.
On 31 December 2019, the customer pays Rs. 5 million for the machine and spare parts, but only takes
physical possession of the machine.
The 80% of Rs. 5 million is to be allocated to machine and remaining 20% to spare parts.
Although the customer inspects and accepts the spare parts, the customer requests that the spare parts be
stored at the entity’s warehouse because of its close proximity to the customer’s factory. The customer has
legal title to the spare parts and the parts can be identified as belonging to the customer. Furthermore, the
entity stores the spare parts in a separate section of its warehouse and the parts are ready for immediate
shipment at the customer’s request. The entity expects to hold the spare parts for two to four years and the
entity does not have the ability to use the spare parts or direct them to another customer.
The entity will receive Rs. 15,000 per month from the customer as custodial charges of spare parts at its
premises.

Required: Evaluate the above situation in accordance with five-step model of IFRS 15.

Answer:
Step 1: Identify the Contract
There is only one contract with the customer.
Step 2: Identify the Performance obligations
There are three performance obligations i.e. the promises to provide:
(i) The machine
(ii) The spare parts
(iii) The custodial services for spare parts
Step 3: Determine the transaction price
There transaction price is both fixed and variable:
(i) Rs. 5 million fixed
(ii) Rs. 15,000 per month variable
Step 4: Allocating transaction price to Performance obligations
The allocation of transaction price shall be as follows:
(i) The machine Rs. 4m (i.e. Rs. 5m x 80%)
(ii) The spare parts Rs. 1m (i.e. Rs. 5m x 20%)
(iii) The custodial services Rs. 15,000 per month
Step 5: Recognize revenue on satisfaction of performance obligations
The revenue shall be recognised as follows:
(i) The machine - at a point in time (control transfer) - 31 December 2019
(ii) The spare parts - at a point in time (control transfer) - 31 December 2019. Bill-and-Hold
arrangement criteria is met and control has been transferred.
(iii) The custodial services - Satisfaction over time - Time based measure (monthly is suitable)

----------( 49 )----------
 “Pray Salah (Namaz) and give peace to your soul and heart.”

REVENUE FROM CONTRACTS WITH CUSTOMERS

(IFRS 15)
IFRS replaced IAS 18 and IAS 11.
Income : increase in economic benefits during an accounting period in the form of inflow of assets or
decrease of liabilities that result in increase of equity , other than those relating to contribution from equity
participants.
Revenue: Income arising in the course of an entity’s ordinary activities.
Customer: is a party that has contracted with an entity to obtain the goods or services that are an output of
the entity’s ordinary activities.
Core Principle of IFRS 15: is that an entity recognises revenue to reflect the transfer of goods or
services to customers in an amount that reflects the consideration to which the entity expects to be entitled
in exchange for those goods or services.
Transfer of goods or services occur when the customer obtains control of goods.
Control is obtained when the customers has the ability to direct the use of and obtain substantially all
remaining benefits from the asset (asset in this IFRS 15 covers both goods and services). (Goods may be
tangible or intangible).
Five step model [Para 2 of IFRS Part A1]
Applying the above core principle involves following a five step model as follows:
Step 1: Identify the Contract with a Customer:
Step 2: Identify the separate performance Obligations in the Contract:
Step 3: Determine the Transaction Price:
Step 4: Allocate the transaction price to each performance obligation
Step 5: Recognise revenue when (or as) the entity satisfies a performance obligation.
Time value of money:
Revenue is the market price less any trade discount allowed.
If a sale is a cash sale, the revenue is the immediate proceeds of the sale.
If a sale is a normal credit sale, the revenue is the expected future receipt.
However, in some cases when the payment is deferred, the cash sale price might be less than the amount of
cash that will eventually be received.
The difference between the total sale value and the cash price of the consideration is recognised as interest
income. However this adjustment is only required if the period between transfer of goods and receipt of cash
is equal to or more than one year. (or if any other information is available)
Stand Alone Price means a price at which an entity would sell a promised good or service separately to a
customer (means market price if a product is sold separately).
Transaction Price means amount of consideration to which an entity expects to be entitled in exchange for
transferring promised goods or services to a customer; excluding amount collected on behalf of third parties
e.g. amount collected for owner or sales tax collected on behalf of government.

A performance obligation may be satisfied at a point in time (typically for transfer of goods) or
A performance obligation may be satisfied over a period of time (typically for transfer of services).

Detailed discussion of IFRS 15:

(A) Identify the Contract [Para 9 of IFRS Part A1]
An entity shall account for a contract with customer only when all of the following criteria are met:
(a) The parties to the contract have approved the contract (in writing or orally etc) and are committed to
perform their respective obligations under the contract.
(b) Entity can identify each party’s rights (e.g goods and cash)
----------( 50 )----------
(c) Entity can identify the payment terms (e.g payment is to be made in 15 days)
(d) Contract has commercial substance. [An exchange of goods lack commercial substance when non-
monetary exchange occurs between entities in the same line of business to facilitate sales to
customers e.g. a contract between two oil companies that agree to an exchange of oil to fulfil demand
from their customers in different specified locations on a timely basis][it means contract will have
commercial substance if risks, timing or amount of the entity’s future cash flows is expected to change
as a result of contract]; and
(e) It is probable that entity will collect the consideration to which it will be entitled in exchange for the
goods or services that will be transferred to the customer. (by considering the customer,s ability to pay the
amount of consideration when it is due)

Question from above can be: criteria to be fulfilled before general IFRS 15 model is applied
Treatment of consideration received; if contract does not meet the criteria for the identification of the
contract:[para 15 of part A]
When a contract does not meet the above criteria and entity receives a consideration from the customer, the
entity shall recognise the consideration received as revenue only when either of the following events has
occurred:
(a) The entity has no remaining obligation to transfer goods or services and all or substantially all of
consideration has been received and is non-refundable; or
(b) The contract has been terminated and consideration is non-refundable.

Does the contract exist if either of the party can terminate it? [Para 12 of IFRS Part A1]
A contract does not exist if each party (either seller or buyer) has the unilateral enforceable right to terminate
a wholly unperformed contract without compensating the other party.
A Contract will be wholly unperformed if the following criteria is met:
(a) Entity has not yet transferred any good or services, and
(b) Entity has not yet received or entitle to receive any consideration.
Combination of contracts (what are the situations in which two or more contracts can be combined
as a single contract) [Para 17 of IFRS Part A1]
The entity must combine two or more contracts entered into at or near the same time with the same
customer (or related party of customer e.g. parent or subsidiary) and treat them as a single contract if one or
more of the following conditions are present:
1. The contracts are negotiated as a package with a single commercial objective.
2. The amount of consideration to be paid in one contract depends on the price or performance of the other
contract; or
3. The goods or services promised in the contracts are a single performance obligation.
Contract Modification [Para 18 , 20 AND 21 of IFRS Part A1]
A contract modification is a change in scope or price (or both) of a contract that is approved by parties to the
contract. E.g. changes in design, quantity, timing or method of performance.
When a contract modification be considered as a separate contract: [Para 20 of IFRS Part A1]
An entity shall account for a contract modification as a separate contract if both the following conditions are
present:
(a) Scope of contract increases because of addition of goods or services; and
(b) The price of the contract increases by an amount of consideration that reflects the entities standalone
selling prices (market price) of additional goods or services.

----------( 51 )----------
If contract modification is not treated as a separate contract [Para 21 of IFRS Part A1]
If contract modification is not treated as a separate contract because both the above conditions are not met;
then;
(a) If remaining goods or services are distinct from previous goods or services transferred; then an entity
shall account for the contract modification as if it were a termination of existing contract and creation
of a new contract.
(b) If remaining goods or services are not distinct; then an entity shall account for the contract
modification as if it were part of the existing contract. (if goods are not distinct the it means old
contract is going on)
[B] Identifying the Performance Obligations: [Para 22 of IFRS Part A1]
At the inception of contract, an entity shall assess the goods or services promised in a contract with
customer and shall identify as a performance obligation each promise to transfer to the customer either:
(a) a good or service or a bundle of goods or services that is distinct; or
(b) A series of goods or services that are substantially the same and have the same pattern of transfer to
customers (e.g. monthly maintenance services, health club or payroll processing services)
Definition of distinct good or service:[para 27 of part A 1]
A good or service is distinct if both the following criteria are met:
(a) Customer can benefit from the good or service either on its own or together with other resources that
are readily available to customer; and
(b) Entity’s promise to transfer the good or service to the customer is separately identifiable from other
promises in the contract.
Explanation of (a) above: If a good or service is regularly sold separately; this would indicate that customers
generally can benefit from the good or service on its own or in combination with other available resources.

Not distinct goods or services [IFRS 15: 29 & 30]

Factors that indicate that two or more promises to transfer goods or services to a customer are not
separately identifiable include the following:
• the entity provides a significant service of integrating the goods or services with other goods or
services promised in the contract into a bundle of goods or services that represent the combined output (e.g.
software and installation)
• one or more of the goods or services significantly modifies or customises, one or more of the other
goods or services promised in the contract.
• the goods or services are highly interdependent or highly interrelated (Q.4 Brilliant Limited)

Revenue recognition from sales of goods with after sale service agreement:
When the selling price of a product includes an identifiable amount for subsequent servicing, that amount is
deferred and recognised as revenue over the period during which the service is performed. The amount
deferred should be sufficient to cover both the cost of servicing and a reasonable profit.
Examples of promised Goods and Services Include: [Para 26 of IFRS Part A1]
(a) Sale of goods produced by an entity (e.g., inventory of a manufacturer);
(b) Resale of goods purchased by an entity (e.g. trading business);
(c) Performing agreed – upon tasks for a customer (e.g. customization of software);
(d) Providing agency services to principal (agent providing services).
(e) Constructing, manufacturing or developing an asset on behalf of a customer (house or building);
(f) Granting licences (Franchises) etc.
(g) Granting options to purchase additional goods/services like giving discount vouchers (will be
discussed in examples)

----------( 52 )----------
Indicators of Transfer of Control Includes: [Para 38 of IFRS Part A1]
(1) The entity has right to payment for asset (means right to receive is established)
(2) The customer has the legal title. (If however entity retains the legal title solely as a protection
against customers failure to pay; still it means control has been transferred by entity to customer at
the time of delivery of asset). [Example is sale on instalment basis].
(3) The entity has transferred physical possession of asset. However, physical transfer may not
always concide with control of an asset. For example; consignment arrangements (sale or return
basis), a customer or consignee may have physical asset that the entity controls. Conversely, in some
bill – and – hold arrangements, an entity may have physical possession of an asset that a customer
controls.
(4) The customer has the significant risks and rewards of ownership of an asset.
(5) The customer has accepted the asset;

Sale on approval basis:

If entity delivers products to a customer for trial or evaluation purposes and the customer is not committed to
pay any consideration until the trial period lapses, control of the product is not transferred to a customer until
either the customer accepts the product or the trial period lapses (whichever is earlier).
Measuring progress towards complete satisfaction of a performance obligation [this discussion is
applicable when performance obligation is satisfied over time]. [Para 41 of IFRS Part A1]
An entity shall recognise revenue over time by measuring the progress towards complete satisfaction of that
performance obligation.
When goods or services are transferred continuously, a revenue recognition method that best depicts the
entity’s performance should be applied.
Methods for measuring progress
There are two types of Methods:
(a) Output Methods; and
(b) Input Methods
Output Methods: [Para B15 of IFRS Part A1]
These methods recognise revenue on the basis of direct measurement of the value to customer of goods or
services transferred to date relative to the remaining goods or services promised under the contract. e.g.:
(a) Surveys of Performance completed to date;
(b) Units produced as a percentage of total units to be produced; or
(c) Units delivered as a percentage of total units to be delivered
(d) Contract milestone reached.

Input Methods: [Para B18 of IFRS Part A1]

These methods recognise revenue on the basis of the entity’s efforts or inputs to the satisfaction of a
performance obligation relative to the total expected inputs to the satisfaction of that performance obligation.
e.g.
(a) Resources consumed as a percentage of total resources to be used;
(b) Labour hours used as a percentage of total labour hours to be used;
(c) Machine hours used as a percentage of total machine hours to be used;
(d) Cost incurred as a percentage of total cost to be incurred.
Measurement:
When a performance obligation is satisfied (rather than right to receive is established); an entity shall
recognise as revenue the amount of the transaction price that is allocated to that performance obligation.
----------( 53 )----------
Determining the Transaction Price: [Para 47 of IFRS Part A1]
Transaction Price means amount of consideration to which an entity expects to be entitled in exchange for
transferring promised goods or services to a customer; excluding amount collected on behalf of third parties
e.g. amount collected for owner or sales tax collected on behalf of government.
Transaction price can be a fixed consideration, variable consideration or consideration other than cash (e.g.
shares or any other fixed asset)
Factors to be considered while determining transaction price: [Para 48 of IFRS Part A1]
When determining the transaction price, an entity shall consider the effects of all of the followings:
(a) Variable consideration;
(b) Constraining estimates of Variable consideration;
(c) Existence of significant financing components;
(d) Non-Cash consideration; and
(e) Consideration payable to customers.
Variable Consideration:
Amount of consideration can vary because of discounts, refunds, incentives etc.
Methods of estimating the variable consideration: [Para 53 of IFRS Part A1]
An entity shall estimate an amount of variable consideration by using either of the following methods:
(a) Expected value method.
(b) Most likely method.

Constraining estimates of Variable consideration:

An entity shall include in the transaction price some or all of the amount of variable consideration estimated
by applying the expected value or most likely method only to the extent that it is highly probable that a
significant reversal in amount of cumulative revenue recognised will not occur when uncertainties associated
with variable consideration is subsequently resolved.

Existence of Significant Financing Component:

In determining the transaction price, an entity shall adjust the promised amount of consideration for the
effects of time value of money if the timing of payments agreed to by the parties to the contract provides the
customer or entity with a significant benefit of financing.
Non-Cash consideration: [Para 66 of IFRS Part A1]
To determine the transaction price for the contracts in which a customer promises consideration in a form
other than cash, an entity shall measure the non-cash consideration at fair value which is at the time of
earning of revenue.(Non-cash considerations includes shares, vehicles, machine etc).
Consideration Payable to a Customer [Para 70-72 of IFRS Part A1]
Consideration payable to a customer includes cash amounts that an entity paid or expected to pay to a
customer.
• An entity shall account for consideration payable to a customer as a reduction of the transaction price
(means deduct from revenue).
• If however, payment to a customer is in exchange for goods or services that are transferred by
customer to entity then simply record the purchase of those goods or services (separately)
Allocating transaction Price to performance obligations [Para 73-75 of IFRS Part A1] (This problem
will arise if more than one performance obligation in a contract)
An entity shall allocate the transaction price to each performance obligation identified in the contract on a
relative standalone selling prices.
Stand-alone Price; means a price at which an entity would sell a promised good or service separately to a
customer.

----------( 54 )----------
Methods of estimating the stand alone price if it is not available: [Para 79 of IFRS Part A1]
If stand-alone selling price is not available (may be because entity do not sell the goods or services
separately) then estimate it by using any of the following method:
(a) Adjusted Market Assessment Approach: means price at which same goods or services are sold
separately by other competitors (suppliers) in the market.
(b) Expected Cost plus Approach: Estimate the cost and then add appropriate profit.
(c) Residual Approach: An entity may estimate the stand-alone selling price by reference to the total
transaction price less the sum of the observable standalone selling prices of other goods or services
promised in the contract.

OTHER ASPECTS OF IFRS 15

Contract costs
Costs might be incurred in obtaining a contract and in fulfilling that contract.
Incremental costs of obtaining a contract [Para 91-94 of IFRS Part A1]
The incremental costs of obtaining a contract are those costs that would not have been incurred if the
contract had not been obtained (or that are incurred as a direct consequence of obtaining the contract)
The incremental costs of obtaining a contract with a customer are recognised as an asset if the entity
expects to recover those costs.
Costs to obtain a contract that would have been incurred regardless of whether the contract was obtained
are expensed as incurred (unless they can be recovered from the customer regardless of whether the
contract is obtained).
An entity may recognise the incremental costs of obtaining a contract as an expense when incurred if the
amortisation period of the asset is one year or less.
Presentation
An unconditional right to consideration is presented as a receivable.
Contract assets
A supplier might transfer goods or services to a customer before the customer pays consideration or before
payment is due.
A contract asset is a supplier’s right to consideration in exchange for goods or services that it has
transferred to a customer [in other words, an amount for which an entity has recognized the revenue
because performance obligation is satisfied but for which right to receive is not yet unconditional]
A contract asset is reclassified as a receivable when the supplier’s right to consideration becomes
unconditional.

Contract liabilities (advance from customers or unearned income)

A contract might require payment in advance or allow the entity a right to an amount of consideration that is
unconditional (i.e. a receivable), before it transfers a good or service to the customer.
In these cases, the entity presents the contract as a contract liability when the payment is made or the
payment is due (whichever is earlier).
Consignment Arrangements [sale or return basis] [Para B77 of IFRS Part A1]
When an entity delivers a product to another party (such as a dealer or a distributor) for sale to end
customers, the entity shall evaluate whether that other party has obtained control of the product at that point
in time. In consignment sales, an entity shall not recognise revenue upon delivery of a product because
control is not normally transferred at that date.
In such a situation, revenue is recognised by the entity when the goods are sold by dealer to customer, or
time period of return is expired (if any) whichever is earlier [Para B78 (a)]

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Bill & Hold Arrangements: [Para B 79 to 81 of IFRS Part A1]
It means a contract under which an entity bills a customer for a product but the entity retains the physical
possession of the product until it is transferred to a customer at a point in time in future.
For example; a customer may request an entity to enter into such a contract because of a customer’s lack of
available space for the product or because of delays in the customer’s production schedules.
In such cases, customer is considered to have obtained the control of a product, even though product
remains in the entity’s physical possession. Consequently entity is only providing custodial services over the
customer’s asset. If entity is charging some fee for custodial services then transaction price needs be
allocated to two performance obligations; i.e.
(a) Control of goods ; and
(b) Custodial services.
Revenue from goods is recognised when control of goods is transferred. Revenue from custodial services is
recognised as the services are rendered.

Performance obligations satisfied over time [IFRS 15: 35]

An entity transfers control of a good or service over time and, therefore, satisfies a performance obligation
and recognises revenue over time, if one of the following criteria is met:

Criteria Example
the customer simultaneously receives and Routine or recurring services such as a cleaning
consumes the benefits provided by the entity’s service or software debugging services or
performance as the entity performs; teaching/training services. [e.g. services of lawyers
and teachers] [Example 2 of Appendix]
the entity’s performance creates or enhances providing interior designing and painting services,
an asset that the customer controls as the wood work or electricity work at a customer’s
asset is created or enhanced; or premises.
the entity’s performance does not create an a customized machinery is being developed for a
asset with an alternative use to the entity and customer and contract specifically prevents the entity
the entity has an enforceable right to payment to direct/transfer this machinery to another customer.
for performance completed to date. Also, the customer has no right to terminate the
contract unless the entity fails to perform its
obligations. [construction by contractor] [Example 3
case B]

When goods or services are transferred continuously, a revenue recognition method that best depicts the
entity’s performance should be applied (and updated as circumstances change).
Acceptable methods include:
• Output methods: units produced, units delivered, contract milestones or surveys of work performed;
• Input methods: costs incurred, labour hours expended, machine hours used.

If a performance obligation is not satisfied over time, an entity satisfies the performance obligation
at a point in time.
Accounting for settlement discounts
Settlement discounts (also known as prompt payment discounts or cash discounts) are offered to credit
customers to encourage early payment of their account. It is not guaranteed that customers will take
advantage of settlement discounts at the point of sale as it is dependent upon whether or not credit customer
pays within the timeframe allowed for settlement discount.

While applying IFRS 15 five step approach, the third step requires an entity to 'Determine the transaction
price', which is the amount to which an entity expects to be entitled in exchange for the transfer of goods and
services. An entity is required to consider the terms of the contract and its customary business practices to
determine the transaction price. IFRS 15 does not distinguish between trade discount and settlement
discount.
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When settlement discounts are offered, the expected consideration is variable as the amount the entity will
actually receive is dependent upon the customer choice as to whether it will take advantage of the discount.
Where a contract contains elements of variable consideration, the entity should estimate the amount of
variable consideration to which it will be entitled under the contract.
The variable consideration is only included in the transaction price if, and to the extent that, it is highly
probable that its inclusion will not result in a significant revenue reversal in the future when the uncertainty
has been subsequently resolved.

When a business makes a sale, it does not know whether the customer will take advantage of the settlement
discount or not, therefore, this is dealt in following ways:
(a) Record the revenue for the full amount if the customer is not expected to pay early:
(i) If customer does not pay early as expected, the full amount will be received as recorded already.
(ii) If customer pays early and is entitled to discount, recognise the reduction in revenue by the
amount of discount. Reduction in revenue may be recorded by debiting the ‘revenue’ account
directly or by debiting ‘discount allowed’ account which is eventually deducted from sales
revenue (similar to sales returns).
(b) Record the revenue for reduced (net of discount) amount if the customer is expected to pay early:
(i) If customer pays early as expected, the net amount will be received as recorded already.
(ii) If customer does not pay early as expected, treat the additional amount received as revenue from
original sales transaction.

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 Coming soon! Our interview with ALLAH! Try to prepare for it.

Provision, Contingent Liabilities & Contingent Assets IAS-37

Provision is a liability of uncertain timing or amount.
Liability is a present obligation arising from past events, the settlement of which is expected to result in an
outflow of resources.

Examples of Provisions
• Provision for taxation
• Provision for gratuity
• Provision for dismantling
• Provision for litigation
• Provision for warranty etc

Difference between a provision and liability:

Provision Liability
Here timing or amount is uncertain (example of a Here timing or amount is not normally uncertain
court case by a debtor, warranty obligation etc.) (trade payable and accrual of expenses)

When to recognize a provision (means incorporation in the Financial statement) [Para 14]
1) There is a present obligation as a result of past events.

Obligation may be
Legal Constructive
That derives from a contract or legislation or That derives from entity’s action that create valid
operation of law (court decision) expectations among the interested parties that
entity will discharge those responsibilities (Example
below)

2) There is a probability of outflow of the resources

3) Although timing or amount is uncertain but a reliable estimate can be made

If all the above conditions are fulfilled, recognize a provision.

Example
Zee Ltd owned a road tanker that overturned in December 20X3 during a bad rain storm. The tanker spilled
its contents thus contaminating a local river. Zee ltd has never before contaminated a river. Zee Ltd has no
legal obligation to clean the river, has no published policies as to its views on the rehabilitation of the
environment and has not made any public statement that it will clean the river. It intends to clean-up the river
and has been able to calculate a reliable estimate of the cost thereof.

Required
Explain whether or not Zee Ltd should recognize a provision in its statement of financial position as at 31 st
December 20X3.

Solution:
The event is the accident and since it happened before year end it is a past event. There is, however, no
present obligation since:
• There is no legal requirement
• There is no constructive obligation to rehabilitate the river since neither:
 A public statement has been made and nor
 There is an established pattern of past practice since this was its first accident like this.

Although Zee Ltd intends to clean-up the river and even has a reliable estimate of the costs thereof, no
provision should be recognized because an obligating event is one that results in the entity having no
realistic alternative but to settle the obligation. Zee Ltd can still change its intension. If however, this
intension has been announced then there is a constructive obligation and a provision should be recognized.

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 Fill your heart with Emaan and it will become the most peaceful place on earth

Measurement of Provision [Para 36]

The amount recognized as a provision shall be the best estimate at the reporting date.
The best estimate of the amount of an obligation is the amount that an entity would pay to settle the liability.

When making these estimates, management should consider:

• Previous experience:
• Similar transaction:
• Possibly expert advice: and
• Events after the reporting period. (IAS-10) (will be discussed Later)

Previous experience may indicate a range of possible outcomes, for which it may be possible to estimate a
probability. This is referred to as the calculation of expected values using this theory of probabilities. The
application of this theory is best explained by way of example.
Under Para 39 of IAS-37.

Example :
Sahiwal Manufacturing has sold 10,000 units in the year. Sales accrued evenly over the year.
It estimates that for every 100 items sold, 20 will require small repairs at a cost of Rs. 100 each, 10 will require
substantial repairs at a cost of Rs. 400 each and 5 will require major repairs or replacement at a cost of Rs. 800
each.
On average the need for a repair becomes apparent 6 months after a sale.
What is the closing provision?
A provision will be required for the sales in the second six months of the year because the repairs necessary
in respect of the sales in the first six months would have been completed by the year end.
Sales accrue evenly, therefore, the sales in the second six months are 5,000 units (10,000 x 6/12).

Repair Number of units Cost per repair (Rs.) Total (Rs.)

Small 20% x 5,000 = 1,000 100 100,000
Substantial 10% x 5,000 = 500 400 200,000
Major 5% x 5,000 = 250 800 200,000
Provision 500,000

Future Events [Para 48]

When calculating the amount of the provision, expected future events should be taken into account when there
is 'sufficient objective evidence' available suggesting that the future event will occur.

Example: Future events

A company owns a number of nuclear plants. The company is presently obliged to dismantle one of these
nuclear plants in 3 years’ time.

The last nuclear plant dismantled by the company cost Rs. 1,000,000 to dismantle, but the company expects
to dismantle this nuclear plant, if using the same technology, at a slightly reduced cost of Rs. 800,000 due to
the increased experienced. There is, however, a chance that completely new technology may be available at
the time of dismantling which could lead to a further Rs. 200,000 cost saving.

Required:
Discuss the measurement of the provision.

Solution:
A provision should reflect expected future events where there is sufficient objective evidence that these will
occur. Since the company has had experience in dismantling plants, it is argued that the expected cost savings
through this experience is reasonably expected to occur. The cost savings expected as a result of the possible
introduction of completely new technology, being outside of the control of the company, should not be taken
into account, unless of course the company has sufficient objective evidence that this technology will be
available. The provision should be measured at Rs. 800,000.

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Gains on disposals of Assets: [Para 51]
When an obligation involves the sale of an entity's assets and the sale thereof is expected to result in a gain,
this gain should not be included in the calculation of the provision since this would reduce the provision, which
would not be consider prudent.

Example:
New legislation means that U LTD must dismantle its nuclear plant in a year's time. The dismantling is
estimated to cost Rs. 300,000 but U Ltd also expects to earn income from the sale of scrap metal from plant
of Rs. 100,000. The effects of discounting are expected to be immaterial.

Required:
Process the required journal entry to raise the provision.

Solution: Gain on disposal of assets

Debit Credit
Nuclear plant 300,000
Provision for dismantling costs 300,000

Expected costs of dismantling (i.e. the Rs 100,000 expected Income is not offset against the expected costs)

Gain will be recognized when it will be earned at the time of sale of scrap metal. (As per IAS-16)

Decommissioning liabilities and similar provisions

A company may be required to ‘clean up’ a location where it has been working when production ceases.

This is often the case in industries where companies are only granted licenses to operate on condition that
they undertake to perform future clean-up operations.

Such industries include, oil and gas, mining and nuclear power.

For example, a company that operates an oil rig may have to repair the damage it has caused to the sea
bed once the oil has all been extracted.

The normal rules apply for the recognition of a provision: a company recognizes a provision only where it
has an obligation to rectify environmental damage as a result of a past event.
A company has an obligation to ‘clean-up’ a site if:
• it is required to do so by law (a legal obligation); or
• its actions have created a constructive obligation to do so.

A constructive obligation might exist if (for example) a company has actually promised to decontaminate a site
or if it has adopted environmentally friendly policies and has made the public aware of this.

Accounting for a provision for a decommissioning liability

IAS 16 Property, plant and equipment identifies the initial estimate of the costs of dismantling and removing
an item and restoring the site upon which it is located as part of the cost of an asset.
Future clean-up costs often occur many years in the future so any provision recognized is usually
discounted to its present value.
Illustration: Initial recognition of a provision for a decommissioning liability
Debit Credit
Non-current asset X
Provision X

The asset is depreciated over its useful life in the same way as other non-current assets.

The provision is remeasured at each reporting date. If there has been no change in the estimates (i.e. the
future cash cost, the timing of the expenditure and the discount rate) the provision will increase each year
because the payment of the cash becomes one year closer. This increase is described as being due to the
unwinding of the discount.

The amount due to the unwinding of the discount must be expensed as borrowing cost.

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 “Always do your work with passion, courage, and honesty in efforts

Future cash flows and discounting: [Para 45]

The possibility that the settlement of an obligation may occur far into the future has an effect on the value of
the obligation in current day terms. The effect that the passage of time has on the value of money is often
referred to as the 'time value of money'.

The increase In the liability each year will be debited to finance charges, (As a second effect of Journal
entry) means:

Financial charge XXX

Provision XXX [Para 60]

Example:
Gujrat Prefabricators Limited (GPL) has won a contract to provide temporary accommodation for workers
involved in building a new airport. The contract involves the erection of accommodation blocks on a public
park and two years later the removal of the blocks and the reinstatement of the site.

The blocks have been built and it is now 31 December 2017 (GPL’s year-end).

GPL estimates that in two years it will have to pay Rs. 2,000,000 to remove the blocks and reinstate the site.
The pre-tax discount rate that reflects current market assessments of the time value of money and the risks
specific to the liability is 10%.

The provision that should be recognised at 31 December 2017 is as follows:

2
Rs. 2,000,000x(1.1)-
= 1,652,893
Note: if pre and post tax both rates are available then use pre tax discount rate.

Example:
A factory plant bought on 1sl January 2021 for Rs. 450,000 cash including costs of installation. The entity is
obliged to decommission the plant after a period of 3 years.
Future decommissioning costs are expected to be Rs. 399,300.
The company uses a discount rate of 10%.

Required:
Journalize all related entries.

Solution
Debit Credit
1 January 2021
Plant: cost (A) 450,000
Bank 450,000
Purchase of plant for cash
Plant (decommissioning) (A) 300,000
Provision for decommissioning 300,000
Initial recognition of the decommissioning obligation
31 December 2021
Finance charges (E) 30,000
Provision for decommissioning 30,000
Increase in liability as a result of unwinding of the discount
Depreciation (E) 250,000
Plant: accumulated depreciation 250,000
Depreciation of plant (450,000 + 300,000) / 3 years
31 December 2022
Finance charges (E) 33,000
Provision for decommissioning 33,000
Increase in liability as a result of unwinding of the discount
Depreciation (E) 250,000
Plant: accumulated depreciation 250,000
Depreciation of plant (450,000 + 300,000) / 3 years
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 Faith is Trusting ALLAH even when we don’t understand his plan.

31 December 2023
Finance charges (E) 36 300
Provision for decommissioning 36 300
Increase in liability as a result of unwinding of the discount
Depreciation (E) 250,000
Accumulated depreciation 250,000
Depreciation of plant (450,000 + 300,000) / 3 years
Provision for decommissioning 399 300
Bank 399 300
Payment in respect of decommissioning

The effect of possible new legislation [para 50]

The effect of possible new legislation is taken into consideration in measuring an existing obligation when
sufficient objective evidence exists that the legislation is virtually certain to be enacted (example from
Appendix)

Obligations can be;

If Present Obligation If Present Obligation If Possible Obligation

(an obligation that may arise in
future)
  
Recognition criteria is met. but suppose no reliable estimate No provision
  
Recognize a provision. No provision instead disclose Only disclose the event under
the obligation in notes under the the heading contingent liabilities
heading of contingent liabilities. unless possibility of outflow of
resources is remote.
Reimbursement: [Para 53]
Reimbursement means amount incurred is expected to be recovered.
It occurs when, for example, a retailer offers a guarantee to its customer, but where the manufacturer in turn
offers the retailer a counter-guarantee.

Expected reimbursement from the manufacturer (or other supplier) should:

• Only be recognized if it is virtually certain that the reimbursement will be received; and
• Should be recognized as a separate asset.

Scenario 1: There is a warranty agreement between manufacturer and customer:

In the instance where the retailer does not the offer a guarantee for faulty goods, but the manufacturer does,
faulty goods would be returned to the retailer who would then send the goods back to the manufacturer who
would then replace the goods. In this case, the retailer should not make a provision for any guarantee since
no guarantee was offered by the retailer; the retailer has no obligation, but is merely acting as an agent
between the customer and manufacturer. In such a case there is no question of any reimbursement as well.

Scenario 2: there is a warranty agreement between retailer and customer. In addition, retailer has a
counter warranty agreement with manufacturer:
A retailer may offer its customers a guarantee that is either partially or fully covered by the manufacturer. In
this case, since the retailer offers the guarantee, the retailer should make a provision for the total expected
costs of fulfilling the guarantee despite the fact that the retailer may then return the goods to the manufacturer
for a full or partial refund. There could be following three possibilities:
a) If reimbursement is virtually certain than recognize a separate receivable, which should not be set off
against the provision for the total expected costs of fulfilling the guarantee. Although the resultant asset
and liability should not be set off against each other, the income and expense may be in the Statement of
Comprehensive Income. [Para 54]
b) If reimbursement is probable, then disclose in notes to financial statements.
c) If reimbursement is only possible, then ignore the reimbursement.

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 One who remembers ALLAH is never Lonely.
Example: Reimbursements

A retailer company sells goods to its customers that are guaranteed.

Required:
State whether the retailer must raise a provision for the cost of meeting future guarantee obligations:
A. The retailer company provides the guarantee.
B. The manufacturer provides the guarantee. The retailer is not liable in any way.
C. The manufacturer provides the guarantee but the retailer company provides a guarantee irrespective of
whether the manufacturer honors his guarantee.
D. The manufacturer and retailer company provides a joint guarantee and jointly & severally accept
responsibility for the guarantee.
E. The manufacturer and retailer company provide a joint guarantee, whereby they share the costs of fulfilling
the guarantee. The retailer is not liable for amounts that the manufacturer may fail to pay.

Solution:
A. The retailer has the obligation and must therefore raise the provision.
B. The manufacturer has the obligation. The retailer has no obligation. No provision should be raised.
C. The retailer must raise a provision for the full cost of the provision and must recognize a separate
reimbursement asset to the extent that it is virtually certain to receive the reimbursement.
D. The portion of the costs that the retailer is expected to pay is recognized as a provision, whereas the portion
of the costs that the manufacturer is expected to pay is disclosed as a contingent liability in case the
manufacturer does not honor his obligation.
E. The portion of the costs that the retailer is expected to pay is recognized as a provision. A contingent liability
is not disclosed for the portion for the costs that the manufacturer is expected to pay since the retailer has
no obligation to pay this amount in the event that the manufacturer does not honor his obligation.

The amount Recognized as reimbursement shall not be more than the amount of provision.
Example: Reimbursement
A retailer company estimates that it will cost Rs. 100,000 to fulfill its obligation in respect of the guarantees
offered to its customers. The manufacturer, however, offers a guarantee to the retailer company.

Required:
Show all related journal entries assuming that
A. The entire Rs. 100,000 is virtually certain of being received from the manufacturer.
B. Amount of Rs. 120,000 is virtually certain of being received from the manufacturer.

Solution:
A Debit Credit
Warranty Expense 100,000
Provision for warranty 100,000
Provision for the cost of fulfilling guarantees

Receivable from supplier 100,000

Warranty expense 100,000
Provision for guarantee reimbursements

B. The journal entries will be same as in scenario A because the reimbursement asset is not allowed to be
measured at more than amount of the provision.

Contingent Asset:
“It is a possible asset that arises from past events and whose existence will be confirmed by the future events
not wholly within the control of entity (e.g. a possible court decision in our favour)”.

Recognition Criteria:
Where the flow of economic benefits from a Contingent assets is:
• Possible or remote then the Contingent assets is simply ignored.
• Probable, a Contingent assets would be disclosed (if material) and
• Virtually Certain The asset is no longer considered to be a Contingent asset and should therefore be
recognized.

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 The Quran is for ourselves, not for our Shelves
Changes in Provisions: [Para 59]
Provision should be reviewed at each balance sheet date and adjust to reflect the best estimate.
Provision is estimated based on circumstances in existence at the time of making the provision. As
circumstances change, the amount of the provision must be reassessed and increased or decreased as
considered necessary. This adjustment is made prospectively (as a change in accounting estimate).

Example:

Cash purchase price of pant (1st January 2021) 450,000

Future decommissioning cost (the outflow expected on 31st December 20x3) as assessed
399,300
on 1st January 2021
Discount rate is 10%
Depreciation straight line to nil residual values is 3 years

On 01.01.2022, it was established that due to unforeseen prices increases, the expected future cost of
decommissioning will be Rs. 665,500.

Required: Prepare related ledgers.

Uses of Provisions: [Para 61]

A provision shall be used only for expenses for which it was created.

Other specific Issues:

Contracts:
Costs that have been contractually committed to but not yet incurred in the current year should not be
recognized as a liability since these are considered to be future costs e.g. contract for future capital
expenditures which are only disclosed in notes. One exception to this rule is an onerous contract.

Onerous Contract:
“An onerous contract is one where the unavoidable costs of meeting the obligations under the contract exceed
the benefits expected to be derived from the contract”.

In this case, the unavoidable costs should be provided for. The unavoidable costs (as per IAS-37) are the
Lower of:
• The cost of fulfilling the contract and
• The compensation or penalties that would be incurred if the contract were to be cancelled.[Para 68]

Example: Onerous Contract

Sillium Ltd entered into a contract to perform certain services.
• The total contract price is Rs. 80,000
• The estimated costs of fulfilling these contractual obligations have been recently reassessed to be Rs.
140,000. No work has yet been done
• A penalty of Rs. 30,000 is payable if the contract is to be cancelled.

Required:
Process the required journal entry.

Solution:

Contract cost 30,000

Provision for Onerous contract 30,000
Minimum cost related to an onerous contract: the cost to exist is Rs. 30,000
Whereas the expected loss is Rs. 60,000 (140,000 – 80,000)

Future Operating Losses: [Para 63]

 A provision shall not be recognized for future operating losses.
A company may forecast that it will make a substantial operating loss in the next year or years. Provision
cannot be made for future operating losses because they arise from future events and not past events.

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 Prayer isn’t For Allah, It’s for us. He doesn’t need us But we need him.

Important Consideration: The past event must:

✓ Exist independent of the entity’s future actions, i.e. if the company closed down today, would the obligation
still exist: and
✓ Always include another party (3rd party) besides the entity. The standard does, however, state that this
other party does not need to be known. (i.e. it could be the public at large). For example goods sold on
warranty to several customers.

This means that a decision made at a board meeting would not lead to a present obligation because this event
does not involve a third party and is not separate from the entity’s future actions (its future actions could be
changed if the board later decides to change its mind). If however it is communicated then a provision may be
recognized.

Disclosures:

Provision: For each class of provision; disclose the followings:

 Opening balance
 Additions due to change in estimates
 Provisions used
 Additions due to passage of time
 Unused amount reversed
 Closing balance

In addition, for each significant provision, following shall be disclose in notes to financial statements
1) Brief description of nature
2) Expected timing of settlement
3) Indication of uncertainties
4) Possibility of any reimbursement (If any).

Contingent Liabilities: For each class of contingent liability:

 A brief description of nature
 Estimate of financial effect
 Indication of uncertainties
 Possibility of reimbursement (if any)

Contingent Asset: Where contingent asset is to be disclosed, the following information is to be provided:
 A brief description of the nature of contingent asset
 An estimate of financial effect.

Restructuring Provisions: [Para 70,71, 72,80 & 81]

Restructuring is defined in IAS-37 as:
• A program that is planned and controlled by management: and
• Materially changes either:
- The scope of a business undertaken by an entity: or
- The manner in which that business is conducted.

Restructuring occurs when for example, a line of business is sold (e.g. Nestle sells a factory) or there is a
change in the management structure. In both cases, there will be a variety of costs involved: for example,
retrenchment (termination benefits) packages will probably need to be paid out and in the case of the sale of
the factory, there may be costs incurred in the removal of certain machinery.

The same definition and recognition criteria must be met before making a provision for the costs of
restructuring although IAS-37 provides further criteria to assist in determining whether the definition and
recognition criteria have been met. The constructive obligation to restructure arises only when:
(i) There must be a detailed formal plan that identifies at least the following:
- The business or part of the business affected:
- The principal location affected:
- The location, function and approximate number of employees who will be compensated for terminating
their services;
- The expenditure that will be undertaken;
- When the plan will be implemented; and

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(ii) The entity must have raised valid expectations in those affected before the end of the reporting period
that it carry out restructuring, by either having:
- Started to implement the plan; or
- Announced its main features to those affected by it.

If the company has started to implement the plan or Announced its main features to those affected by it
After the end of the reporting period but before the date of authorization of financial statements then disclose
the restructuring as a non adjusting event as per IAS 10, if material.

Costs of restructuring a business should provide for costs for only those costs that are directly associated
with the restructuring, being:
• Those that are necessary; and
• Not associated with the ongoing activities of the entity (future operating costs are not part of the provision ,
for example;
1. retaining and relocation costs for continuing staff,
2. investment in new systems ,
3. marketing;
4. expected losses on disposal of assets

Example: Restructuring Cost

A few days before year end, D Ltd announced its intension to close its shoe factory within six months of year
end. There is a detailed formal plan that lists, amongst other things, the expected cost of closure:
• Retrenchment packages (means termination benefits) costs Rs. 1,000,000
• Retraining the staff members who will be relocated to other factories Rs. 500,000
• Loss on sale of factory assets Rs. 100,000

Required:
Process the journal entry.

Solution:

Restructuring costs 1,000,000

Provision for restructuring costs 1,000,000
Provision for restructuring costs

Future repairs to assets (IAS 37 appendix)

Some assets need to be repaired or to have parts replaced at intervals during their lives.
For example, suppose that a furnace has a lining that has to be replaced every five years. If the lining is not
replaced, the furnace will break down.
AS 37 states that a provision cannot be recognized for the cost of future repairs or replacement parts, instead
of recognizing a provision, a company should capitalize expenditure incurred on replacement of an asset and
depreciate this cost over its useful life.

This is the period until the part needs to be replaced again. For example, the cost of replacing the furnace
lining should be capitalised, so that the furnace lining is a non-current asset; the cost should then be
depreciated over five years. (Note: IAS 16: Property, plant and equipment states that where an asset has two
or more parts with different useful lives, each part should be depreciated separately.)
Normal repair costs, however, are expenses that should be included in profit or loss as incurred

Contingent Liability is a
1. Possible obligation from the past events, whose existence will be confirmed only by the occurrence or
nonoccurrence of one or more uncertain future events.
2. Present obligation from the past events that is not recognized because the recognition criteria are not
met.

Example of contingent liability:

At the yearend Omnicorn is defending itself in a court case. If Omnicorn loses, then it will have to pay out Rs
3 million in fines and court fees. If they win then they will not have to pay anything. Their lawyers have advised
them that the verdict could go either way.

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 The Greatest thing a Friend can do for you is bring you closer to ALLAH

The Rs 3 million fine is a possible obligation arising out from the past event (otherwise they would not have
been in court at the yearend). But the obligation will only be confirmed by the verdict of the court. The jury’s
verdict is beyond the control of Omnicorn.

Omnicorn will not recognize the Rs 3 million. Instead it will disclose the detail of court case and the amounts
involved in the “Notes to the Financial Statements”

For example in notes a disclosure of contingent liability will look like as follows:
“Company is defending a court case. In the opinion of the lawyer its outcome is uncertain because it is
dependent on court verdict. Therefore a provision has not been recognized. If the company losses the case,
it may have to pay approximately Rs 3 million in fines.” There is no possibility of any reimbursement.

Events after the Reporting Period (IAS-10)

Some legal requirements in Pakistan relating to this topic

1. Every company in Pakistan is required to conduct an AGM of its shareholders within a period of 120
days following the close of its financial year.
2. One agenda item of AGM is to discuss and approve the financial statements.
3. At least 21 days before AGM a notice of AGM along with a signed copy of financial statements should
be dispatched to shareholders.
Overview:
Although one might assume that events that occur after the current year end should not be taken into account
in the current year’s financial statements, this is not always the case.
Events after the reporting period are defined in IAS-10 are:
• Those events, both favorable or unfavorable,
• That occurs between the end of the reporting period and the date when the financial statements are
authorized for issue.

Events after the Reporting Period

Adjusting Events Non-adjusting Events

Assume that an entity has a December year end and that the financial statements for 20x1 were completed
and ready for authorization on 25th March 20x2. In this case, the period 1st January 20x2 to 25th March 20x2,
is the post-reporting date period’, and events taking place during this period need to be carefully analyzed in
terms of this standard into one of two categories:
➢ Adjusting events and
➢ Non-adjusting events.

Examples
1. Statement of financial position date is 30-6-2014. As on reporting date there is stock costing Rs 75,000.
On July 5th, 2014 stock is damaged due to rains because of which it is sold for Rs 5,000 on 10th July, 2014.
Ans. This loss in value of stock is a non-adjusting event because the condition of loss do not exist at the
reporting date. It should however be disclosed in notes if considered material.

2. Statement of financial position date is 30-6-2014. Suppose stock costing Rs 100,000 was damaged on
June 25th, 2014. It is sold on 8th July, 2014 for Rs 20,000.
Ans. Condition of loss existed at the reporting date, therefore it is an adjusting event. Loss of Rs 80,000
should be recorded at reporting date by measuring the stock at 20,000.

3. On 20th June, 2014 factory of a debtor is destroyed by fire. On 20th July 2014, court declared the customer
insolvent and he is not able to pay anything against his debts. As on reporting date, Rs 5 million was
receivable.
Ans. Condition of loss existed at reporting date therefore it is an adjusting event. Loss of Rs 5 million
should be provided in the financial statements for the year ended 30th June, 2014.

4. Example of discovery of fraud after the reporting date which existed at the reporting date.

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Adjusting Events:
Adjusting events are defined in IAS-10 as:
Those that provide evidence of conditions that existed at the end of the reporting period. Adjusting events are
taken into account (adjusted for) when preparing the current year’s financial statements.

Example: Events after the Reporting Date

A debtor that owed Newyear Limited Rs. 100,000 at 31st December 20x2.
• Had his factory destroyed in a fire and as a result, filed for insolvency:
• A letter from the debtor’s lawyers to state that they will probably pay 30% of the balance was received in
February 20x3
• The financial statements are not yet authorized for issues
• The fire occurred during December 20x2

Required:
Explain whether the above event should be adjusted for or not in the financial statements of Newyear limited
as at 31st December 20x2. If the event is adjusting provide the journal entries.

Solution:
The event that resulted in the debtor to become insolvent was the fire, which happened before year end. This
is therefore an adjusting event. The adjustment would be as follows:

Bad Debts 70,000

Allowance for bad debts 70,000
Expected loss on debtor: (100,000 x 70%)

Please note that the event need to not to be unfavorable to be an adjusting event, For example, a debtor that
was put into provisional liquidation at year end may reverse the liquidation proceedings during the post-
reporting date period, in which case it may be considered appropriate to exclude the value of this account from
the estimated doubtful debts and thus increase the value of the debtors at year end.

Non-Adjusting Events after the Reporting Period:

Non-adjusting events after the reporting period are defined in IAS-– 10 as:
➢ Those that are indicative of the condition that arose after the reporting period.
➢ Non-adjusting events are not taken into account (adjusted for) when preparing the current year’s financial
statements, but may need to be disclosed if considered material.
➢ If the event gives information about a condition that only developed after year end, then this event has
obviously no connection with the financial statements that are being finalized. If, however, the event is so
material that non-disclosure thereof would affect the user’s understanding of the financial statements,
then, although the event is a non-adjusting one, disclosure of the event may be appropriated.

Example: Event after the Reporting Period

A debtor that owed Newyear Limited Rs. 100,000 31st December 20x2 (year-end) had their factory destroyed
in a fire.
• As a result, this debtor filed for insolvency and will probably pay 30% of the balance owing. A letter from
the debtor’s lawyers to this effect was received by Newyear Limited in February 20x3
• The financial statements are not yet authorized for issue.
• The fired occurred during January 20x3

Required:
Explain whether the above event should be adjusted for or not in the financial statements of New year Limited
as at 31st December 20x2. If the event is adjusting provide the journal entries.
Solution:
The event that caused the debtor to go insolvent was the fire, which happened after year end. This is therefore
a non-adjusting event. Disclosure of this may be necessary if the amount is considered to be material.

Dividends: [Para 12]

Dividends relating to the period under review that are declared during the post-reporting date period must not
be recognized (adjusted for) since they do not meet the criteria of a present obligation. They do not reflect a
present obligation because the obligation event is the declaration and where this declaration does not occur
before year end, it is not a past event. These must be disclosed in the notes to the financial statements.

----------( 68 )----------
 Never think that any request you have is too much for ALLAH.

Going Concern Assumption: [Para 14]

An entity will continue its business in the foreseeable future (normally 12 months after the reporting date) and
has neither the intention nor the necessity of liquidation or cease trading.
i) If business is going concern than prepare the financial statements according to the requirements of IFRS.
ii) If going concern assumption is no longer valid then financial statement shall be prepared on the basis of
market values and settlement values rather than according to relevant IFRS requirements.

The going concern assumption

A deterioration in operating results and financial position after the end of the reporting period may indicate that
the going concern presumption is no longer appropriate.
There are a large number of circumstances that could lead to going concern problems.

Example
Suppose government banned the products manufactured by the company after the reporting date but before
the date of authorization of financial statements.
It is a non-adjusting event according to the previous discussion. However, if a non-adjusting event affects
the going concern assumption of the entity, then it is treated as an adjusting event. Therefore financial
statement should be prepared according to the market and settlement values on the reporting date.
This is one important exception to the normal rule that the financial statements reflect conditions as at the end
of the reporting period.

For example:
• The financial difficulty of a major customer leading to their inability to pay their debt to the agreed schedule
if at all.
• An event leading to a crucial non-current asset falling out of use. This might cause difficulties in supplying
customers and fulfilling contracts.
• Shortages of important supplies
• The emergence of a highly effective competitor.

Disclosure: [Para 17]

The following information should be disclosed:
• The Date that the Financial Statements were Authorized for Issue;
• The Person or Persons who authorized the issue of the financial statements;
• For each material category of non-adjusting event the end of the reporting period a narrative description
of:
➢ The nature of the event; and
➢ The estimated financial effect or a statement that such an estimate is not possible

Example of Adjusting Events: [Para 9]

➢ Settlement of a court case after the reporting period that confirm that present obligation existed at the
reporting date.
➢ Sale of inventories after the reporting date may give evidence about NRV at the reporting date (if the
condition or price of stock has not changed between the reporting date and date of sale)
➢ Determining after the reporting date of cost of asset purchased or proceeds from sale before reporting
date.
➢ The discovery of fraud or error after the reporting date that shows that Financial Statement were incorrect
at the reporting date.

Example of Non-Adjusting Events: [Para 22]

➢ Destruction of plant by fire after the reporting date.
➢ Change in market value of shares after the reporting date.
➢ Commencement of major litigations after the reporting date.
➢ Acquisition or disposal of asset after the reporting date.

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 Guilt is a gift from ALLAH warning us that what
we are doing is violating our soul
Self-Test Questions
Q.1 Flyby night Limited is a delivery company that delivers packages between Durban and Johannesburg
on an overnight basis. During the past few years, the trucks have suffered a number of mechanical failures
and an increasing number of accidents. In order to reduce the cost of travelling by road, the company
purchased an aero plane at a cost of Rs 4 500,000. As a condition to its continued use, the aero plane requires
a major inspection every 10,000 flying hours. The aero plane had flown 4,000 hours since its last major
inspection on the date of purchase and has flown 273 hours since the date of purchase. Flyby night Limited
has estimated that the next major inspection is expected to cost Rs 500,000 (based on the aero plane’s
previous major inspection, which cost the seller Rs 420,000).

The following entry has been processed;

Major inspection (Asset) 500,000
Provision for major inspection (Liability) 500,000

Required:
Analyze and discuss the accounting treatment of the major inspection. Your analysis should include a
discussion of a liability, a provision and an asset.

Q.2 Leo Limited leases an industrial site close to a game reserve. The company recently obtained approval
for heavy plant and machinery to operate on the site for a period of five year. The approval is in terms
of license granted by the Minister of Environmental Affair approved the licensee because the main
activity of Leo Limited is the production of environmental friendly paper from recycled material

The plant and machinery was purchased on 1 October 20X2 for Rs 1,000,000. Installation costs of Rs 175
480 were incurred and paid over the months of October, November and December of 20X2. The plant and
machinery was in a condition necessary for it to be capable of operating in the manner intended by
management on 1 January 20x3

The plant and machinery has an estimated useful life of five years with no residual value. In terms of the
license, Leo Limited is obliged to dismantle the plant and machinery and restore the area at the end of its
useful life. Future decommissioning costs are expected to be Rs 120,000. The company uses a discount rate
of 10% to calculate the present value of the decommissioning cost.
The financial accountant prepared the Following schedule reflecting the unwinding of the discounted
decommissioning costs:

Years to
Date. 10% discount factor PV
decommissioning date
01/01/X3 5 0.621 74,520
31/12/X3 4 0.683 81,960
31/12/X4 3 0.751 90,120
31/12/X5 2 0.826 99,120
31/12/X6 1 0.909 109,030
31/12/X7 0 1.000 120,000

Required:
a) Discuss the appropriate accounting treatment for the future decommissioning costs. Your answer should
refer to the accounting framework and to the relevant accounting standards.
b) Prepare all the journal entries relating to the above transactions that would have been processed in the
accounting records of Leo Limited for the year ended 31- December 20X3
c) Prepare the relevant extracts from the income statement of Leo Limited for the year ended 31 December
20X4 and from the balance sheet at 31 December 20X4.

Comparatives are required.

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 ALLAH makes the impossible, Possible.
Solutions
A.1 Flyby Night
Is the future major inspection an asset:

The future major inspection does not, meet the definition of an asset:
• The company does not control a resource since the major inspection has not yet been performed;
• There is no past event since the major inspection is to be performed in the future;
• If there is no resource there can be no expectation of an inflow of future economic benefits.

Is the future major inspection as a liability:

Similarly, a provision for the future major inspection should not be raised because there is no liability:
• Since the major inspection has not yet occurred, there is no past event;
• Therefore there is no present obligation at year end (the major inspection could, in fact, be completely
avoided by selling or otherwise disposing off/ abandoning the airplane before the inspection becomes
necessary); and
• Since there is neither a past event nor present obligation, the outflow of future economic benefits is not
yet expected.

Assets – cost of acquisition and significant parts:

 The acquisition of an asset should be measured at the necessary cost incurred in bringing the asset to a
location and condition suitable for its intended use.
 10,000 – 4,000 = 6,000 flying hours available on the date of acquisition.
 Note that the previous major inspection performed should be recognized as a separate component to the
aeroplane asset (i.e. a significant part of) since it is significant in cost and has a different useful life to the
rest of the aeroplane parts.

Asset – subsequent measurement:

The major inspection, which is recognized as a separate significant part, is depreciated as the flying hours are
used up. Thus a ‘major inspection’ asset of Rs 252,000 (Rs 420,000 [cost of previous inspection] x 6000 hrs /
10,000 hrs) should be recognized on acquisition date. This will result in the cost of the ‘physical aeroplane’
asset being Rs 4 248,000 (Rs 4 500,000 – Rs 252,000). The ‘major inspection’ asset will have been
depreciated by Rs 11 466 since purchase date (Rs 252,000 x 273 hours / 6,000 hours). Once the 6,000 flying
hours that were available on purchase date are used up, and a new inspection is actually performed, the
previous major inspection cost asset will be derecognized and the new inspection costs will be
capitalised(when the next inspection is performed) and depreciated over the future flying hours.

Conclusion:
The journal must be reversed as follows:
DEBIT CREDIT
PARTICULARS
(Rs.) (Rs.)
Provision for Major Inspection (Liability) 500,000
Major Inspection (asset) 500,000

A.2
a) Appropriate Accounting Treatment for the cost of Future Decommissioning:
The issue is to determine whether to recognize a provision in respect of future decommissioning costs.
The licence granted allows the operation of the plant and machinery but includes a clause that requires
the entity to dismantle the plant and restore the area in the future. There is therefore a legal obligation for
the costs associated with the future dismantling and restoration.

A past event that leads to present obligation is called as obligating event. The obligating event is the
installation of plant and machinery in terms of this licence and thus there is a legal obligation present at
the year end. Since there is a:
i. Past Obligating Event: The installation of plant that leads to present obligation because of licence.
ii. There is a probability of cash outflow of resources; and
iii. A reliable estimate can be made (i.e 120,000 but it should be on the basis of present value.)

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 Be Patient – For what was written for you
was written by the greatest of writers
Therefore provision should be recognized and must be capitalized as per IAS-16 to the cost of plant and
machinery (because this obligation gives the company access to an inflow of resources from the related plant
and machinery).

Note: Decommissioning and dismantling are two terms that are used frequently in the accounting world for the
deinstallation of plant and machinery.

b) Journal Entries
1-10-2003
Plant 1,000,000
Cash 1,000,000
31-12-2002
Plant 175,480
Cash 175,480
1-1-2003
Plant 74,520
Provision for decommissioning 74,520
(At PV of Future cash outflow)
31-12-2003
Finance Cost 7,440
Provision for Decommissioning 7,440

(74,520-81,960)
31-12-2003
Depreciation 250,000
Acc Depreciation 250,000
(1,175,480+74,520)÷5

c) Extracts from Income Statements

For the year ended 31-12-2004
2004 2003
Finance Cost (8,160) (7,440)
Depreciation (250,000) (250,000)

Statement of Financial Position (Extracts)

As on 31-12-2004
2004 2003
Non-Current Assets
Plant 1,250,000 1,250,000
Acc Depreciation (500,000) (250,000)
750,000 1,000,000
Equity & Liability

Non-Current Liabilities
Provision for Decommissioning 90,120 81,960

----------( 72 )----------
EXTRA PRACTICE QUESTIONS
Question No. 1
The following information pertains to Zamil Limited (ZL) for the year ended 31 December 2014:
(a) On 20 December 2014, ZL lodged a claim of Rs. 10 million with one of its vendors for supply of inferior
quality goods. On 1 February 2015, the vendor agreed to adjust Rs. 6 million against future purchases
of ZL. For the remaining claim amount, ZL took up the matter with vendor’s parent company in UK and
it is probable that 70% of the remaining claim would be recovered. (04)
(b) In February 2015, it was revealed that ZL’s cashier withdrew Rs. 10 million fraudulently from ZL’s bank
accounts. Of these, Rs. 7 million was withdrawn before 31 December 2014. ZL and its insurance
company reached an agreement for settlement of the claim at Rs. 8 million. (05)
(c) In October 2014, ZL decided to relocate its production unit from Sukkur to Karachi. In this respect, a
detailed plan was approved by the management and a formal public announcement was made on 1
December 2014. ZL has planned to complete the relocation by the end of June 2015. the related costs
have been estimated as under:
Rs. In million
Redundancy cost 3.58
Relocation of staff to Karachi 6.45
Staff training 0.86
Salary of existing operation manager (responsible to supervise the relocation) 1.20
6.09

(d) In December 2014, a citizen committee of the area met with the directors of the company and lodged a
complaint that ZL’s vehicles carrying chemicals are not fully equipped with the safety equipment and
resultantly creating serious threats to health of the residents. The management held a meeting in this
regard on 25 December 2014 and decided to install the safety equipment in its vehicles.
The estimated cost of installing the equipment is Rs. 25 million. The company has neither legal
obligation nor any published policy regarding installation of such safety equipment in its vehicles. (04)
Required: Discuss how each of the above issues should be dealt with in ZL’s financial sttements for the year
ended 31 December 2014. (Quantify effects where practicable) (Spring 15, Q#3)

Question No. 2
Walnut Limited (WL) is engaged in the business of import and distribution of electronic appliances. The
following events took place subsequent to the reporting period i.e. 31 December 2011:
(i) On 15 January 2012, one of WL’s competitors announced launching of an upgraded version of DVD
players. WL’s inventories include a large stock of existing version of DVD players which are valued at
Rs. 15 million. Because of the introduction of the upgraded version, the net realizaable value of the
existing version in WL’s inventory at 31 December 2011 has reduced to Rs. 12.5 million.
(ii) On 20 December 2011, the board of directors decided to close down the division which imports and
sells mobile sets. This decision was made public on 29 December 2011. However, the business was
actually closed on 29 February 2012.
Net costs incurred in connection with the closure of this division were as follows:

Rs. In million
Redundancy costs 1.50
Staff training 0.15
Operating loss from 1 July 2011 to closure of division 0.80
Less: profit on sale of remaining mobile sets (0.50)
1.95

(iii) On 16 January 2012, LED TV sets valuing Rs. 3 million were stolen from a warehouse. These sets were
included in WL’s inventory as at 31 December 2011.

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 “Before going to sleep every night Forgive everyone and sleep with Clean Heart”

(iv) WL owns 9,000 shares of a listed company whose price as on 31 December 2011 was Rs. 22 per share.
During February 2012, the share price declined significantly after the government announced a new
legislation which would adversely affect the company’s operations. No provision in this regard has been
made in the draft financial statements.
(v) On 31 January 2012, a customer announced voluntary liquidation. On 31 December 2011, this customer
owed Rs. 1.5 million.
(vi) On 15 February 2012, WL announced final dividend for the year ended 31 December 2011 comprising
20% cash dividend and 10% bonus shares, for its ordinary shareholders.
Required:
Describe how each of the above transactions should be accounted for in the financial statements of Walnut
Limited for the year ended 31 December 2011. Support your answer in the light of relevant International
Financial Reporting Standards. (16)
(Spring 12, Q.3)
Question No. 3
A factory worker of Industrial Chemicals Limited (ICL) was seriously injured on 10 June 2015 during a
production process. Subsequent developments in this matter are as follows:
(i) On 26 July 2015, the worker filed a claim for Rs. 25 million and alleged violation of safety measures on
the part of ICL. The lawyers of ICL anticipate that there is 60% probability that the court would award
Rs. 12 million and 40% likelihood that the amount would be Rs. 8 million.
(ii) According to the terms of the insurance policy, ICL filed a claim of Rs. 18 million which was principally
accepted by the insurance company on 5 august 2015 to the extent of Rs. 14 million. ICL is negotiating
with the insurance company and it is probable that ICL would recover a further sum of Rs. 2 million.
(iii) On representation by the Labour Union, the management is considering to pay to the affected worker
an amount of Rs. 1.5 million, in addition to the compensation that may be awarded by the court.
Required:
Explain accounting treatment and the disclosure requirements in respect of the above matters in ICL’s financial
statements for the year ended 30 June 2015. Support your answer by referring to the relevant guidelines
contained in International Financial Reporting Standards. (12)

Q. 4 The following information pertains to Neptune Limited (NL) which is engaged in the manufacturing
of batteries and chemicals:

(a) In July 2015, NL was sued by a customer who claimed damages of Rs. 2 million on account of supply
of 2000 defective batteries in January 2015. The legal advisor at that time anticipated that it is probable
that the case would be decided in favour of the customer.

In March 2016, an independent team submitted a report to the Court showing that 80% of the batteries
were not faulty and there were minor defects in the remaining batteries. As a result, the company's
lawyer formed the view that it was highly unlikely that the Court would award compensation to the
customer.
On 5 July 2016, the Court decided the suit and ordered NL to replace all (20%) the faulty
batteries supplied to the customer.
(05)
(b) In July 2014, NL entered into a two year contract with a supplier of raw material. With effect from 1
November 2014, the supplier stopped the supply of raw material and demanded price increase of 30%.
Due to stoppage of supply, NL was unable to meet its sales orders. NL filed a suit claiming damages of
Rs. 40 million from the supplier on 15 June 2015. On 30 June 2015, NL’s lawyer anticipated that NL
would be awarded damages up to 60% of its claim.

On 15 August 2016 the Court decided the case in favour of NL and awarded damages
of Rs. 30 million to the company. (05)

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(c) On 30 April 2015, NL’s Board of Directors decided to dispose of the chemical division which was
incurring heavy losses. The decision was made public on 10 December 2015. NL commenced
negotiations with Venus Limited in March 2016. The sale was finally executed on 31 July 2017.

Costs incurred during the months of July and August 2016 in connection with the closure of the division
were as follows:

Rs. in million
Redundancy cost 10.5
Staff training for relocation to battery segment 3.5
Operating loss from 1 July 2016 till closure of business 2.0 (05)

Required:
Discuss giving reasons how each of the above issues should be dealt with in the financial statements of NL
for the years ended 30 June 2015 and 2016 in accordance with the requirements of International Financial
Reporting Standards.

(Statements are authorized for issue three months after the year-end)

Q.5 Oval Limited (OL) deals in medicines and surgical instruments. OL is in the process of finalizing its
financial statements for the year ended 31 December 2018. Following matters are under consideration:
(i) OL sells instruments A-1 and B-1 with 1-year warranty. These units are purchased from a manufacturer
Star Limited (SL). The details of warranty are as under:

A-1: SL provides warranty services to the customers and recovers 50% of the cost from OL. However,
in case of SL’s default, the warranty services would have to be provided by OL.
B-1: OL provides warranty services to the customers and recovers the entire cost from SL.

On 31 December 2018, it is estimated that total cost of Rs. 4 million and Rs. 7 million would be incurred
in next year for providing warranty services for A-1 and B-1 respectively sold in 2018.

(ii) In October 2018, OL was sued by a customer for Rs. 18 million on account of supply of substandard
surgical instruments.

By end of the year, OL communicated to the customer via email to pay Rs. 5 million. In respect of the
remaining amount of the claim, OL’s lawyers anticipate that there is 70% probability that the court would
award Rs. 6 million and 30% probability that the amount would be Rs. 4 million.

OL lodged a claim with the supplier in December 2018. The supplier principally accepted the claim to
the extent of Rs. 9 million. However, OL is still negotiating with the supplier and it is probable that OL
would recover a further sum of Rs. 3 million.

(iii) OL has imported 7,000 units of a medicine at a cost of Rs. 70 million. However, in November 2018, a
study was published in a medical journal which reveals that results of an alternate medicine are much
better. At year end, 5000 units were in stock. On 25 January 2019, 4000 units were sold at Rs. 8,000
per unit. OL also paid 10% commission.

Required:
Discuss how the above issues should be dealt with in the financial statements of OL for the
year ended 31 December 2018. Support your answers in the context of relevant IFRSs. (12)

Question 6: Multan Petrochem Limited (MPL) operates in the oil extraction and refining business and is
preparing its draft financial statements for the year ended 31 December 2016. The following information has
been collected for the preparation of the provisions and contingencies notes.
(1) A new site was acquired on 1 January 2015 and is being used as the site for a new oil refinery. Initial
preparation work was undertaken at the site at the start of 2015 and the oil refinery was completed and
ready for use on 31 December 2015. The new refinery was expected to have a useful life of 25 years.
MPL has a well-publicised policy that it will reinstate any environmental damage caused by its activities.
The present value of the estimated cost of reinstating the environment is Rs. 1,300,000 for damage
caused during the initial preparation work. This amount is based on a discount rate of 8%.

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(2) An explosion at one of MPL’s oil extraction plants on 1 July 2016 has led to a number of personal injury
claims being made by employees who were injured during the explosion. Five claims have been made
to date but if these claims are successful, it is likely that a further three employees who were also injured
will make a claim. MPL’s lawyers estimate that it is probable that the claims will succeed and that the
estimated average cost of each payout will be Rs. 150,000. The lawyers have recommended that MPL
settles the claims out of court as quickly as possible at their estimated amount for all eight employees
injured to avoid any adverse publicity.
An additional two claims have been made by employees for the stress, rather than injury, that the
explosion has caused them. If these claims were to succeed the lawyers have estimated that the likely
payout would be around Rs. 10,000 per employee. However, the lawyers have stated that they believe
it to be unlikely that these employees will win such a case.
MPL made an insurance claim to try to recover the personal injury costs that it is probable that it will
incur. The claim is now in its advanced stages and the insurance company has agreed to meet the cost
of the claims in full. The insurance company will refund MPL once the claims have been settled.
(3) The future of MPL’s business operations is in doubt following the explosion at the oil extraction plant.
The national press criticised MPL for the way that it handled the problem. To address this, on 1 October
2016 MPL paid Rs. 12,000 to a risk assessment specialist who has recommended introducing a new
disaster recovery plan at an estimated cost of Rs. 500,000.

(4) MPL entered into a lease in the previous period for some office space. However, the company’s plans
changed and the office space was no longer required. At 1 January 2016 a correctly calculated provision
had been made for the future outstanding rentals of Rs. 80,000 for the remaining five years. This was
based on a discount rate of 8%. The rent paid during the period was Rs. 15,000. In addition, MPl has
signed a sub-lease to rent out the space for the first six months of next year for total rental income of
Rs. 6,000. No other tenants are expected to be found for the office space.
Required:
(a) Prepare the provisions and contingencies notes for inclusion in the financial statements of MPL for the
year ended 31 December 2016.
(b) List the amounts that should be recognised in the statement of profit or loss for the year ended 31
December 2016.

Question 7: Sahiwal Transformers Ltd (STL) is organised into several divisions. The following events relate to
the year ended 31 December 2017.

1. A number of products are sold with a warranty. At the beginning of the year the provision stood at Rs.
750,000.
A number of claims have been settled during the period for Rs. 400,000.
As at the yearend there were unsettled claims from 150 customers. Experience is that 40% of the claims
submitted do not fulfil warranty conditions and can be defended at no cost.
The average cost of settling the other claims will be Rs. 7,000 each.

2. A transformer unit supplied to Rahim Yar Khan District Hospital exploded during the year. The hospital has
initiated legal proceedings for damages of Rs. 10 million against STL.
STL’s legal advisors have warned that STL has only a 40% chance of defending the claim successfully.
The present value of this claim has been estimated at Rs. 9 million.
The explosion was due to faulty components supplied to STL for inclusion in the transformer. Legal
proceedings have been started against the supplier. STL’s legal advisors say that STL have a very good
chance of winning the case and should receive 40% of the amount that they have to pay to the hospital.
3. On 1 July 2017 STL entered into a two-year, fixed price contract to supply a customer 100 units per month.
The forecast profit per unit was Rs. 1,600 but, due to unforeseen cost increases a n d production
problems, each unit is anticipated to make a loss of Rs. 800.
Required:
Prepare the provisions and contingencies note for the financial statements for the year ended 31 December
2017, including narrative commentary.

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 Be somebody in the eyes of ALLAH, even if you are nobody in the eyes of people.

Solutions:
Answer No. 1
(a) Claim for supply of inferior quality goods
• Claim to the extent of Rs. 6 million is accepted by the vendor, therefore, a claim would be
recognized as an asset by ZL as it is virtually certain that it will be received.
• For the probable claim amount of Rs. 2.8 million [(10 – 6) × 70%].
- a contingent asset amounting to Rs. 2.8 million should also be disclosed, giving a brief
description of the contingent asset at the end of the reporting period.
• Recovery of Rs. 1.2 million (10 – 6) × 30% is not probable, therefore, it would not be accounted
for or disclosed.
(b) Withdrawal of funds from ZL’s bank accounts fraudulently
• Cash withdrawal before 31 December 2014 amounted to Rs. 7 million for ZL’s bank accounts is
an adjusting event as the event existed on 31 December 2014 though it was revealed after the
year end. Cash lost to the extent of 80% is certain to be received, therefore a claim of Rs. 5.6
million (7 x 80%) would be recognized as an asset. Remaining amount of Rs. 1.4 million (7 x 20)
is no more receivable, therefore, it would be charged to profit and loss account for the year ended
31 December 2014.
Loss 1.4
Receivable 5.6
Bank 7
• Cash withdrawal of Rs. 3 million is a non-adjusting event as it occurred after year end. However,
if the event is considered to be material, a disclosure should be made along with the expected
insurance claim their against.
(c) Relocation of unit from Sukkur to Karachi
• A provision for restructuring cost is to be recognised, as a formal restructuring plan has been
finalised and approved by the management and a formal public announcement was made prior
to 31 December 2014. Therefore, a constructive obligation has arisen on 1 December 2014.
• However, a provision should only be made for redundancy cost of Rs. 3.58 million as it pertains
to the closing of Sukkur unit.
• Costs for staff training and relocation of staff relate to future conduct of the business and should
not be recorded in the year ended 31 December 2014.
• Salary of the existing operation manager should not be recorded as it is not incremental cost of
restructuring and would be incurred whether relocation takes place or not.
(d) Installation of safety equipment to carrying vehicles of ZL:
• For the year ended 31 December 2014, ZL is not required to make any provision for liability due
to non installation of safety equipment to its chemical carrying vehicles. As
- There is no law requiring ZL to install the safety equipment.
- There is no constructive obligation to install the safety’ equipment, since ZL has neither
past practice nor any published policy in this respect.
• Although, decision has been made on 25 December 2014 to install the safety’ equipment, cost
would only be recorded on actual incurrence of cost, i.e purchase and installation of safety
equipment.

Answer No. 2
i. It is a non-adjusting event as introduction of a new version of DVD Player after the reporting period is
indicative of conditions that arose after the reporting period. Therefore, the price decrease will not
affect NRV.
However, if decrease in the value of inventory after the reporting period is material, it should be
disclosed in the financial statements.----------( 77 )----------
ii. The provision should be recognized because the obligating event is the communication of event to
the public which creates a valid expectation that the division will be closed.
However, the provision should only be recognized to the extent of redundancy cost.
IAS prohibits the recognition of future operating losses, staff training and profits on sale of assets.
iii. Entry

Dr. Cr.
Restructuring expenses Rs. 1.50
Provision for restructuring expenses Rs. 1.50

Additionally, operating loss of Rs. 0.20 million (i.e. 0.80 × 2/8) for 2012 will be disclosed as under:
Disclosures:
Nature of event: Future operating losses will be incurred in 2012.
Amount: Rs. 0.20 million.
iv. This is a non-adjusting event because the burglary and theft of consumable stores occurred after
reporting date.
However, if the event is material, it should be disclosed in the financial statements unless the loss is
recoverable from the insurance company.
v. Disclosures
Nature of event: LED TV sets were stolen from a warehouse.
Amount: Rs. 3 million.
vi. The drop in value of investment in shares is a non-adjusting event. Since the legislation was
announced after the reporting date, the event is not a past event. However, if the amount is material,
it should be disclosed in the financial statements.
vii. This is an adjusting event as it provides evidence of conditions that existed at the end of the reporting
period. The insolvency of a debtor and the inability to pa usually builds up over a period of time and it
can therefore be assumed that it was facing financial difficulty at year-end. A bad debts expense of
Rs. 1.5 million should be recognized in income statement.
viii. It is a non-adjusting event because the declaration was announced after the year-end and there was
no obligation at year end. Details of the bonus shares declaration must, however, be disclosed.
ix. Disclosures
Nature of event: Share price declined significantly.
Amount: Decrease in per share value - -------

Answer No. 3
Industrial Chemicals Limited
Accounting treatment and disclosures for the year ended 30 June 2015
Provisions and contingent liability:

According to IAS 37, a provision shall be recognised when all the following conditions are met:
• There is a present obligation (legal or constructive) as a result of past event.
• It is probable that outflow of resources will be required to settle the obligations.
• A reliable estimate can be made of the amount of the obligations.

In view of the above, a provision shall be made to the extent the above conditions are met as explained under:
(i) Rs. 10.4 million (12 × 60% + 8 × 40%) for the pending claim of the worker on expected value basis and
12 million on most likely basis that ICL would require to pay this amount as advised by ICL’s lawyers.
For the remaining amount of Rs. 14.6 million (25 – 10.4), it is not probable that an outflow of economic
benefits will be required. Therefore, a contingent liability would be disclosed giving information as under:

• A brief nature of the contingent liability.

• Where practicable an estimate of finance liability and indication of uncertainties; and
• The possibility of any reimbursement

----------( 78 )----------
(ii) As regards the additional compensation of Rs. 1.5 million under consideration of the management,
neither provision nor disclosure shall be made as the obligation is neither legal nor constructive as the
matter is still under consideration and no formal intimation was made that may create a valid expectation
in this respect.

(iii) Reimbursements:
According to IAS 37, where some or all of the expenditure required to settle a provision is expected to
be reimbursed by another party:
• The reimbursement shall be recognized where it is virtually certain that reimbursement will be
received.
• The amount recognized in respect of the reimbursement shall not exceed the amount of
provision.
• The reimbursement receivable shall be treated as a separate asset.
In view of the above, accounting treatment and disclosure in respect of insurance claim will as under:
• Insurance claim to the extent of Rs. 14 million is accepted in principle by the insurance company;
therefore, it will be taken as ‘virtually certain to be received’. However, the insurance claim to be
recognized as receivable shall be restricted to Rs. 10.4 million for which the provision is recorded.
• Recovery of the insurance claim to the extent of Rs. 2.0 million is probable, therefore, a
contingent asset would be disclosed for this amount giving information as under:
➢ A brief nature of the contingent asset; and
➢ An estimate of financial effect and indication of uncertainties.
A.4
(a) 2015 Financial Statements:
NL should have made a provision of Rs. 2 million because:
(i) NL had a present obligation as a result of past event;

(ii) The validity of customer's claim was confirmed by the company's lawyer which shows that an outflow
will be required to settle the obligation
(iii) A reliable estimate of the amount of outflow was available.

2016 Financial Statements:

The settlement of the case in July 2016 was an adjusting event for the year ended 30 June 2016. The
provision created in 2015 is to be reversed. The company should revise the provision keeping in view of
the cost of replacement.

(b) 2015 Financial Statements:

NL should disclose the recoverable damages as contingent assets because:
a. IFRS does not allow recognition of a contingent asset in the financial statement;

b. an inflow of economic benefits is probable and is confirmed by the company's lawyer

c. NL should disclose the brief description of the nature of contingent assets and an estimate of their
financial effect i.e. inflow of Rs. 24 million.

2016 Financial Statements:

Since this is an adjusting event as subsequent to year ended 30 June 2016, the court has decided to
award a compensation of Rs. 30 million. After the court's order recovery of Rs. 30 million is virtually
certain, as a result, it is no longer a contingent asset and it should be recognized as an asset.

2015 Financial Statements:

Neither provisions nor disclosure should be made as there is no constructive or legal obligation as on 30
June 2015 because:
▪ NL has no detailed formal plan for the disposal
▪ NL has not made its decision public and consequently did not raise any valid expectation in those
affected

----------( 79 )----------
 2016 Financial Statements:
The provision should be recognized because the obligating event is the communication of the plan to the
public which creates a valid expectation that the division will be closed.

However, the provision should only be recognised to the extent of redundancy cost. IAS-37 prohibits the
recognition of future operating losses and staff training costs.

Ans.5
(i) As on 31 December 2018, OL should recognize a provision for warranty service to be provided as
there is a present obligation as a result of a past event (sale of A-1 and B-1 in 2018). The amount of
provision would be:
• Rs. 2 million (4×50%) in respect of A-1 as OL is liable to SL for 50% cost of services.
• Rs. 7 million (entire cost) in respect of B-1 as OL is responsible to the customers for providing
warranty services.
OL is required to disclose a contingent liability for remaining warranty cost of (which should be incurred
by SL) as OL would be responsible for it in case of default. (Joint and several liability)

Further OL should recognize a separate asset (receivable) to the extent that reimbursements from SL
in respect B-1 are virtually certain. In the statement of profit or loss, the expense relating to warranty
services may be presented net of the amount recognized as receivable (reimbursement). If however,
reimbursement is only probable then disclose.

(ii) As on 31 December 2018, OL is required to record a liability of Rs. 5 million as this has already been
approved by OL. In respect of remaining amount of the claim, a provision of Rs. 5.4 million (6 x 70%
+ 4 x 30%) or 6 million based on most likely basis, shall be made as it is most likely that OL would
require to pay this amount as advised by OL’s lawyers.

Further OL should recognize a separate asset (receivable) to the extent of Rs. 9 million as it is
accepted in principle by the supplier. Therefore, it will be taken as ‘virtually certain to be received’. In
the statement of profit or loss, the expense relating to the provision may be presented net of amount
recognized as receivable (reimbursement).

However, recovery of the claim to the extent of Rs. 3 million is probable, therefore, a contingent asset
would be disclosed.

(iii) Introduction of new alternative drug with better results is an indication of reduction in value of existing
medicine kept in stock. It is more evident by subsequent sales of such units at lower price i.e. Rs.
8,000 with 10% commission to distributors. According to IAS 2, inventory should be recorded at lower
of cost or NRV (i.e. estimated selling price less estimated costs necessary to make the sale). So OL
is required to carry entire stock of this medicine at NRV i.e. Rs. 36 million [5,000×7,200 (8,000 – 800)]
as against the cost of Rs. 50 millions (5,000 x 70,000,000/7,000)

Answer 6: Part (a) Provisions and contingencies

Environmental Legal Onerous Total

damage claims lease
At 1 Jan 2016 1,300,000 – 1,300,000
Provision made - - 80,000 80,000
Unwinding of the discount (8%) 104,000 6,400 110,400
Utilised in the year – – (15,000) (15,000)
Charge/(credit) to statement of
profit or loss (150,000 x 8) – 1,200,000 (6,000) 1,194,000

At 31 Dec 2016 (W) 1,404,000 1,200,000 65,400 2,669,400

----------( 80 )----------
 Stay close to anything that reminds you of ALLAH
Environmental damage

The provision in respect of the environmental damage relates to restoration of land following the initial ground
work undertaken to set up a new oil refinery. The company has an advertised policy that it will restore all
environmental damage caused by its business operations. The provision is based on the estimated cost of
reinstating the environmental damage caused and is not likely to be paid until 2040.
Legal claims
During the year an explosion at one of the company’s oil extraction plants caused a number of employees to
suffer injury. This provision is to cover personal injury claims made by the individuals concerned. The provision
is based on lawyers’ best estimate of the likely amount at which the claims can reasonably be settled. It is
hoped that the claims will be settled in the next financial year. It is expected that the full amount of these claims
will be reimbursed by an insurance company following their payment.
Onerous lease
The company has an ongoing lease obligation in respect of office space that is not being utilised by the
company. The outstanding lease liability at the year-end was Rs. 65,400 and the lease has another four years
to run. MPL has found a tenant for the office space on a six-month lease and this will reduce the outstanding
obligation by Rs. 6,000 in 2017.

Contingent liability
Following the explosion at the oil extraction plant a number of employees have made claims againstthe company
for undue stress. Based on lawyers’ advice the company do not believe that it is probable that a court case
against the company will be decided. If such a case was to be succeded the estimated payout in total is Rs.
20,000 (10,000 x 2).
Workings
Personal injury claims: 8 × 150,000 = 1,200,000

Part (b)
Summary of amounts included in income statement for year ended 31 December 2016

Operating costs: Rs.

Movement in provision (1,200,000 – 1,200,000) 0
Consultancy fees 12,000
Provision for onerous contract (80,000-6,000) 74,000
Depreciation on oil refinery environmental damage (1,300,000 ÷ 25yrs) 52,000
Borrowing costs
Unwinding of the discount (104,000+6,400) 110,400

Answer 7:
Legal Onerous
Warranty Total
claim contract
Rs. 000 Rs. 000 Rs. 000 Rs. 000
At 1 January 2017 750 nil nil 750
Used in the year (400) (400)
Statement of profit or loss
(balance) 280 9,000 1,440 10,720
At 31 December 2017 630 9,000 1,440 11,070
W1 W2
Warranty: The company grants warranties on certain categories of goods. The measurement of the provision
is on the company’s experience of the likelihood and cost of paying out under the warranty.

Legal claim: The legal claim provision is in respect of a claim made by a customer for damages as a result of
faulty equipment supplied by the company. It represents the present value of the amount at which the
company's legal advisors believe the claim is likely to be settled.
----------( 81 )----------
Onerous contract: The provision for the onerous contract is in respect of a two-year fixed-price contract which
the company entered into on 1 July 2017. Due to unforeseen cost increases and production problems, a loss
on this contract is now anticipated. The provision is based on the amount of this loss up to the end of the
contract.

Contingent asset: The company is making a claim against a supplier of components. These components led
in part to the legal claim against the company for which a provision has been made above. Legal advice is that
this claim is likely to succeed and should amount to around 40% of the total damages (Rs. 9 millions x 40% =
3.6 million).

W1 Warranty provision: 150 x 60% x Rs. 7,000 = Rs. 630,000.

W2 Onerous contract: 18 months (from jan 2018 to june 2019) x 100 units x Rs. 800 =
Rs. 1,440,000 (actual loss of past six months would have already been
recognized).

----------( 82 )----------
Further Practice
Example 01:
Question: Earley Inc is finalising its accounts for the year ended 31 December 2014. The following events
have arisen since the year end and the financial director has asked you to comment on the final accounts.
(a) At 31 December 2014 trade receivables included a figure of Rs. 250,000 in respect of Nedengy Inc.
On 8 March 2015, when the current debt was Rs. 200,000, Nedengy Inc went into receivership. Recent
correspondence with the receiver indicates that no dividend will be paid to unsecured creditors (means
no further amount would be received).
(b) On 15 March 2015 Earley Inc sold its former head office building, for Rs. 2.7 million. At the year end the
building was unoccupied and carried at a value of Rs. 3.1 million.
(c) Inventories at the year-end included Rs. 650,000 of a new electric tricycle, the Opasney. In January
2015 the European Union declared the tricycle to be unsafe and prohibited it from sale. An alternative
market, in Bongolia, is being investigated, although the current price is expected to be cost less 30%.
(d) Stingy Inc, a subsidiary in Outer Sonning, was nationalised in February 2015. The Outer Sonning
authorities have refused to pay any compensation. The net assets of Stingy Inc have been valued at
Rs. 200,000 at the year end.
(e) Freak floods caused Rs. 150,000 damage to the Southcote branch of Earley Inc in January 2015.
The branch was fully insured.
(f) On 1 April 2015 Earley Inc announced a 1 for 1 rights issue aiming to raise Rs. 15 million.

Required:
Explain how you would respond to the matters listed above.

Answer:

(a) IAS 10 Events After the Statement of financial position Date states that assets and liabilities should be
adjusted for events occurring after the statement of financial position date that provide additional
evidence relating to conditions existing at the statement of financial position date. It specifically includes
the example of bad debts, where evidence of bankruptcy of a debtor occurs after the year end.
In this case, Nedengy appears to have recovered part of the debt and as such only Rs.200,000 needs
to be provided. It may be argued that the receivership has occurred as a result of events occurring after
the statement of financial position date, as a result of a change in legislation for example, but this is
unlikely.
(b) It is likely that the fall in the value of the property will fit the IAS 10 definition of adjusting events noted
in (a) above, unless, again, it can be argued that the decline in the property market occurred after the
year-end.
IAS 36 Impairment of assets and IAS 16 Property, Plant and Equipment require that the carrying amount
of property, plant and equipment should be reviewed periodically in order to assess whether the
recoverable amount has fallen below the carrying amount. Where it has, the property, plant and
equipment should be written down to the recoverable amount, either through the statement of profit or
loss as an expense, or though other comprehensive income to revaluation reserve in shareholder’s
equity, but only to the extent that the balance on the revaluation reserve relates to a previous revaluation
surplus on the same asset.
(c) IAS 2 Inventories requires that inventories be stated at the lower on cost and net realisable value. Net
realisable value is the estimated selling price in the ordinary course of business less the estimated
costs of completion and the estimated costs necessary to make the sale. It should only be disclosed in
current year.
Unless Earley was making a significant margin on the tricycles, it is likely that the reduction in selling
price of 30% will necessitate a write- down to net realisable value, especially considering the
transportation costs to Bongolia which must be included. If the Bongolian option is unlikely to proceed,
it may be necessary to write the tricycles down to scrap value.
(d) Under IAS 10, the nationalisation is likely to be regarded as a non-adjusting event that merely requires
disclosure in the financial statements. The loss of the investment should be accounted for in the year
in which it occurred, but disclosed in the current year.
----------( 83 )----------
 If the loss of the subsidiary results in Earley no longer being a going concern, then the event becomes
an adjusting event
(e) As per IAS 10, Non adjusting events are those post reporting date events the conditions of which arise
after reporting date, in the given situation the loss amounting Rs.150,000 due to floods in January 2015
i.e. after reporting date, hence the same may be disclosed as non- adjusting event.
(f) As per IAS 10, Non adjusting events are those post reporting date events the conditions of which arise
after reporting date. Since the declaration was announced after year-end, there is no past event and
no obligation at year-end, hence the same may be disclosed as non- adjusting event.

Example 02:
Question: You have been asked to advise on the appropriate accounting treatment for the following situations
arising in the books of various companies. The year end in each case can be taken as 31 December 2015
and you should assume that the amounts involved are material in each case.
(a) At the year end there was a debit balance in the books of a company of Rs. 15,000, representing an
estimate of the amount receivable from an insurance company for an accident claim. In February 2016,
before the directors had agreed the final draft of the published accounts, correspondence with lawyers
indicated that Rs. 18,600 might be payable on certain conditions.
(b) A company has an item of equipment which cost Rs. 400,000 in 2012 and was expected to last for ten
years. At the beginning of the 2015 financial year the book value was Rs. 280,000. It is now thought
that the company will soon cease to make the product for which the equipment was specifically
purchased. Its recoverable amount is only Rs. 80,000 at 31 December 2015.
(c) On 30 November a company entered into a legal action defending a claim for supplying faulty
machinery. The company’s solicitors advise that there is a 20% probability that the claim will succeed.
The amount of the claim is Rs. 500,000.
(d) An item has been produced at a manufacturing cost of Rs. 1,800 against a customer’s order at an agreed
price of Rs. 2,300. The item was in inventory at the year-end awaiting delivery instructions. In January
2016 the customer was declared bankrupt because of an event occurred in Dec. 2015. and the most
reasonable course of action seems to be to make a modification to the unit, costing approximately Rs.
300, which is expected to make it marketable with other customers at a price of about Rs. 1,900.
(e) At 31 December a company has a total potential liability of Rs. 1,000,400 for warranty work on contracts.
Past experience shows that 10% of these costs are likely to be incurred, that 30% may be incurred but
that the remaining 60% is highly unlikely to be incurred.
Required:
For each of the above situations outline the accounting treatment you would recommend and give the
reasoning of principles involved.

Answer:
(a) IAS 37 Provisions contingent liabilities and contingent assets states that contingent gains should not be
recognised as income in the financial statements. The company has a debit balance already in its books
which indicates that it must be reasonably certain that at least part of the claim will be paid. This element
of the claim then is probably not a contingency at all. The remaining part (the difference between the
Rs.15,000 and the Rs.18,600) is, and should be disclosed and not accrued.
(b) IAS 16 Property, Plant and Equipment requires that the carrying amount of property, plant and
equipment should be reviewed periodically in order to assess whether the recoverable amount has
fallen below the carrying amount. Where it has, the property, plant and equipment should be written
down to the recoverable amount through the statement of profit or loss as an expense. In this case this
would result in the recognition of an expense of Rs.160,000. (240,000 (280,000 – 40,000) – 80,000).
(c) IAS 37 states that contingent liabilities should not be recognised. Though a provision should be made for
amounts where the company has an obligation to pay them.
The question in this case is whether or not there is an obligating event within the context of IAS 37. It
seems inappropriate to recognise a provision in respect of this amount but the possible liability should
be disclosed as a contingent liability by explaining:
(i) the nature of the contingency
(ii) the uncertainties surrounding the ultimate outcome
(iii) the likely effect, ie Rs.500,000 loss.

----------( 84 )----------
(d) IAS 2 Inventories requires that inventories be stated at the lower on cost and net realisable value. Net
realisable value is the estimated selling price in the ordinary course of business less the estimated costs
of completion and the estimated costs necessary to make the sale.
In this case, cost is Rs.1,800 and net realisable value is Rs.1,600 [1,900-300]
(e) The company should set up a provision for Rs.100,040, i.e. should accrue for the 10% probable liability.
It should disclose the possible liability under contingent liabilities. The disclosure is as noted in (c) except
that the financial effect is Rs.300,120 (30% x Rs.1,000,400). The balance should be ignored as it is a
remote contingent liability.

Example 3: J-Mart Limited

Question: J-Mart Limited, a chain of departmental stores has distributed its operations into four Divisions
i.e. Food, Furniture, Clothing and Household Appliances. The following information has been extracted from
the records:
(i) The company allows the dissatisfied customers to return the goods within 30 days. It is estimated that
5%
of the sales made in June 2015 will be refunded in July 2015.
(ii) On June 2, 2015, three employees were seriously injured as a result of a fire at the company’s
warehouse. They have lodged claims seeking damages of Rs. 2.0 million from the company. The
company’s lawyers have advised that it is probable that the court may award compensation of Rs.
400,000.
(iii) Under a new legislation, the company is required to fit smoke detectors at all the stores by December
31, 2015. The company has not yet installed the smoke detectors.
(iv) On June 20, 2015, the board of directors decided to close down the Household Appliances Division.
However, the decision was made public after June 30, 2015.
(v) The company has a large warehouse in Lahore which was acquired under a three-year rent agreement
signed on April 1, 2014. The agreement is non- cancellable and the company cannot sub-let the
warehouse. However, due to operational difficulties, the company shifted the warehouse to a new
location.
(vi) A 15% cash dividend was declared on July 5, 2015.

Required:
Describe how each of the above issue should be dealt with in the financial statements for the year ended June
30, 2015. Support your point of view in the light of relevant International Accounting Standards.

Answer
(i) The conditions attached to the sale give rise to a constructive obligation on the reporting date.
A provision for the sales return should be recognised for 5% of June 2015 sales. The
related cost should also be treated as stock with customer.
(ii) Since the law suit was already in progress at year-end and the amount of compensation can
also be estimated, it is an adjusting event.
A provision of Rs. 400,000 should be made.
(iii) There is no obligating event at the year end either for the costs of fitting the smoke
detectors or for fines under the legislation (because still there are six months to install after the
year end.).
No provision should be recognised in this regard.
(iv) The obligating event is the communication of decision to the customers and employees, which
gives rise to a constructive obligation from that date, because it creates a valid expectation
that the division will be closed.
Since no communication has yet been made, no provision is required in this regard.
(v) The obligating event is the signing of the lease contract, which gives rise to a legal
obligation.
A provision is required for the unavoidable rent payments.
(vi) Since the declaration was announced after year-end, there is no past event and no
obligation at year-end and is therefore non-adjusting event.
Details of the dividend declaration must, however, be disclosed.

----------( 85 )----------
 Why wish upon a star? when we can pray to the one who created that star.

Example 4: Badar
Question: The following information relates to the financial statements of Badar for the year to 31 March
2015.
The mining division of Badar has a 3 year operating licence from an overseas government. This allows it to
mine and extract copper from a particular site. When the licence began on 1 April 2014, Badar started to build
on the site. The cost of the construction was Rs. 500,000.
The overseas country has no particular environmental decommissioning laws. In its past financial statements
Badar has given information about the company’s environmental policy and has provided examples to
demonstrate that it is a responsible company that believes in restoring mining sites at the end of the extraction
period. The cost of removing the construction at the end of the three years is estimated to be Rs. 100,000.
The cost of the site currently shown in the trial balance is Rs. 500,000. The company has a cost of borrowing
of 10%.
Required:
Explain the correct accounting treatment for the above (with calculations if appropriate).

Answer: IAS 37 Provisions, Contingent Liabilities and Contingent Assets only permits a provision to be
made if three conditions are met:
(i) The company has a present obligation, either legally or constructively, as a result of a past events;
(ii) Probable outflow of resources is required to settle the obligation; and
(iii) A reliable estimate is available.
Although there is no legal requirement to restore the site, the company has established a constructive
obligation by setting a valid expectation in the market, due to its published policies and past practice.
It therefore appears probable that Badar will have to pay money to improve the site and so a provision should
be created for the expected amount. As the expected payment of Rs.100,000 will not be settled for three
years, the provision should be discounted and entered at its net present value of Rs.75,131 (Rs.100,000 x
(1.1)-3). Over the three years, the discounting should be unwound and charged to profit or loss as finance
costs, resulting in a provision of Rs.100,000 by the end of the third year.
The cost of the construction work has been correctly capitalised. The cost of the future decommissioning work
should be added to this asset so that the total costs of the site can be matched to the revenue from the copper
over the period of mining. This will result in an asset of Rs.575,131 which should be depreciated over the three
year life.
Example 5: Georgina
Question: Georgina Company is preparing its financial statements for the year ended 30 September
2015. The following matters are all outstanding at the year end.
(1) Georgina is facing litigation for damages from a customer for the supply of faulty goods on 1 September
2015. The claim, which is for Rs. 500,000, was received on 15 October 2015. Georgina’s legal advisors
consider that Georgina is liable and that it is likely that this claim will succeed. On 25 October 2015
Georgina sent a counter-claim to its suppliers for Rs. 400,000. Georgina’s legal advisors are unsure
whether or not this claim will succeed.
(2) Georgina’s sales director, who was dismissed on 15 September, has lodged a claim for Rs. 100,000
for unfair dismissal. Georgina’s legal advisors believe that there is no case to answer and therefore
think it is unlikely that this claim will succeed.
(3) Although Georgina has no legal obligation to do so, it has habitually operated a policy of allowing
customers to return goods within 28 days, even where those goods are not faulty. Georgina estimates
that such returns usually amount to 1% of sales. Sales in September 2015 were Rs. 400,000. By the
end of October 2015, prior to the drafting of the financial statements, goods sold in September for Rs.
3,500 had been returned.
(4) On 15 September 2015 Georgina announced in the press that it is to close one of its divisions in
January 2016. A detailed closure plan is in place and the costs of closure are reliably estimated at Rs.
300,000, including Rs. 50,000 for staff relocation.

Required: State, with reasons, how the above should be treated in Georgina’s financial statements for the year
ended 30 September 2015.
----------( 86 )----------
Answer:
(1) Litigation for damages
Under IAS 37, a provision should only be recognised when:
❑ an entity has a present obligation as a result of a past event
❑ it is probable that an outflow of economic benefits will be required to settle the obligation
❑ a reliable estimate can be made of the amount of the obligation.
Applying this to the facts given:
• Georgina’s legal advisors have confirmed that there is a legal obligation. This arose from the past
event of the sale, on 1 September 2015 (i.e. before the year end).
• Probable is defined as ‘more likely than not’. The legal advisors have confirmed that it is likely that the
claim will succeed.
• A reliable estimate of Rs.500,000 has been made. Therefore a provision of Rs.500,000 should be made.

Counter-claim
IAS 37 requires that such a reimbursement should only be recognised where receipt is ‘virtually certain’. Since
the legal advisors are unsure whether this claim will succeed no asset should be recognised in respect of this
claim.

(2) Claim for unfair dismissal

In this case, the legal advisers believe that success is unlikely (i.e. possible rather than probable).
Therefore, this claim meets the IAS37 definition of a contingent liability:
• a possible obligation
• arising from past events
• whose existence will be confirmed only by the occurrence or non-occurrence of one or more
uncertain future events.
The liability is a possible one, which will be determined by a future court case or tribunal. It did arise from
past events (the dismissal had taken place by the year end).
This contingent liability should be disclosed in the financial statements (unless the legal advisors believe
that the possibility of success is in fact remote, and then even no disclosure is necessary).

(3) Returns
Applying the IAS 37 conditions in (1) to the facts given:
Although there is no legal obligation, a constructive obligation arises from Georgina’s past [Link]
has created an expectation in its customers that such refunds will be given.
• As at the year end, based on past experience, an outflow of economic benefits is probable.
• A reliable estimate can be made. This could be 1% × 400,000 but since the returns are now all in the
actual figure of Rs.3,500 can be used as 28 days have already passed.
Therefore a provision of Rs.3,500 should be made.

(4) Closure of division

Applying the above IAS37 conditions in (1) to the facts given:
• A present obligation exists because at the year end there is a detailed plan in place and the closure has
been announced in the press.
• An outflow of economic benefits is probable.
• A reliable estimate of Rs.300,000 has been made.
However, IAS 37 specifically states in respect of restructuring that any provision should include only direct
expenses, not ongoing expenses such as staff relocation or retraining. Therefore a provision of Rs.250,000
(300,000 – 50,000) should be made.

----------( 87 )----------
Example 6: Rowsley
Question: Rowsley is a diverse group with many subsidiaries. The group is proud of its reputation as a ‘caring’
organisation and has adopted various ethical policies towards its employees and the wider community in which
it operates. As part of its Annual Report, the group publishes details of its environmental policies, which include
setting performance targets for activities such as recycling, controlling emissions of noxious substances and
limiting use of non-renewable resources.
The finance director is reviewing the accounting treatment of various items prior to finalising the accounts for
the year ended 31 March 20X4. All items are material in the context of the accounts as a whole. The accounts
are due to be approved by the directors on 30 June 20X4.
Legal claim
During the year to 31 March 20X4, a customer started legal proceedings against the group, claiming that one of
the food products that it manufactures had caused several members of his family to become seriously ill. The
group’s lawyers have advised that this action will probably not succeed.
Environmental impact of overseas subsidiary
The group has an overseas subsidiary that is involved in mining precious metals. These activities cause
significant damage to the environment, including deforestation. The company expects to abandon the mine in
eight years’ time. The mine is situated in a country where there is no environmental legislation obliging
companies to rectify environmental damage and it is very unlikely that any such legislation will be enacted
within the next eight years. It has been estimated that the cost of cleaning the site and re-planting the trees
will be Rs. 25 million if the re-planting was successful at the first attempt, but it will probably be necessary to
make a further attempt, which will increase the cost by a further Rs. 5 million.

Required:
Explain how each of the items above should be treated in the consolidated financial statements for the year
ended 31 March 20X4.

Answer:
Introduction
All scenarios relate to the rules of IAS 37 Provisions, contingent liabilities and contingent assets. In each
scenario, the key issue is whether or not a provision should be recognised.
Under IAS 37, a provision should only be recognised when three conditions are met:
❑ There is a present obligation as a result of a past event; and
❑ It is probable that a transfer of economic benefits will be required to settle the obligation; and
❑ A reliable estimate can be made of the amount of the obligation.

Legal proceedings
It is unlikely that the group has a present obligation to compensate the customer; therefore no provision should
be recognised. However, there is a contingent liability. Unless the possibility of a transfer of economic benefits
is remote, the financial statements should disclose a brief description of the nature of the contingent liability,
an estimate of its financial effect and an indication of the uncertainties relating to the amount or timing of any
outflow.

Environmental damage
It is clear that there is no legal obligation to rectify the damage. However, through its published policies, the
group has created expectations on the part of those affected that it will take action to do so. There is, therefore,
a constructive obligation to rectify the damage and a transfer of economic benefits is probable.

The group must recognise a provision for the best estimate of the cost. As the most likely outcome is that more
than one attempt at re-planting will be needed, the full amount of Rs. 30 (25+5) million should be provided. The
expenditure will take place sometime in the future, and so the provision should be discounted at a pre-tax rate
that reflects current market assessments of the time value of money and the risks specific to the liability.

The financial statements should disclose the carrying amount at the end of the reporting period, a description
of the nature of the obligation and the expected timing of the expenditure. The financial statements should also
give an indication of the uncertainties about the amount and timing of the expenditure.

----------( 88 )----------
Further discussion of IAS 10 and 37:
Date of authorization [IAS 10: 4, 5 & 7 and Companies Act, 2017: Section 232]

In Pakistan, the financial statements must be approved by the board of directors of the company and signed
on behalf of the board of directors by the chief executive and at least one director of the company, and in case
of a listed company also by the chief financial officer. The date of approval by members in annual general
meeting is not the date of authorisation

Example:

The management of an entity completes draft financial statements for the year to 30 June 2012 on 31 August
2012. On 18 September 2012, the board of directors reviews the financial statements and authorises them for
issue. The entity announces its profit and selected ‘other financial information’ on 19 September 2012. The
financial statements are made available to shareholders and others on 1 October 2012. The shareholders
approve the financial statements at their annual meeting on 24 October 2012 and the approved financial
statements are then filed with SECP/registrar on 20 November 2012.

Required:

What is date of authorization for issue of financial statements?

ANSWER:

The financial statements are authorised for issue on 18 September 20X2 (date of board of directors
authorisation for issue).

Events after the reporting period include all events up to the date when the financial statements are authorized
for issue, even if those events occur after the public announcement of profit or of other selected financial
information

Example:

On 30 June 2011, G Limited is involved in a court case. It is being sued by a supplier. On 15 September 2011,
the court decided that G Limited should pay the supplier Rs.45,000 in settlement of the dispute. The financial
statements for G Limited for the year ended 30 June 2011 were authorised for issue on 04 October 2011.

The settlement of the court case is an adjusting event after the reporting period:

• It is an event that occurred between the end of the reporting period and the date the financial
statements were authorised for issue.

• It provided evidence of a condition that existed at the end of the reporting period. In this case, the
court decision provides evidence that the company had an obligation to the supplier as at the end of
the reporting period.

Since it is an adjusting event after the reporting period, the financial statements for the year ended 30 June
20X1 must be adjusted to include a provision for Rs.45,000. The alteration to the financial statements should
be made before they are approved and authorised for issue.

Accounting treatment of non-adjusting events [IAS 10: 10, 11 & 21]

Non-adjusting events are indicative of conditions that arose after the year end. The accounting treatment is
not to adjust the amounts recognized in financial statements. However, the nature and financial effect (if can
be made) of material non-adjusting events shall be disclosed.

Example:

A decline in fair value of investments between the end of the reporting period and the date when the financial
statements are authorized for issue

----------( 89 )----------
ANSWER:

An entity does not adjust the amounts recognised in its financial statements for the investments. Similarly, the
entity does not update the amounts disclosed for the investments as at the end of the reporting period,
although it may need to give additional disclosure of nature of event and financial effect, if it is material

Dividends [IAS 10: 12 & 13 and Companies Act, 2017: Section 243]

In Pakistan, final dividend is proposed by the Board of Directors and is approved by members in Annual
General Meeting (AGM) i.e. date of recognising liability is the date of AGM. Interim dividend is declared by
directors i.e. date of declaration and recognizing liability is date of directors meeting.

Example:

ABC Limited is in the process of finalizing its financial statements for the year ended June 30, 2021. Assume
today is 31st August 2021 and the intended date of authorisation of financial statements is September 15,
2021.

a) On July 7, 2021, ABC Limited announced to discontinue producing its Product C due to heavy loss which
represented 22% of total revenue.
b) On July 27, 2021 the auditors have pointed out that certain sales invoices were omitted from recording
during March 2021.
c) The board of directors announced the dividend for its ordinary shareholders of Rs. 3 per share on July 09,
2021 from the profits for the year ended 30 June 2021.
d) On July 12, 2021 information was received that a foreign customer had gone into liquidation in May 2021.
There are no chances of recovery of this debt now.
e) On August 20, 2021 it was discovered that another customer, who owed Rs.100,000 at year end was
declared insolvent on 15 August 2021 after its premises burnt down two weeks ago. The premises were
completely destroyed and were not insured.
f) On July 15, 2021 one of corporate customer declared bankruptcy. The liquidator announced that only 30%
of the debt would be paid on liquidation.
g) On August 15, 2021 the company sold 1,000 units of Product B for only Rs. 120 per unit due to damage
caused by water spoilage on August 05, 2021. The cost per unit was Rs.200. However, this Product had
been valued at its NRV of Rs. 150 per unit on June 30, 2021.
h) On July 15, 2021 the company sold 1,000 units of Product C for only Rs. 120 per unit. The cost per unit
was Rs. 200.

Required: Identify the above events as either adjusting or non-adjusting and briefly suggest accounting
treatment.

Answer

a) Non-adjusting event – being material, only disclosure shall be made. (Discontinuance of operations).

b) Adjusting event – The correction of error should be made in financial statements for the year ended June
30, 20Y1 as it pertained to March 20Y1.

c) Non-adjusting event – No amount shall be recognised in the financial statements in respect of the dividend
announced after the year end. However, the same shall be disclosed in notes to the financial statements.

d) Adjusting event – The foreign debt should be written off as an expense in financial statements for the year
ended June 30, 20Y1 since there are no chances of recovery.

e) Non-adjusting – Although the debt owing by the customer existed at reporting date, the inability of the
customer to pay did not exist at reporting date – this condition only arose in 15 August 20Y1 after the fire.
Thus, reporting the debtor at its full carrying amount of Rs. 100,000 is correct at 30 June 20Y1, according
to circumstances in existence at this date.

f) Adjusting event – The debtor’s balance should be written down by 70% amount due to his bankruptcy/
insolvency. (As Question is silent)

g) Non-adjusting event – The inventory shall continue to be valued at Rs. 150 per unit as the damage caused
after the year end.
----------( 90 )----------
h) Adjusting event – The inventory shall be valued at lower of cost (i-e. Rs.150 per unit) or net realisable
value (NRV) i-e. Rs. 120 per unit as the cost of an item would not be recoverable if inventory will be sold.
(As Question is silent)

Example: Fit Limited (FL) is in the course of finalizing its financial statements for the year ended June 30,
2020. Due to international recession the company has lost its major customers. The company now intends to
cease its business operations and liquidate the company.

Required:

What would be impact of above issue on the financial statements?

ANSWER:

FL should not prepare the financial statements on a going concern basis. It must also disclose the fact that
the financial statements have not been prepared on going concern basis and give relevant disclosures under
IAS 1

Example: A company has given guarantee for loan taken by its associated company. The company may or
may not have to pay the guaranteed amount as associated company may or may not default. It is a contingent
liability

Example:

A company has not complied with a legal requirement. The law states that penalty can be up to Rs. 1m.
However, the law is not enforced strictly, and it is not probable that the amount will have to be paid. It is a
contingent liability

Example:

In a litigation, the entity’s lawyers have advised that damages will have to be paid. However, no reliable
estimate of the amount could be made. It is a contingent liability.

Example:

An entity filed a litigation against one of its vendor claiming damages for Rs. 3 million for supplying the faulty
goods. The company may or may not win the case. This is a contingent asset

Example:

An entity has legal obligation to clean up the environmental damage caused by its operation. The entity is
obliged to rectify damage already caused. The provision shall be recognised.

Example:

Alpha Properties owns various office floors in shopping malls across the city of Multan. The government
introduces legislation that requires safety glass to be fitted in all windows on floors above the ground floor.
The legislation only applies initially to new buildings, but all buildings will have to comply within 3 years.
Discuss.

ANSWER

There is no obligating event. Even though Alpha Properties will have to comply within 3 years it can avoid the
future expenditure by its future actions, for example by selling the office floors. There is no present obligation
for that future expenditure and no provision is recognised

Example:

Alpha Chemicals operates in a country where there is no environmental legislation. Its operations cause
pollution in this country. Alpha Chemicals has a widely published policy in which it undertakes to clean up all
contamination that it causes, and it has honoured this published policy. Discuss

----------( 91 )----------
ANSWER

There is an obligating event. Alpha Chemicals has a constructive obligation which will lead to an outflow of
resources embodying economic benefits regardless of the future actions of the entity. A provision would be
recognised for the clean-up

The concept of obligation [IAS 37: 20 to 22]

An obligation always involves another party to whom the obligation is owed. It is not necessary, however, to
know the identity of the party to whom the obligation is owed, indeed the obligation may be to the public at
large.

Example:

Alpha Engineering provides 3-year warranty, to make any manufacturing defects good, at time of sale. It
maintains record of product serial number and date of sale but does not keep record relating to customer
identification. Discuss

ANSWER

There is an obligating event. It is not necessary to know the identity of customers to whom obligations owed.

An obligation always involves a commitment to another party. It means that management decision alone does
not result in obligation. It becomes obligation when it is communicated to those affected by it.

Example:

A week before year end, Alpha Textiles decided to close a factory. The closure will lead to 500 redundancies
at a significant cost to the entity. At year end, no news of this plan had been communicated to the workforce.
Discuss

Answer:

There is no obligating event. This will only come into existence when decision is communicated to the
workforce.

An event that does not give rise to an obligation immediately may do so at a later date, because of changes
in the law or because an act by the entity gives rise to a constructive obligation

Example:

An entity caused environmental damage and there was no obligation (neither legal nor constructive) to remedy
the consequences. The cause of this damage will become an obligating event when a new law will require the
existing damage to be rectified, or the entity will publicly accepts responsibility for rectification in a way that
creates a constructive obligation.

Where details of a proposed new law have yet to be finalised, an obligation (legal) arises only when the
legislation is virtually certain to be enacted as drafted. Differences in circumstances surrounding enactment
make it impossible to specify a single event that would make the enactment of a law virtually certain. In many
cases it will be impossible to be virtually certain of the enactment of a law until it is enacted.

Example: Alpha Limited guaranteed ABC Bank that Beta Limited (an associate of Alpha Limited) shall repay
its loan. It is almost certain that Beta Limited will repay the loan and Alpha Limited shall not have to pay the
guaranteed amount. Discuss

Answer:

No provision is recognised. The outflow of economic benefits is not probable.

----------( 92 )----------
A summarised chart suggesting the accounting term and treatment based on chances of outflow may
be useful:

Qualitative Quantitative Accounting treatment

general term range*
Obligation Assets
Remote 0 to 5% Do nothing Do nothing
Possible 5%+ to 50% Disclose contingent liability Do nothing
Probable 50%+ to 85% Recognize provision Disclose contingent asset
Virtually certain 85%+ to 99.9% Recognize liability Recognize asset and related
income
Certain 100%
*based on professional judgement and may vary according to circumstances.

Original standard (Appendix example in part B).[take before IAS 10 page 90 of Vol 2]

Example:

A manufacturer gives warranties at the time of sale to purchasers of its product. Under the terms of the contract
for sale the manufacturer undertakes to make good, by repair or replacement, manufacturing defects that
become apparent within three years from the date of sale. On past experience, it is probable that there will be
some claims under the warranties and a reliable estimate is available.

Required: Discuss the accounting treatment

ANSWER:

Obligation: The obligating event is the sale of the product with a warranty, which gives rise to a present legal
obligation under the warranty contract.

Outflow: Probable for the warranties as a whole.

Reliable estimate: Available.

Conclusion: A provision is recognised for the best estimate of the costs of making good under the warranty
products sold before the end of reporting period.

Example:

An entity in the oil industry causes contamination and operates in a country where there is no environmental
legislation. However, the entity has a widely published environmental policy in which it undertakes to clean up
all contamination that it causes. The entity has a record of honouring this published policy. The entity has
reliably estimated the cost to be incurred on clean-ups.

Required: Discuss the accounting treatment

ANSWER:

Obligation: The obligating event is the contamination of the land, which gives rise to a present constructive
obligation because the conduct of the entity has created a valid expectation on the part of those affected by it
that the entity will clean up contamination.

Outflow: Probable.

Reliable estimate: Available.

Conclusion: A provision is recognised for the best estimate of the costs of clean-up.

----------( 93 )----------
Example:

An entity operates an offshore oilfield where its licensing agreement requires it to remove the oil rig at the end
of production and restore the seabed. 90% of the eventual costs relate to the removal of the oil rig and
restoration of damage caused by building it, and 10% arise through the extraction of oil. At the end of the
reporting period, the rig has been constructed but no oil has been extracted. The reliable estimate for removal
of oil rig is available.

Required: Discuss the accounting treatment

ANSWER:

Obligation: The construction of the oil rig creates a present legal obligation under the terms of the licence to
remove the rig and restore the seabed and is thus an obligating event. At the end of the reporting period,
however, there is no obligation to rectify the damage that will be caused by extraction of the oil.

Outflow: Probable.

Reliable estimate: Available.

Conclusion: A provision is recognised for the best estimate of 90% of the eventual costs that relate to the
removal of the oil rig and restoration of damage caused by building it. These costs are included as part of the
cost of the oil rig.

The 10% of costs that arise through the extraction of oil are recognised as a liability when the oil is extracted
and not before

Example:

Under new legislation, an entity is required to fit smoke filters to its factories by 30 June 2022. The entity has
not fitted the smoke filters. The cost of smoke filters is Rs. 15 million. In case of non-compliance a fine of Rs.
3 million may be payable.

Required: What is impact of this at 31 December 2021, the end of the reporting period?

ANSWER

Obligation: There is no obligation because there is no obligating event either for the costs of fitting smoke
filters or for fines under the legislation.

Outflow: Not applicable

Reliable estimate: Available.

Conclusion: No provision is recognised for the cost of fitting the smoke filters.

Example:

Under new legislation, an entity is required to fit smoke filters to its factories by 30 June 2022. The entity has
not fitted the smoke filters. The cost of smoke filters is Rs. 15 million. In case of non-compliance, a fine of Rs.
3 million may be payable.

Required: What is impact of this at 31 December 2022, the end of the reporting period?

ANSWER

Obligation: There is still no obligation for the costs of fitting smoke filters because no obligating event has
occurred (the fitting of the filters). However, an obligation might arise to pay fines or penalties under the
legislation because the obligating event has occurred (the non-compliant operation of the factory).

Outflow: Assessment of probability of incurring fines and penalties by non-compliant operation depends on
the details of the legislation and the stringency of the enforcement regime.

Reliable estimate: Available.

Conclusion: No provision is recognised for the costs of fitting smoke filters. However, a provision is
recognised for the best estimate of any fines and penalties if probable to be imposed
----------( 94 )----------
Example:

The government introduces a number of changes to the income tax system. As a result of these changes, an
entity in the financial services sector will need to retrain a large proportion of its administrative and sales
workforce in order to ensure continued compliance with financial services regulation. At the end of the
reporting period, no retraining of staff has taken place.

Required: Discuss the accounting treatment

Answer:

Obligation: There is no obligation because no obligating event (retraining) has taken place.

Outflow: Not applicable.

Reliable estimate: Irrelevant.

Conclusion: No provision is recognised

Example:

After a wedding in 2020, ten people died, possibly as a result of food poisoning from products sold by the
entity. Legal proceedings are started seeking damages of Rs. 20 million from the entity but it disputes liability.
Up to the date of authorisation of the financial statements for the year to 31 December 2020 for issue, the
entity’s lawyers advise that it is probable that the entity will not be found liable.

Required: Discuss the accounting treatment for financial statements for year 2020.

Answer:

Obligation: On the basis of the evidence available when the financial statements were approved, there is no
obligation as a result of past events.

Outflow: Not applicable.

Reliable estimate: Available.

Conclusion: No provision is recognised. The matter is disclosed as a contingent liability unless the probability
of any outflow is regarded as remote

Example:

After a wedding in 2020, ten people died, possibly as a result of food poisoning from products sold by the
entity. Legal proceedings are started seeking damages of Rs. 20 million from the entity but it disputes liability.
Up to the date of authorisation of the financial statements for the year to 31 December 2020 for issue, the
entity’s lawyers advise that it is probable that the entity will not be found liable.

However, when the entity prepares the financial statements for the year to 31 December 2021, its lawyers
advise that, owing to developments in the case, it is probable that the entity will be found liable for the damages
as claimed.

Required: Discuss the accounting treatment for financial statements for the year 2021.

Answer:

Obligation: On the basis of the evidence available, there is a present obligation.

Outflow: Probable

Reliable estimate: Available i.e. Rs. 20 million.

Conclusion: A provision is recognised for the best estimate of the amount to settle the obligationi.e. Rs. 20
million

----------( 95 )----------
Example:

A furnace has a lining that needs to be replaced every five years for technical reasons. At the end of the
reporting period, the lining has been in use for three years. The cost of replacement after two years is Rs. 10
million.

Required: Discuss the accounting treatment

ANSWER:

Obligation: There is no present obligation.

Outflow: Not applicable.

Reliable estimate: Irrelevant.

Conclusion: No provision is recognised. The cost of replacing the lining is not recognised because, at the
end of the reporting period, no obligation to replace the lining exists independently of the company’s future
actions—even the intention to incur the expenditure depends on the company deciding to continue operating
the furnace or to replace the lining.

Instead of a provision being recognised, the depreciation of the lining takes account of its
consumption, i.e. it is depreciated over five years. The re-lining costs then incurred are capitalised
with the consumption of each new lining shown by depreciation over the subsequent five years.

Example:

An airline is required by law to overhaul its aircraft once every three years. The next overhauling is estimated
to cost Rs. 45 million.

Required: Discuss the accounting treatment

ANSWER:

Obligation: There is no present obligation.

Outflow: Not applicable.

Reliable estimate: Irrelevant.

Conclusion: No provision is recognised. The costs of overhauling aircraft are not recognised as a provision
for the same reasons as the cost of replacing the lining is not recognised as a provision in previous scenario.
Even a legal requirement to overhaul does not make the costs of overhaul a liability, because no obligation
exists to overhaul the aircraft independently of the entity’s future actions—the entity could avoid the future
expenditure by its future actions, for example by selling the aircraft.
Instead of a provision being recognised, the depreciation of the aircraft takes account of the future
incidence of maintenance costs, i.e., an amount equivalent to the expected maintenance costs is
depreciated over three years

Uncertainties surrounding the amount to be recognised as a provision are dealt with by various means
according to the circumstances. The following guidance is relevant:
Circumstances Suggested best estimate
The provision being measured involves a large Use expected value i.e. the obligation is estimated
population of items. by weighting all possible outcomes by their
associated probabilities.
There is a continuous range of possible outcomes The mid‑point of the range is used.
and each point in that range is as likely as any other.
A single obligation is being measured. The individual most likely outcome may be the best
estimate of the liability. However, even in such a
case, the entity considers other possible outcomes.
Where other possible outcomes are either mostly The best estimate will be the higher or lower
higher or mostly lower than the most likely outcome. amount.

----------( 96 )----------
Example:

An entity sells goods with a warranty under which customers are covered for the cost of repairs of any
manufacturing defects that become apparent within the first six months after purchase.

If minor defects were detected in all products sold, repair costs of Rs. 850,000 would result. If major defects
were detected in all products sold, repair costs of Rs. 4,500,000 would result.

The entity’s past experience and future expectations indicate that, for the coming year, 75% of the goods sold
will have no defects, 20% of the goods sold will have minor defects and 5% of the goods sold will have major
defects.

Required

Calculate the amount of provision to be recognised in respect of warranty

ANSWER:

The best estimate in this case is expected value of the warranty expenditure. The expected value of the cost
of repairs is

Outcome x Probability Rs.

Rs. Nil x 75% -
Rs. 850,000 x 20% 170,000
Rs. 4,500,000 x 5% 225,000
Total 395,000

Example: Many customers (i-e.30 out of 40) of Zeta Limited (ZL) filed claims for compensation due to supply
of faulty goods. ZL estimates that each claim will be settled in the range of Rs. 80,000 to Rs. 100,000 per
claim, each amount in this range is as likely as any other. Calculate the amount of provision

ANSWER:

The mid-point should be used i.e. Rs. 90,000 per claim x 30 customers = Rs. 2,700,000 (Provision).

Example:

A suit for infringement of patents, seeking damages of Rs. 2 million, was filed by a third party. Entity’s legal
consultant is of the opinion that an unfavourable outcome is most likely.

On the basis of past experience, he has advised that there is 60% probability that the amount of damages
would be Rs. 1 million and 40% likelihood that the amount would be Rs. 1.5 million.

Required: Briefly advise on measurement of above provision

ANSWER:

The entity should make a provision of the amount of Rs. 1 million being most likely outcome. The expected
value is more suitable when there is large population of similar items

Example:

An entity has to rectify a serious fault in a major plant that it has constructed for a customer. The individual
most likely outcome for the repair to succeed at the first attempt at a cost of Rs. 200,000. However, there is
significant chance that second attempt would be necessary costing an additional Rs. 80,000.

Required: Briefly advise on measurement of provision

ANSWER:

A provision of Rs. 280,000 is best estimate as there is significant chance that second attempt would be
necessary.

----------( 97 )----------
Example:

An entity in the oil industry causes contamination but cleans up only when required to do so under the laws of
the particular country in which it operates. One country in which it operates has had no legislation requiring
cleaning up, and the entity has been contaminating land in that country for several years. At 31 December
2020 it is virtually certain that a draft law requiring a clean-up of land already contaminated will be enacted
shortly after the year-end. The cleaning up will cost Rs. 4 million in present value terms.

Required: Discuss accounting treatment

ANSWER:

The obligating event is the contamination of the land because of the virtual certainty of legislation requiring
cleaning up and since outflow is probable and a reliable estimate of Rs. 4,000,000 is available, a provision is
recognised for the best estimate of the costs of the clean-up.
Example:
Z Limited installed a plant costing Rs. 25 million with a useful life of 10 years. There is legal requirement to
restore the site used by the plant at the end of its useful life which shall cost Rs. 1 million. The plant may be
sold for Rs. 3.5 million at the end of useful life. The assistant accountant is of the view that there is no need
to create the provision for restoration as this shall be adjusted against the expected gain on disposal of the
plant.
Required: Comment on the statement made by the assistant accountant
ANSWER:
Gains from the expected disposal of assets are not taken into account while measuring a provision. Therefore,
a provision at present value of Rs. 1 million shall be recognised
Example:
Daniyal Distribution (DD) are dealers of Product CC which are sold to customers with one-year warranty. The
product is manufactured by Maria Multinational (MM).
Under the warranty arrangement, DD just verifies customer data on warranty claims and repair and
replacement is made directly by MM. In case MM defaults, DD has no obligation. DD received 50 claims and
estimates that repair and replacement would cost Rs. 400,000 which shall be settled by MM.

Required: Discuss the accounting treatment for DD.

ANSWER:

DD has not obligation to settle the claim and therefore neither the provision nor the reimbursement asset is
recognised. There is no disclosure requirement.

Example:

Daniyal Distribution (DD) are dealers of Product CC which are sold to customers with one-year warranty. The
product is manufactured by Maria Multinational (MM).

Under the warranty arrangement, DD is responsible to repair and replace the items and submits the detail of
warranty claims to MM which pays 80% of the cost incurred to DD. In the past, MM has never denied any
claim of repairs and replacements made by DD.

DD received 50 claims and estimates that repair and replacement would cost Rs. 400,000

Required: Discuss the accounting treatment for DD.

ANSWER:

DD has present obligation to settle the claims and a provision of Rs. 400,000 shall be recognised. A separate
reimbursement asset of Rs. 320,000 (80%) is also to be recognised. In SPL the net expense of Rs. 80,000
may be presented. Disclosure of reimbursement shall also be made.

----------( 98 )----------
Example:

Daniyal Distribution (DD) are dealers of Product CC which are sold to customers with one-year warranty. The
product is manufactured by Maria Multinational (MM).

Under the warranty arrangement, DD is responsible to repair and replace the items and submits the detail of
warranty claims to MM which evaluates claims and may or may not pay the claims based on their evaluation
criteria.

DD received 50 claims and estimates that repair and replacement would cost Rs. 400,000. It is probable that
Rs. 100,000 would be received from MM.

Required: Discuss the accounting treatment for DD.

ANSWER:

DD has present obligation to settle the claims and a provision of Rs. 400,000 shall be recognised. No separate
asset shall be recognised but a contingent asset of Rs. 100,000 shall be disclosed.

Example:

A claim has been made against X Limited for damage suffered by adjacent property due to work being
undertaken on building of X Limited by a sub-contractor. The lawyers have confirmed that X Limited will have
to pay damages of Rs. 3 million but due to a clause in agreement with sub-contractor will also be able to
recover Rs. 2 million from the sub-contractor.

The recovery from sub-contractor is virtually certain.

Required: Pass the journal entry for the above

Answer:

Debit Rs. Credit

Rs.
Receivable from sub-Contractor 2000,000
Compensation expense (net) 1,000,000
Provision for damages 3,000,000

Review Provisions shall be reviewed at the end of each reporting period and adjusted to reflect
the current best estimate.
If it is no longer probable that an outflow of resources embodying economic benefits will
Reversal be required to settle the obligation, the provision shall be reversed.
Where discounting is used, the carrying amount of a provision increases in each period
Change in to reflect the passage of time. This increase is recognised as borrowing cost.
present value

Example:

In Year 1, a claim of Rs. 12 million was filed against the company. The lawyers were of the opinion that it is
probable to pay the damages of Rs. 12 million.

In Year 2, the case is still pending but lawyers now estimate that an amount of Rs. 15 million might be payable.

In Year 3, the case is still pending and due to development in the case lawyers now estimate that only Rs. 9
million might be payable

Required: Journal entries

----------( 99 )----------
ANSWER

Journal entries

Debit Rs. m Credit Rs. m

Date Particulars
Year 1 Profit or loss 12
Provision for legal damages 12
Year 2 Profit or loss 3
Provision for legal damages 3
Year 3 Provision for legal damages 6
Profit or loss 6
⯈ Example:

On year end of 31 December 2021, a provision is expected to be settled for Rs. 110,000 one year later. The
suitable discount rate is 10%.

Required: Pass Journal entries in respect of above for the year 2021 and 2022 assuming that the provision
was settled as expected.

⯈ ANSWER:

Journal entries

Date Particulars Debit Rs. Credit Rs.

31 Dec 20Y1 Expense/Profit or loss 100,000

Provision [Rs. 110,000 x 1.10-1] 100,000

31 Dec 20Y2 Finance cost [Rs. 100,000 x 10%] 10,000

Provision 10,000

31 Dec 20Y2 Provision 110,000

Bank 110,000

Use of provision [IAS 37: 61 & 62]

A provision shall be used only for expenditures for which the provision was originally recognised. Only
expenditures that relate to the original provision are set against it. Setting expenditures against a provision
that was originally recognised for another purpose would conceal the impact of two different events.

⯈ Example:

A company has created a provision of Rs.300,000 for the cost of warranties and guarantees. The company
now finds that it will probably has to pay Rs.250,000 to settle a legal dispute.

It cannot use the warranties provision for the costs of the legal dispute. An extra Rs. 250,000 expense must
be recognised.

⯈ Example:

Last year an employee filed a claim of Rs. 4 million against the company. The lawyers were of the opinion that
it is probable to pay the damages of Rs. 4 million and therefore, the company recognised the provision for this
amount.

During the year, the case has now been decided in favour of the company. However, in another legal suit for
copyright infringement against the company (filed during the year) the company had to pay damages of Rs. 4
million. The payment has not been recorded yet.

Required: Pass the journal entries for the above transactions.

----------( 100 )----------
ANSWER:

Journal entries

Sr.# Particulars Debit Rs. m Credit Rs. m

1 Provision for employee claim 4

Profit or loss (reversal) 4

2 Damages exp (PL) 4

Bank (payment of other litigation) 4

⯈ Example:

Quality Garments Limited (QGL) is a manufacturer of readymade garments. During May 2014, a fire broke out
in one of its units which resulted in deaths and severe injuries to a number of workers.

At the time of finalization of QGL's financial statements for the year ended 30 June 2014, the following issues
pertaining to the fire are under consideration:

i. Families of certain deceased workers have filed compensation claims amounting to Rs. 60 million. A
government agency has imposed a penalty of Rs. 35 million for negligence on the part of the company.
QGL's lawyers anticipate that the company would have to pay Rs. 20 million and Rs. 10 million to settle
the workers' claims and the penalty respectively.

ii. To maintain goodwill of the company, the Board of Directors is considering additional payments to the
families of the deceased workers amounting to Rs. 25 million.

iii. Loss to fixed assets and inventories is estimated at Rs. 60 million. In this respect, a fire insurance claim
has been lodged. Due to certain policy clauses, QGL’s consultant anticipates that the claim for Rs. 15
million may not be accepted. The matter is under negotiation with the insurance company.

iv. Due to closure of the unit for repair, QGL would not be able to meet sales orders of Rs. 50 million. This
will reduce QGL's profitability for the half year ending 31 December 2014 by Rs. 10 million.

Required:

Discuss how the above issues should be dealt with in the financial statements of QGL for the year ended 30
June 2014. Support your answers in the context of relevant International Financial Reporting Standards.

Answer:

Part (i) Liability for workers’ compensation and penalty

Provisions are recognised when there is present obligation, probable outflow and reliable estimate. All the
conditions as mentioned for provisions are met to the extent of Rs. 20 million for the claims of families of
workers and Rs. 10 million for the penalty levied by a government agency. Therefore, a provision of Rs. 30
million (20+10) would be made.

For the remaining amount of Rs. 65 million (60+35-30), it is not probable that an outflow of economic benefits
will be required. Therefore, a contingent liability would be disclosed giving information about nature, estimate
of financial effect, indication of uncertainties and possibility of reimbursement.

Part (ii) Additional compensation for the families of the deceased workers

The obligation for additional compensation to the families of the deceased workers is neither legal nor
constructive obligation as the matter is still under consideration and no formal announcement was made that
may create a valid expectation.

There is neither present obligation (for provision) nor possible obligation (for disclosure as contingent liability).
Therefore, no provision or disclosure is required in this respect.
----------( 101 )----------
Part (iii) Insurance claim

This is reimbursement scenario. Reimbursement is recognised as asset when virtually certain and disclosed
as contingent asset when probable.

If the insurance claim to the extent of Rs. 45 million (60-15) is virtually certain to be received; an insurance
claim would be recognized for this amount.

If an inflow for the remaining amount of Rs. 15 million is probable, a contingent asset would be disclosed
giving information about nature and financial effect. OR where an inflow for the remaining amount of Rs. 15
million is not probable, no contingent asset should be disclosed.

Part (iv) Reduction in future profit by Rs. 10m for the half year ending 31 Dec 2014

There is no present obligation to incur future losses. No provision or disclosure is required for future operating
losses as they arise from future events not past events.

⯈ Example:

SK Limited is engaged in trading of chemical products and has entered into following contract on December
20, 2020 with XYZ Limited (a firm contract) to buy 500 units of Product X at Rs. 10 to be delivered on January
20, 2021. On December 31, 2020 the purchase price of Product X has fallen to Rs. 7 per unit.

Required: Record journal entries due to change in purchase price at December 31, 2020, the year-end.

ANSWER:

Expected loss on firm purchase contract Rs. 10 – 7 = Rs. 3 x 500 units = Rs. 1,500

Journal entry

Debit Rs. Credit Rs.

Date Particulars

31 Dec 20Y0 Loss on onerous contract 1,500

Provision for onerous contract 1,500

Implementation and announcement of restructuring [IAS 37: 73 & 74]

Evidence that an entity has started to implement a restructuring plan would be provided, for example, by
dismantling plant or selling assets or by the public announcement of the main features of the plan.

Only if public announcement is made in such a way and in sufficient detail that it gives rise to valid expectations
in other parties such as customers, suppliers and employees (or their representatives) that the entity will carry
out the restructuring.

If it is expected that there will be a long delay before the restructuring begins or that the restructuring will take
an unreasonably long time, it is unlikely that the plan will raise a valid expectation on the part of others that
the entity is at present committed to restructuring, because the timeframe allows opportunities for the entity to
change its plans.

Status of management decision [IAS 37: 75 to 77]

A constructive obligation is not created solely by a management decision. It must have been implemented or
announced before the end of reporting period as well. If an entity implements or announces, only after the
reporting period, disclosure is required under IAS 10. Although a constructive obligation is not created solely
by a management decision, an obligation may result from other earlier events together with such a decision.

For example, negotiations with employee representatives for termination payments, or with purchasers for the
sale of an operation, may have been concluded subject only to board approval. Once that approval has been
obtained and communicated to the other parties, the entity has a constructive obligation to restructure.

----------( 102 )----------

In some countries, notification to employees’ representatives may be necessary before the board decision is
taken. Because a decision by such a board involves communication to these representatives, it may result in
a constructive obligation to restructure.

⯈ Example:

On 12 December 2010 the board of an entity decided to close down a division. Before the end of the reporting
period (31 December 2010) the decision was not communicated to any of those affected and no other steps
were taken to implement the decision.

Required: Assuming that the reliable estimate is available, what will be accounting treatment for the above?

Answer:

There has been no obligating event and so there is no obligation as the decision has not been communicated
and no constructive obligation has arisen. Therefore, no provision is recognized

⯈ Example:

On 12 December 2010, the board of an entity decided to close down a division making a particular product.
On 20 December 2010 a detailed plan for closing down the division was agreed by the board; letters were
sent to customers warning them to seek an alternative source of supply and redundancy notices were sent to
the staff of the division.

Required: Assuming that the reliable estimate is available, what will be accounting treatment for the above?

Answer:

Obligation: The obligating event is the communication of the decision to the customers and employees, which
gives rise to a constructive obligation from that date, because it creates a valid expectation that the division
will be closed.

Outflow: Probable

Reliable estimate: Available.

Conclusion: A provision is recognised at 31 December 2010 for the best estimate of the costs of closing the
division.

Measurement [IAS 37: 80 to 83] (cost of restructuring)

A restructuring provision shall include only the direct expenditures arising from the restructuring, which are
those that are both:

• Necessary for restructuring.

• not associated with the ongoing activities of the entity. (Future operating costs are not part of provision)

A restructuring provision does not include such costs as:

• retraining or relocating continuing staff;

• marketing; or

• investment in new systems and distribution networks.

Identifiable future operating losses up to the date of a restructuring are not included in a provision, unless they
relate to an onerous contract. Gains on the expected disposal of assets are not taken into account in
measuring a restructuring provision, even if the sale of assets is a result of the restructuring. These
expenditures relate to the future conduct of the business and are not liabilities for restructuring at the end of
the reporting period. Such expenditures are recognised on the same basis as if they arose independently of a
restructuring.

----------( 103 )----------

⯈ Example:

S & Co has year-end of 30 June. On June 25, 2021 S & Co has decided to change its management and
operational structure in order to work efficiently and competitively. The plan has been formally approved and
announced to all major stakeholders. The implementation shall start from August 31, 2021. The following costs
are expected to be incurred:

Answer:

Rs.

Shifting allowance to employees 500,000

Consultant fee for restructuring 700,000

New computer and distribution network systems 1,500,000

Staff training 50,000

Advertisement of new and improved operations 120,000

Implementation expenses specifically incurred for restructuring 450,000

Required: Which of the above shall be included in measurement of provision for restructuring?

Answer:

Only consultant fee of Rs. 700,000 and implementation expenses of Rs. 450,000 shall be included in the
measurement of the provision.

Loan guarantee / joint obligations [IAS 37: 27 to 29]

An entity may become surety (guarantor) for loan granted to some other entity. These are disclosed as
contingent liabilities being possible obligation. However, in case of default, possible obligation becomes
present obligation and a provision is to be recognised.

Where an entity is jointly and severally liable for an obligation, the part of the obligation that is expected to be
met by other parties is treated as a contingent liability. The entity recognises a provision for the part of the
obligation for which an outflow of resources embodying economic benefits is probable, except in the extremely
rare circumstances where no reliable estimate can be made.

⯈ Example:

Naba Power Limited (NPL) is preparing its financial statements for the year ended 30 June 2017. Following
issues are under consideration.

(a) NPL entered into a contract on 1 August 2016 to supply customised batteries to a new customer. As
per the terms of the agreement, NPL is required to deliver 50,000 batteries at the end of each month from
December 2016 to September 2017 at a consideration of Rs. 15 million per month. Penalty for each late
delivery or cancellation of the contract would be Rs. 5 million and Rs. 20 million respectively.

On 1 August 2016 NPL had estimated that cost of production would be Rs. 10 million per month. However,
cost of production increased subsequently. Despite the increase in the cost of production, NPL made timely
deliveries till May 2017 at a total cost of Rs. 99 million. Supply for June 2017 was made on 15 July 2017 at a
total cost of Rs. 18 million of which Rs. 14 million had been incurred till 30 June 2017. It is estimated that Rs.
55 million would need to be spent to make the last 3 deliveries within time.

(b) On 15 May 2017 an explosion occurred at one of NPL’s factories. Several claims were filed by affected
employees against NPL. The details are as under:

(i) Seven injured employees made claims before 30 June 2017 and further three injured employees
lodged claims in July 2017. According to NPL’s legal advisor, the probability that NPL would be determined to
be negligent is 80%. If NPL is found negligent, the estimated average cost of each payout will be Rs. 1 million.

----------( 104 )----------

(ii) Additional four employees made claims before 30 June 2017, seeking compensation for the stress,
rather than any injury, caused to them. If these claims succeed, the legal advisor is of the view that the
estimated average cost of each payout will be Rs. 0.7 million. However, according to the legal advisor, the
chance that these employees will succeed is 30%.

(iii) 80% of all such payouts are recoverable according to the terms of the insurance policy.

(c) On 1 November 2016 a new law was introduced requiring all factories to install specialized safety
equipment within five months. The equipment costing Rs. 15 million was ordered in February 2017 to be
installed by 30 April 2017. However the supplier delayed installation till 31 July 2017. On 5 August 2017 the
company received a notice from the authorities levying a penalty of Rs. 1.6 million i.e. Rs. 0.4 million for each
month during which the violation continued. It is probable that this penalty will be recovered from the supplier.

Required: Discuss how each of the above issues should be dealt with in NPL’s financial statements for the
year ended 30 June 2017. (Quantify effects where practicable).

Answer:

Part (a) Penalty, write-down and onerous contract

NPL should recognize following provision / expense as on 30 June 2017:

Rs. in million

Provision for penalty (Note 1) 5

Write down to NRV [14 minus 11 (15–4)] (Note 2) 3

Provision for onerous contract [45–55] (Note 3) 10

18

Note 1: Supply for June 2017 was made after delay of 15 days so as per terms of agreement provision for
penalty should be made for this adjusting event.

Note 2: Since cost incurred till 30 June 2017 (Rs. 14 million) is higher than the net realizable value of inventory
i.e., Rs.11 million (selling price of 15 million less 4 (18 – 4) million cost to be incurred) expense of Rs. 3 million
related to write-down of inventory to NRV should be recognized.

Note 3: Since estimated cost of Rs. 55 million which would need to be spent is more than the total revenue of
Rs. 45 million for last 3 deliveries, the contract is considered as onerous and the provision should be made at
Rs. 10 million that is lower of cost of fulfilling it (Rs. 10 million i.e., 55 – 45) or penalty arising from failure to
fulfil it (Rs 20 million).

Part (b) Claim regarding NPL’s negligence

As on 30 June 2017 NPL should recognize a provision for ten injured employees because at reporting date
there is present obligation in respect of past event (injuries suffered from explosion occurred before year end).
NPL’s lawyers estimate that probability of NPL being declared negligent is 80% which is considered as
probable. Therefore, provision should be made for total payout of Rs 10 million (1 million for each employee).

According to the terms of insurance policy, 80% of the cost is recoverable from insurance company so it is
virtually certain that reimbursement will be made. According to IAS 37, NPL should recognize a separate asset
(receivable) of Rs. 8 million (10 million × 80%). In the statement of comprehensive income provision may be
presented net of reimbursement amount.

As per legal adviser, there is only 30% chance that the claims lodged against the company for undue stress
will succeed so payment of Rs 2.8 million (0.7 million × 4) is possible (not a present) obligation. Consequently,
provision is not required and NPL should disclose this amount as contingent liability giving brief description of
the event and estimate of financial effect.

Part (c) Penalty for non-compliance of new law

As on 30 June 2017, NPL should recognize expense of Rs. 1.2 million (0.4×3) in relation to penalty for non-
compliance of new law from 1 April to 30 June 2017 because at the reporting date there is a present obligation
----------( 105 )----------
(payment of penalty) in respect of a past event (non-compliance of statutory requirement). NPL should disclose
the penalty amount in its financial statement.

Since the reimbursement of penalty amount from the vendor is probable, the reimbursement of only two
months (May and June 2017) of Rs. 0.8 million (0.4×2) should be disclosed as a contingent asset giving brief
description of the event and estimate of financial effect.

⯈ Example:

In 2000, an entity involved in nuclear activities recognizes a provision for decommissioning costs of Rs. 300
million. The provision is estimated using the assumption that decommissioning will take place in 60–70 years’
time. However, there is a possibility that it will not take place until 100–110 years’ time, in which case the
present value of the costs will be significantly reduced to Rs. 136 Million.

The narrative illustrative disclosures may be presented as follows:

Disclosure: A provision of Rs. 300 million has been recognised for decommissioning costs. These costs are
expected to be incurred between 2060 and 2070; however, there is a possibility that decommissioning will not
take place until 2100–2110. If the costs were measured based upon the expectation that they would not be
incurred until 2100–2110 the provision would be reduced to Rs. 136 million.

Aggregation [IAS 37: 87]

In determining which provisions or contingent liabilities may be aggregated to form a class, it is necessary to
consider whether the nature of the items is sufficiently similar for a single statement about them to fulfil the
disclosure requirements.

⯈ Example:

An entity manufactures two electronic products, Product A and Product B. Product A is sold under warranty
for 3 years while Product B is sold under warranty for 5 years. The provision of warranty on both products may
be aggregated.

⯈ Example: It is not appropriate to aggregate the provision of warranty and provision relating to legal
proceedings for copyright issue.

Where disclosure might affect entity’s position [IAS 37: 92]

In extremely rare cases, disclosure of some or all of the information required by IAS 37 disclosures can be
expected to prejudice seriously the position of the entity in a dispute with other parties on the subject matter
of the provision, contingent liability or contingent asset.

In such cases, an entity need not disclose the information, but shall disclose the general nature of the dispute,
together with the fact that, and reason why, the information has not been disclosed.

----------( 106 )----------

Provision, Contingent Liabilities & Contingent Assets IAS-37
Provision is a liability of uncertain timing or amount.
Liability is a present obligation arising from past events, the settlement of which is expected to result in an
outflow of resources.
Examples of Provisions
• Provision for taxation
• Provision for gratuity
• Provision for dismantling
• Provision for litigation
• Provision for warranty etc

Difference between a provision and liability:

Provision Liability
Here timing or amount is uncertain (example of a Here timing or amount is not normally uncertain
court case by a debtor, warranty obligation etc.) (trade payable and accrual of expenses)

When to recognize a provision (means incorporation in the Financial statement) [Para 14]
1) There is a present obligation as a result of past events.

Obligation may be
Legal Constructive
That derives from a contract or legislation or That derives from entity’s action that create valid
operation of law (court decision) expectations among the interested parties that
entity will discharge those responsibilities (Example
below)

2) There is a probability of outflow of the resources

3) Although timing or amount is uncertain but a reliable estimate can be made

If all the above conditions are fulfilled, recognize a provision.

Measurement of Provision [Para 36]

The amount recognized as a provision shall be the best estimate at the reporting date.
The best estimate of the amount of an obligation is the amount that an entity would pay to settle the liability.

When making these estimates, management should consider:

• Previous experience:
• Similar transaction:
• Possibly expert advice: and
• Events after the reporting period. (IAS-10) (will be discussed Later)

Previous experience may indicate a range of possible outcomes, for which it may be possible to estimate a
probability. This is referred to as the calculation of expected values using this theory of probabilities. The
application of this theory is best explained by way of example.
Future Events [Para 48]
When calculating the amount of the provision, expected future events should be taken into account when there
is 'sufficient objective evidence' available suggesting that the future event will occur.

Gains on disposals of Assets: [Para 51]

When an obligation involves the sale of an entity's assets and the sale thereof is expected to result in a gain,
this gain should not be included in the calculation of the provision since this would reduce the provision, which
would not be consider prudent.

----------( 107 )----------

Decommissioning liabilities and similar provisions
A company may be required to ‘clean up’ a location where it has been working when production ceases.

This is often the case in industries where companies are only granted licenses to operate on condition that
they undertake to perform future clean-up operations.

Such industries include, oil and gas, mining and nuclear power.

For example, a company that operates an oil rig may have to repair the damage it has caused to the sea
bed once the oil has all been extracted.

The normal rules apply for the recognition of a provision: a company recognizes a provision only where it
has an obligation to rectify environmental damage as a result of a past event.
A company has an obligation to ‘clean-up’ a site if:
• it is required to do so by law (a legal obligation); or
• its actions have created a constructive obligation to do so.

A constructive obligation might exist if (for example) a company has actually promised to decontaminate a site
or if it has adopted environmentally friendly policies and has made the public aware of this.

Accounting for a provision for a decommissioning liability

IAS 16 Property, plant and equipment identifies the initial estimate of the costs of dismantling and removing
an item and restoring the site upon which it is located as part of the cost of an asset.
Future clean-up costs often occur many years in the future so any provision recognized is usually
discounted to its present value.
Illustration: Initial recognition of a provision for a decommissioning liability
Debit Credit
Non-current asset X
Provision X

The asset is depreciated over its useful life in the same way as other non-current assets.

The provision is remeasured at each reporting date. If there has been no change in the estimates (i.e. the
future cash cost, the timing of the expenditure and the discount rate) the provision will increase each year
because the payment of the cash becomes one year closer. This increase is described as being due to the
unwinding of the discount.

The amount due to the unwinding of the discount must be expensed as borrowing cost.

The increase In the liability each year will be debited to finance charges, (As a second effect of Journal
entry) means:

Financial charge XXX

Provision XXX [Para 60]

The effect of possible new legislation [para 50]

The effect of possible new legislation is taken into consideration in measuring an existing obligation when
sufficient objective evidence exists that the legislation is virtually certain to be enacted (example from
Appendix)

Obligations can be;

If Present Obligation If Present Obligation If Possible Obligation

(an obligation that may arise in
future)
  
Recognition criteria is met. but suppose no reliable estimate No provision
  
Recognize a provision. No provision instead disclose Only disclose the event under
the obligation in notes under the the heading contingent liabilities
heading of contingent liabilities. unless possibility of outflow of
resources is remote.
----------( 108 )----------
Reimbursement: [Para 53]
Reimbursement means amount incurred is expected to be recovered.
It occurs when, for example, a retailer offers a guarantee to its customer, but where the manufacturer in turn
offers the retailer a counter-guarantee.

Expected reimbursement from the manufacturer (or other supplier) should:

• Only be recognized if it is virtually certain that the reimbursement will be received; and
• Should be recognized as a separate asset.

Scenario 1: There is a warranty agreement between manufacturer and customer:

In the instance where the retailer does not the offer a guarantee for faulty goods, but the manufacturer does,
faulty goods would be returned to the retailer who would then send the goods back to the manufacturer who
would then replace the goods. In this case, the retailer should not make a provision for any guarantee since
no guarantee was offered by the retailer; the retailer has no obligation, but is merely acting as an agent
between the customer and manufacturer. In such a case there is no question of any reimbursement as well.

Scenario 2: there is a warranty agreement between retailer and customer. In addition, retailer has a
counter warranty agreement with manufacturer:
A retailer may offer its customers a guarantee that is either partially or fully covered by the manufacturer. In
this case, since the retailer offers the guarantee, the retailer should make a provision for the total expected
costs of fulfilling the guarantee despite the fact that the retailer may then return the goods to the manufacturer
for a full or partial refund. There could be following three possibilities:
a) If reimbursement is virtually certain than recognize a separate receivable, which should not be set off
against the provision for the total expected costs of fulfilling the guarantee. Although the resultant asset
and liability should not be set off against each other, the income and expense may be in the Statement of
Comprehensive Income. [Para 54]
b) If reimbursement is probable, then disclose in notes to financial statements.
c) If reimbursement is only possible, then ignore the reimbursement.

The amount Recognized as reimbursement shall not be more than the amount of provision.
Contingent Asset:
“It is a possible asset that arises from past events and whose existence will be confirmed by the future events
not wholly within the control of entity (e.g. a possible court decision in our favour)”.
Recognition Criteria:
Where the flow of economic benefits from a Contingent assets is:
• Possible or remote then the Contingent assets is simply ignored.
• Probable, a Contingent assets would be disclosed (if material) and
• Virtually Certain The asset is no longer considered to be a Contingent asset and should therefore be
recognized.
Changes in Provisions: [Para 59]
Provision should be reviewed at each balance sheet date and adjust to reflect the best estimate.
Provision is estimated based on circumstances in existence at the time of making the provision. As
circumstances change, the amount of the provision must be reassessed and increased or decreased as
considered necessary. This adjustment is made prospectively (as a change in accounting estimate).

Uses of Provisions: [Para 61]

A provision shall be used only for expenses for which it was created.

Other specific Issues:

Contracts:
Costs that have been contractually committed to but not yet incurred in the current year should not be
recognized as a liability since these are considered to be future costs e.g. contract for future capital
expenditures which are only disclosed in notes. One exception to this rule is an onerous contract.

----------( 109 )----------

Onerous Contract:
“An onerous contract is one where the unavoidable costs of meeting the obligations under the contract exceed
the benefits expected to be derived from the contract”.

In this case, the unavoidable costs should be provided for. The unavoidable costs (as per IAS-37) are the
Lower of:
• The cost of fulfilling the contract and
• The compensation or penalties that would be incurred if the contract were to be cancelled.[Para 68]

Future Operating Losses: [Para 63]

 A provision shall not be recognized for future operating losses.
A company may forecast that it will make a substantial operating loss in the next year or years. Provision
cannot be made for future operating losses because they arise from future events and not past events.

Important Consideration:

The past event must:

✓ Exist independent of the entity’s future actions, i.e. if the company closed down today, would the obligation
still exist: and
✓ Always include another party (3rd party) besides the entity. The standard does, however, state that this
other party does not need to be known. (i.e. it could be the public at large). For example goods sold on
warranty to several customers.

This means that a decision made at a board meeting would not lead to a present obligation because this event
does not involve a third party and is not separate from the entity’s future actions (its future actions could be
changed if the board later decides to change its mind). If however it is communicated then a provision may be
recognized.

Disclosures:

Provision: For each class of provision; disclose the followings:

 Opening balance
 Additions due to change in estimates
 Provisions used
 Additions due to passage of time
 Unused amount reversed
 Closing balance

In addition, for each significant provision, following shall be disclose in notes to financial statements
1) Brief description of nature
2) Expected timing of settlement
3) Indication of uncertainties
4) Possibility of any reimbursement (If any).

Contingent Liabilities: For each class of contingent liability:

 A brief description of nature
 Estimate of financial effect
 Indication of uncertainties
 Possibility of reimbursement (if any)

Contingent Asset: Where contingent asset is to be disclosed, the following information is to be provided:
 A brief description of the nature of contingent asset
 An estimate of financial effect.

Restructuring Provisions: [Para 70,71, 72,80 & 81]

Restructuring is defined in IAS-37 as:
• A program that is planned and controlled by management: and
• Materially changes either:
- The scope of a business undertaken by an entity: or
- The manner in which that business is conducted.

----------( 110 )----------

 Restructuring occurs when for example, a line of business is sold (e.g. Nestle sells a factory) or there is a
change in the management structure. In both cases, there will be a variety of costs involved: for example,
retrenchment (termination benefits) packages will probably need to be paid out and in the case of the sale of
the factory, there may be costs incurred in the removal of certain machinery.

The same definition and recognition criteria must be met before making a provision for the costs of
restructuring although IAS-37 provides further criteria to assist in determining whether the definition and
recognition criteria have been met. The constructive obligation to restructure arises only when:
(i) There must be a detailed formal plan that identifies at least the following:
- The business or part of the business affected:
- The principal location affected:
- The location, function and approximate number of employees who will be compensated for terminating
their services;
- The expenditure that will be undertaken;
- When the plan will be implemented; and
(ii) The entity must have raised valid expectations in those affected before the end of the reporting period
that it carry out restructuring, by either having:
- Started to implement the plan; or
- Announced its main features to those affected by it.

If the company has started to implement the plan or Announced its main features to those affected by it
After the end of the reporting period but before the date of authorization of financial statements then disclose
the restructuring as a non adjusting event as per IAS 10, if material.

Costs of restructuring a business should provide for costs for only those costs that are directly associated
with the restructuring, being:
• Those that are necessary; and
• Not associated with the ongoing activities of the entity (future operating costs are not part of the provision ,
for example;
1. retaining and relocation costs for continuing staff,
2. investment in new systems ,
3. marketing;
4. expected losses on disposal of assets

Future repairs to assets (IAS 37 appendix)

Some assets need to be repaired or to have parts replaced at intervals during their lives.
For example, suppose that a furnace has a lining that has to be replaced every five years. If the lining is not
replaced, the furnace will break down.
AS 37 states that a provision cannot be recognized for the cost of future repairs or replacement parts, instead
of recognizing a provision, a company should capitalize expenditure incurred on replacement of an asset and
depreciate this cost over its useful life.

This is the period until the part needs to be replaced again. For example, the cost of replacing the furnace
lining should be capitalised, so that the furnace lining is a non-current asset; the cost should then be
depreciated over five years. (Note: IAS 16: Property, plant and equipment states that where an asset has two
or more parts with different useful lives, each part should be depreciated separately.)
Normal repair costs, however, are expenses that should be included in profit or loss as incurred
Contingent Liability is a

1. Possible obligation from the past events, whose existence will be confirmed only by the occurrence or
nonoccurrence of one or more uncertain future events.
2. Present obligation from the past events that is not recognized because the recognition criteria are not
met.

Events after the Reporting Period (IAS-10)

Some legal requirements in Pakistan relating to this topic

1. Every company in Pakistan is required to conduct an AGM of its shareholders within a period of 120
days following the close of its financial year.
2. One agenda item of AGM is to discuss and approve the financial statements.
3. At least 21 days before AGM a notice of AGM along with a signed copy of financial statements should
be dispatched to shareholders.
----------( 111 )----------
Overview:
Although one might assume that events that occur after the current year end should not be taken into account
in the current year’s financial statements, this is not always the case.
Events after the reporting period are defined in IAS-10 are:
• Those events, both favorable or unfavorable,
• That occurs between the end of the reporting period and the date when the financial statements are
authorized for issue.

Events after the Reporting Period

Adjusting Events Non-adjusting Events

Assume that an entity has a December year end and that the financial statements for 20x1 were completed
and ready for authorization on 25th March 20x2. In this case, the period 1st January 20x2 to 25th March 20x2,
is the post-reporting date period’, and events taking place during this period need to be carefully analyzed in
terms of this standard into one of two categories:
➢ Adjusting events and
➢ Non-adjusting events.

Adjusting Events:
Adjusting events are defined in IAS-10 as:
Those that provide evidence of conditions that existed at the end of the reporting period. Adjusting events are
taken into account (adjusted for) when preparing the current year’s financial statements.

Please note that the event need to not to be unfavorable to be an adjusting event, For example, a debtor that
was put into provisional liquidation at year end may reverse the liquidation proceedings during the post-
reporting date period, in which case it may be considered appropriate to exclude the value of this account from
the estimated doubtful debts and thus increase the value of the debtors at year end.

Non-Adjusting Events after the Reporting Period:

Non-adjusting events after the reporting period are defined in IAS-– 10 as:
➢ Those that are indicative of the condition that arose after the reporting period.
➢ Non-adjusting events are not taken into account (adjusted for) when preparing the current year’s financial
statements, but may need to be disclosed if considered material.
➢ If the event gives information about a condition that only developed after year end, then this event has
obviously no connection with the financial statements that are being finalized. If, however, the event is so
material that non-disclosure thereof would affect the user’s understanding of the financial statements,
then, although the event is a non-adjusting one, disclosure of the event may be appropriated.

Dividends: [Para 12]

Dividends relating to the period under review that are declared during the post-reporting date period must not
be recognized (adjusted for) since they do not meet the criteria of a present obligation. They do not reflect a
present obligation because the obligation event is the declaration and where this declaration does not occur
before year end, it is not a past event. These must be disclosed in the notes to the financial statements.

Going Concern Assumption: [Para 14]

An entity will continue its business in the foreseeable future (normally 12 months after the reporting date) and
has neither the intention nor the necessity of liquidation or cease trading.
i) If business is going concern than prepare the financial statements according to the requirements of IFRS.
ii) If going concern assumption is no longer valid then financial statement shall be prepared on the basis of
market values and settlement values rather than according to relevant IFRS requirements.

The going concern assumption

A deterioration in operating results and financial position after the end of the reporting period may indicate that
the going concern presumption is no longer appropriate.
There are a large number of circumstances that could lead to going concern problems.

Example
Suppose government banned the products manufactured by the company after the reporting date but before
the date of authorization of financial statements.
----------( 112 )----------
 Never think that any request you have is too much for ALLAH.

It is a non-adjusting event according to the previous discussion. However, if a non-adjusting event affects
the going concern assumption of the entity, then it is treated as an adjusting event. Therefore financial
statement should be prepared according to the market and settlement values on the reporting date.
This is one important exception to the normal rule that the financial statements reflect conditions as at the end
of the reporting period.

Disclosure: [Para 17]

The following information should be disclosed:
• The Date that the Financial Statements were Authorized for Issue;
• The Person or Persons who authorized the issue of the financial statements;
• For each material category of non-adjusting event the end of the reporting period a narrative description
of:
➢ The nature of the event; and
➢ The estimated financial effect or a statement that such an estimate is not possible

Date of authorization [IAS 10: 4, 5 & 7 and Companies Act, 2017: Section 232]
In Pakistan, the financial statements must be approved by the board of directors of the company and signed
on behalf of the board of directors by the chief executive and at least one director of the company, and in case
of a listed company also by the chief financial officer. The date of approval by members in annual general
meeting is not the date of authorisation

A summarised chart suggesting the accounting term and treatment based on chances of outflow may
be useful:

Qualitative Quantitative Accounting treatment

general term range*
Obligation Assets
Remote 0 to 5% Do nothing Do nothing
Possible 5%+ to 50% Disclose contingent liability Do nothing
Probable 50%+ to 85% Recognize provision Disclose contingent asset
Virtually certain 85%+ to 99.9% Recognize liability Recognize asset and related
income
Certain 100%
*based on professional judgement and may vary according to circumstances.

Review Provisions shall be reviewed at the end of each reporting period and adjusted to reflect
the current best estimate.

Reversal If it is no longer probable that an outflow of resources embodying economic benefits will
be required to settle the obligation, the provision shall be reversed.

Change in Where discounting is used, the carrying amount of a provision increases in each period
present value to reflect the passage of time. This increase is recognised as borrowing cost.

Where disclosure might affect entity’s position [IAS 37: 92]

In extremely rare cases, disclosure of some or all of the information required by IAS 37 disclosures can be
expected to prejudice seriously the position of the entity in a dispute with other parties on the subject matter
of the provision, contingent liability or contingent asset.

In such cases, an entity need not disclose the information, but shall disclose the general nature of the dispute,
together with the fact that, and reason why, the information has not been disclosed.

----------( 113 )----------

 Being a Muslim is about changing yourself, Not changing Islam.
IFRIC – I
Changes in existing decommissioning, restoration and similar liabilities
IFRIC 1 applies where an entity has previously included decommissioning or restoration costs within the cost
of an item of property, plant or equipment, and created a corresponding provision. Such a provision should
be discounted to present values using a discount rate.

IFRIC 1 mainly addresses how an entity accounts for any subsequent changes to the amount of the liability
that may arise from;

• a revision in the timing or amount of the estimated costs or

• a change in the current market-based discount rate.

Background and issue

Many entities have obligations to dismantle, remove and restore items of property, plant and equipment’.
Under IAS 16, Property, Plant and Equipment, the cost of an item of property, plant and equipment includes
the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is
located.

IAS 37 Provisions, Contingent Liabilities and Contingent Assets contains requirements on how to measure
decommissioning, restoration and similar liabilities. This Interpretation provides guidance on how to account
for the effect of subsequent changes in the measurement of existing decommissioning, restoration and similar
liabilities.

Scope

IFRIC 1 applies to changes in the measurement of any existing decommissioning, restoration or similar
liability that is both:

• Recognised as part of the cost of an item of property, plant and equipment in accordance with IAS 16
• Recognised as a liability in accordance with IAS 37.

For example, a decommissioning, restoration or similar liability may exist for decommissioning a plant or
rehabilitating environmental damage, in extractive industries, or the removal of equipment.
Point to remember:
Effect of remeasurement of all provision is to be taken to P,L except decommissionig liability.

Consensus:
Changes in measurement of an existing decommissioning, restoration and similar liability that result from:
i. Changes in cash flows or
ii. A change in the discount rate shall be accounted for in accordance with following paragraphs:

A. If the related asset measured using the cost model:

a) Changes in liability shall be:
• Added to, or
• Deducted from,
• The cost of the related asset in the current period.

For example:
Asset xx or Provision xx
Provision xx Asset xx

----------( 114 )----------

 When Love is for the sake of ALLAH, It never dies.

Q1 and Q.2 from question bank

If the change in the liability had resulted from a change in the discount rate, instead of a change in the
estimated cash flows, the accounting for the change would have been the same but the next year’s finance
cost would have reflected the new discount rate. (e.g. suppose rate is changed to 6%)

a) The amount deducted from cost of the asset shall not exceed its carrying amount. If a decrease in
liability exceeds the carrying amount of an asset, the excess shall be recognized in profit or loss.
b) If the adjustment results in an addition to the cost of an asset, the entity shall consider whether this is
an indication that new carrying amount of the asset may not be fully recoverable.

If it is such an indication, the entity shall test the asset for impairment by estimating its recoverable
amount, and shall account for any impairment loss (if any).

B. If the related asset is measured using the revaluation model:

a) Changes in liability alter the revaluation surplus or loss previously recognized on that asset, so that:
i. a decrease in liability shall be recognized in OCI and increase the revaluation surplus within
equity, except that
• it shall be recognized in profit or loss to the extent that it reverses a revaluation loss on the asset that
was previously recognized in profit or loss.

For example:
Provision xx
R. xx
Surplus(OCI)

or In case of previous deficit recognized in profit or loss:

Provision xx
P/L (other income) xx

ii. An increase in liability shall be recognized in profit or loss, except that it shall be recognized in
OCI and reduce the surplus within equity to the extent of any credit balance existing in the revaluation
surplus for the asset.
P.L (other xx
expenses)
Provision xx

or In case of previous surplus on revaluation:

[Link](OCI) xx
Provision Xx

Q3 and Q.4 from question bank

a) A change in liability is an indication that asset may have to be revalued in order to ensure that the
carrying amount does not differ materially from that which would be determined using fair value at the end
of the reporting period. If a revaluation is necessary, all assets of that class shall be revalued.
b) The change in the revaluation surplus arising from a change in the liability is separately identified and
disclosed as such.
c) The periodic unwinding of discount shall be recognized in profit or loss as finance cost as it occur.
Capitalization under IAS-23 is not permitted.

----------( 115 )----------

 Every new breath that ALLAH allows you to take is not just a blessing but also a responsibility

IFRIC-1- Q.B
Q.1 Violet power Limited [IFRIC 1 with cost model]
Violet Power Limited is running a coal based power project in Pakistan. The Company has built its plant in an
area which contains large reserves of coal. The company has signed a 20 years agreement for sale of power
to the Government. The period of the agreement covers a significant portion of the useful life of the plant. The
company is liable to restore the site by dismantling and removing the plant and associated facilities on the
expiry of the agreement.

Following relevant information is available:

• The plant commenced its production on July 1, 2015. It is the policy of the company to measure the related
assets using the cost model;
• Initial cost of plant was Rs. 6,570 million including erection, installation and borrowing costs but does not
include any decommissioning cost;
• Residual value of the plant is estimated at Rs. 320 million;
• Initial estimate of amount required for dismantling of plant, at the time of installation of plant was Rs. 780
million. However, such estimate was reviewed as of June 30, 2016 and was revised to Rs. 1,021 million;
• The Company follows straight line method of depreciation; and
• Real risk-free interest rate prevailing in the market was 8% per annum when initial estimates of
decommissioning costs were made. However, at the end of the year such rate has dropped to 6% per
annum.

Required
1. Prepare accounting entries for the year ended June 30, 2016.
2. Work out the carrying value of plant and decommissioning liability as of June 30, 2016.

Q.2 BRAVO LIMITED [IFRIC 1 with cost model]

The financial statements of Bravo Limited (BL) for the year ended 30 September 2013 are under finalisation
and the following matters are under consideration:
BL’s plant was commissioned and became operational on 1 April 2008 at a cost of Rs. 130 million. At the time
of commissioning its useful life and present value of decommissioning liability was estimated at 20 years and
Rs. 19 million respectively.
BL’s discount rate is 10%.
There has been no change in the above estimates till 30 September 2013 except for the decommissioning
liability whose present value as at 1 April 2013 was estimated at Rs. 25 million.

It is the policy of the company to measure the assets using the cost model.
Required:
• Prepare journal entries for the year ended 30.09.2013
• Compute the related amounts as they would appear in the statements of financial position and
comprehensive income of Bravo Limited for the year ended 30 September 2013 in accordance with IFRS.
(Ignore corresponding figures)

Q.3 WASTE MANAGEMENT LIMITED [IFRIC 1 with revaluation]

Waste Management Limited (WML) had installed a plant in 2005 for generation of electricity from garbage
collected by the civic agencies. WML had signed an agreement with the government for allotment of a plot of
land, free of cost, for 10 years. However, WML has agreed to restore the site, at the end of the agreement.

Other relevant information is as under:

• Initial cost of the plant was Rs. 80 million on April 1, 2005. It is estimated that the site restoration cost
would amount to Rs. 10 million.
• It is the policy of the company to measure its plant and machinery using the revaluation model.
• When the plant commenced its operations i.e. on April 1, 2005 the prevailing market based discount rate
was 10%.
• On March 31, 2007 the plant was revalued at Rs. 70 million including site restoration cost.
• On March 31, 2009 prevailing market based discount rate had increased to 12%.
• On March 31, 2011 future estimate of site restoration cost was revised to Rs. 14 million.
• Useful life of the plant is 10 years and WML follows straight line method of depreciation.

----------( 116 )----------

 Many skin colors. One Ummah. No Racism is ISLAM.

Required:
Prepare accounting entries for all the relevant years upto the year ended March 31, 2011 based on the above
information, in accordance with International Financial Reporting Standards. (Ignore taxation.)

Q.4 GLADIATOR LIMITED [IFRIC 1 with revaluation model]

Faraz is a chartered accountant and employed as Finance Manager of Gladiator Limited (GL). He has
recently returned after a long medical leave and has been provided with draft financial statements of GL for
the year ended 30 June 2017. Following figures are reflected in the draft financial statements:

------- Rs. in million -------

Profit before tax 125

Total assets 1,420

Total liabilities 925

While reviewing the financial statements, he noted the following issues:

As at 30 June 2017, dismantling cost relating to a plant has increased from initial estimate of Rs. 30 million
to Rs. 40 million. Further, fair value of the plant on that date was assessed at Rs. 112 million (net of present
value of dismantling cost). [Sometimes this sentence is written as: Fair value of plant is 112 million net of
dismantling cost]. No accounting entries have been made in respect of increase in dismantling liability and
revaluation of the plant. Appropriate discount rate is 8%.

The plant had a useful life of 5 years when it was purchased on 1 July 2015. The carrying value of plant and
related revaluation surplus included in the financial statements are Rs. 135.4 million (after depreciation for
the year ended 30 June 2017) and Rs. 3.15 million (after transferring incremental depreciation (means surplus
to retained earnings) for the year ended 30 June 2017) respectively.

Required:
Determine the revised amounts of profit before tax, total assets and total liabilities for the year ended
30.06.2017 after incorporating the impact of above adjustments, if any.

----------( 117 )----------

 “Men and Women have equal rewards for their deeds”. Quran 3:195

Solution 4:
Impact on
Profit Before Total Total
tax assets liabilities
----------- Rs. in million -----------
As per question 125.00 1,420.00 925.00
Revaluation of plant (W-1) 8.35
Increase in provision (W-1) 7.94

Revised Amounts 125.00 1,428.35 932.94

Workings:
30-06-2017:
Plant:
C.A of Plant (GIVEN) = 135.4
F.V[112+40(1.08)-3 ] = 143.75
R.S = 8.35
Plant 8.35
R.S (OCI) 8.35
Revised balance of surplus [3.15+8.35]=11.5
Re measurement of Decommissioning liability as on 30.06.2017:
Original estimate = 30(1.08)-3` = 23.81
Revised estimate = 40(1.08)-3 = 31.75
Difference(increase) = 7.94
Revaluation surplus (OCI) 7.94
Provision 7.94
Revised amounts of revaluation surplus are:
Revaluation surplus
Provision 7.94 Unadjusted b/d 3.15
c/d 3.56 Plant 8.35

----------( 118 )----------

Test
Question: Alpha Limited (AL) bought plant on 1st July 2017 for Rs.4500 million. AL has a legal obligation to
dismantle the plant at the end of life of four years. On the date of acquisition, it was estimated that the cost
of dismantling would amount to Rs.600 million. AL uses the revaluation model for subsequent measurement
of its property, plant and equipment and account revaluation on the net replacement method. Depreciation is
provided on straight line basis. Applicable discount rate is 10%p.a.

The details of revaluation carried out by the Professional Valuer and the revision in the estimated cost of
dismantling as at 30. June 2018 and 2019 are as follows:

Rs in “million”

2019 2018
Revalued amount of plant* 1800 3375
Revised estimate of Dismantling cost 450 826
*excluding dismantling cost

Required:

1. Prepare journal entries to record the above transactions in the books of AL for the year ended 30 June
2019, in accordance with International Financial Reporting Standards.

2. Prepare extracts from statement of profit or loss and statement of financial position as onj 30.06.2019 with
comparatives.

Note: if more than one standards are applicable on same date then first apply requirements of IAS-16, then
other standards.

⯈ Example:

On 1 January 2021, Adeel Limited (AL) installed a plant at a total cost of Rs. 100,000 with useful life of 5 years
and nil residual value. There is legal requirement to dismantle the plant at the end of useful life. It was
estimated that dismantling would require cash outflows of Rs. 16,105 at the end of useful life. Relevant pre-
tax discount rate was estimated as 10%.

On 31 December 2021, the estimate of dismantling cash outflows and relevant pre-tax discount rate was
revised to Rs. 19,735 and 11%, respectively.

On 31 December 2022, the estimate of dismantling cash outflows and relevant pre-tax discount rate was
revised to Rs. 13,971 and 14%, respectively.

In later December 2023, the plant suffered a damage and its recoverable amount was determined to be Rs.
5,000 only on 31 December 2023, following the impairment review.

On 31 December 2023, the estimate of dismantling cash outflows and relevant pre-tax discount rate was
revised to Rs. 5,382 and 16%, respectively.

AL has financial year end of December 31.

Required: Prepare movement of plant’s carrying amount and provision for dismantling, identifying the amounts
that will be charged to profit or loss from 1 January 2021 to 31 December 2023 for AL.

----------( 119 )----------

⯈ ANSWER:

Adeel Limited – Movement in PPE and Provision

PPE Provision PL
Particulars Rupees Working
1 Jan 2021 110,000 10,000 [100,000 + 16,105 x 1.10-5]
Depreciation (22,000) 22,000 [110,000 / 5 years]
Interest 1,000 1,000 [10,000 x 10%]
31 Dec 2021 88,000 11,000
Increase in provision 2,000 2,000 (balancing)
31 Dec 2021 90,000 13,000 [19,735 x 1.11-4]
Depreciation (22,500) 22,500 [90,000 / 4 years]
Interest 1,430 1,430 [13,000 x 11%]
31 Dec 2022 67,500 14,430
Decrease in provision (5,000) (5,000) (balancing)
31 Dec 2022 62,500 9,430 [13,971 x 1.14-3]
Depreciation (20,833) 20,833 [62,500 / 3 years]
Interest 1,320 1,320 [9,430 x 14%]
31 Dec 2023 before loss 41,667 10,750
Impairment loss (36,667) 36,667 [41,667 - 5,000]
31 Dec 2023 5,000 10,750
Decrease in provision (5,000) (6,750) 1,750 (balancing)
31 Dec 2023 - 4,000 [5,382 x 1.16-2]

⯈ Example:

On 1 January 2021, Multan Limited (ML) installed at a total cost of Rs. 100,000 with useful life of 5 years and
nil residual value. There is legal requirement to dismantle the plant at the end of useful life. It was estimated
that dismantling would require cash outflows of Rs. 16,105 at the end of useful life. Relevant pre-tax discount
rate was estimated as 10%.

On 31 December 2021, plant was revalued to Rs. 87,500 and the estimate of dismantling cash outflows and
relevant pre-tax discount rate was revised to Rs. 19,735 and 11%, respectively.

On 31 December 2022, plant was revalued to Rs. 67,000 and the estimate of dismantling cash outflows and
relevant pre-tax discount rate was revised to Rs. 13,971 and 14%, respectively.

On 31 December 2023, the plant was revalued to Rs. 40,000 and the estimate of dismantling cash outflows
and relevant pre-tax discount rate was revised to Rs. 5,382 and 16%, respectively.

ML has financial year end of December 31.

Required: Prepare movement of plant’s carrying amount, provision for dismantling and revaluation surplus,
identifying the amounts that will be charged to profit or loss from 1 January 2021 to 31 December 2023 for
ML.
⯈ ANSWER:
Multan Limited – Movement in PPE, Provision and Revaluation surplus
Revaluation Other Working
Particulars PPE Provision OCI (Rs.) PL PL
Rupees
1 Jan 2021 110,000 10,000 [100,000 +
16,105 x 1.10-5]
Depreciation (22,000) 22,000 [110,000 / 5
years]
Interest 1,000 1,000 [10,000 x 10%]
31 Dec 2021 88,000 11,000

----------( 120 )----------

 Revaluation loss (500) (500)
87,500 11,000
Increase in provision 2,000 (2,000) (balancing)
31 Dec 2021 87,500 13,000 0 (2,500) [19,735 x 1.11-4]
Depreciation (21,875) 21,875 [87,500 / 4
years]
Interest 1,430 1,430 [13,000 x 11%]
31 Dec 2022 65,625 14,430
Revaluation surplus 1,375 1,375
(W.1)
67,000 14,430
Decrease in (5,000) 4,000 1,000 (balancing)
provision (W.2)
31 Dec 2022 67,000 9,430 4,000 0 [13,971 x 1.14-3]
Depreciation (22,333) 22,333 [67,000 / 3
years]
Incremental (1,333) [4,500 / 3 years]
depreciation
Interest 1,320 1,320 [9,430 x 14%]
31 Dec 2023 44,667 10,750 0
Revaluation loss (4,667) (2,667) (2,000)
40,000 10,750 0
Decrease in (6,750) 4,750 2,000 (balancing)
provision
31 Dec 2023 40,000 4,000 4,750 0 [5,382 x 1.16-2]

W.1)

R. Surplus = 1,375

Reversal of loss [500+2,000] 2,500 Cr R. Surplus 0

Extra depreciation to be charged (22,000 – 21,875)125 Dr
Net reversal of loss 2,375 Cr
However loss up to 1,375 can be reversed

W.2) remaining loss of 1,000 (2,375 – 1,375) can further be reversed in the entry of decrease in provision,
which means all loss now reversed. Balancing figure of 4,000 will be taken as revaluation surplus.

Accounting entries
A. ADEEL LIMITED

Date Description Dr. Cr.

YEAR
2021
1.1.2021 Plant (bal.) 110,000
Cash/Bank 100,000
Provision for dismantling [16,105(1.1)-5] 10,000
31.12.2021 Depreciation [110,000 / 5] 22,000
Accumulated Depreciation 22,000
31.12.2021 Finance cost (10,000 x 10%) 1,000
Provision for dismantling 1,000
31.12.2021 Plant 2,000
Provision for dismantling (W-1) 2,000

----------( 121 )----------

 YEAR
2022
31.12.2022 Depreciation (*90,000 / 4) 22,500
Accumulated Depreciation 22,500
*110,000 – 22,000 + 2,000 = 90,000

31.12.2022 Finance Cost (13,000 x 11%) 1,430

Provision for dismantling 1,430
31.12.2022 Provision for dismantling (W-2) 5,000
Plant 5,000
YEAR
2023
31.12.2023 Depreciation (*62,500/ 3) 20,833
Accumulated Depreciation 20,833
*90,000 - 22,500 – 5,000 = 62,500

31.12.2023 Finance Cost (9,430 x 14%) 1,320

Provision for dismantling 1,320
31.12.2023 Impairment Loss (W-3) 36,667
Accumulated Impairment Loss 36,667
31.12.2023 Provision for dismantling (W-4) 6,750
Plant 5,000
Expense (P/L) (bal.) 1,750

(W-1) Change in estimates 2021:

= 11,000
Provision as per the books (10,000 + 1,000)

Provision should be [19,375(1.11)-4] = 13,000

Increase in provision = 2,000

(W-2) Change in estimates 2022:

Provision as per the books (13,000 + 1,430) = 14,430

Provision should be [13,971(1.14)-3] = 9,430

Decrease in provision = 5,000

(W-3) Impairment Loss:

= 41,667
Carrying Amount (62,500 – 20,833)

Recoverable Amount = 5,000

Impairment Loss = 36,667

(W-4) Change in estimates 2023:

Provision as per the books (9,430 + 1,320) = 10,750

Provision should be [5,382(1.16)-2] = 4,000

Decrease in provision = 6,750

----------( 122 )----------

A. Multan Limited

Date Description Dr. Cr.

YEAR
2021 Plant (bal.)
1.1.2021 Cash/Bank 110,000
Provision for dismantling [16,105(1.1)-5] 100,000
Depreciation [110,000 / 5] 10,000
31.12.2021 Accumulated Depreciation 22,000
Finance cost (10,000 x 10%) 22,000
31.12.2021 Provision for dismantling 1,000
Accumulated Depreciation 1,000
31.12.2021 Plant 22,000
Revaluation loss (P/L) 22,000
Plant
31.12.2021 500
Carrying amount 88,000
500
FV 87,500
Revaluation loss 500
Revaluation loss (P/L)
31.12.2021 2000
Provision for dismantling
2000
Provision as per books (10,000 + 1,000) 11,000
Provision should be 19,735 (1.11)-4 13,000
Increase in provision 2,000

YEAR Depreciation (87,500 / 4)

2022 Accumulated Depreciation
31.12.2022 Finance Cost (13,000 x 11%) 21,875
Provision for dismantling 21,875
31.12.2022 Accumulated Depreciation 1,430
Plant 1,430
31.12.2022 Plant 21,875
Reversal of loss (P/L) 21,875
31.12.2022 Carrying amount (87,500 – 21,875) 65,625 1,375
Fair value 67,000 1,375
Revaluation surplus 1,375

Reversal of loss 2,500 Cr Rev. Surplus =

0 (500 + 2000)
Extra dep to be charged 125 Dr
31.12.2022 (22,000 – 21,875) 5,000
Net Reversal of loss 2,375 Cr 4,000
*However Loss can only be reversed up to 1,375 1,000
Provision for dismantling
Revaluation Surplus
Reversal of loss
[ 2,375 – 1,375 = 1,000 (loss to be reversed)]
Provision as per books (13,000 + 1,430) 14,430
Provision should be 13,971(1.14)-3 9,430
Decrease in provision 5,000
YEAR
2023 Depreciation (67,000/ 3)
31.12.2023 Accumulated Depreciation 22,333
Revaluation surplus (4,000/3) 22,333
31.12.2023 Retained earnings 1,333
1,333

----------( 123 )----------

31.12.2023 Finance Cost (9,430 x 14%) 1,320
Provision for dismantling 1,320
31.12.2023 Accumulated Depreciation 22,333
Plant 22,333
31.12.2023 Revaluation surplus (4,000 – 1,333) 2,667
Revaluation loss (bal.) 2,000
Plant 4,667
Carrying amount (67,000 – 22,333) 44,667
31.12.2023 Fair value 40,000 6,750
Revaluation loss 4,667 2,000
Provision for dismantling 4,750
Reversal of loss
Revaluation surplus (bal.)

Provision as per books (9,430 + 1,320) 10,750

Provision should be 5,382(1.16)-2 4,000
Decrease in provision 6,750

Reversal of loss 2,000 Cr Rev. Surplus 4,750Cr

Dep to be charged ---
Net reversal of loss 2,000 Cr

----------( 124 )----------

 “He Knows what is in every Heart” – Surah Mulk {67:13}

Financial Instruments [IFRS 9]

Financial instrument is a contract between two parties in which:

• One entity has a financial asset in its books; and

• The other entity has financial liability or equity instrument in its books.

As a basic discussion financial asset simply means a contractual right to receive cash or an equity
instrument of another entity;

Similarly, a financial liability means a contractual obligation to pay cash.

For example:

1. Company X sells goods to company Y on credit for Rs. 200,000.

Company X Company Y
Debtor-Y 200,000 Purchase 200,000
Sales 200,000 Creditor-X 200,000
There is a receivable in the books of company X. There is a payable in the books of company.
(Receivable means a right to receive; in other (Payable means an obligation to pay;
words, Receivable from customer is an example In other words, Payable to supplier is an
of a financial asset) example of financial liability)

2. Company XYZ deposited money in MCB bank Rs. 300,000

Company XYZ MCB Bank

MCB Bank 300,000 Cash 300,000

Cash 300,000 XYZ a/c 300,000
Company has a right to receive money (a MCB bank has an obligation to pay money (a
financial financial liability) on demand by depositor (i.e
asset) from MCB Company XYZ).

Similarly, there are other examples of financial instruments around us but this word of financial instruments
is new for us. E.g. bank loans, redeemable preference shares, debentures, interest receivable/interest
payable.

3. Company ABC issued debenture certificates of 500,000

Company ABC Debenture Holder

Cash 500,000 Investment in debentures (F.A) 500,000
Debenture (Financial liability) 500,000 Cash
(Obligation to repay amount means a financial 500,000
liability) (Right to receive back amount means a financial
asset)

4. Company X issues 100,000 ordinary shares of Rs. 10 each at Rs. 12 each to company Y for 1,200,000.

Company X Company Y
Cash 1,200,000 Investment in shares 1,200,000
Share Capital 1,000,000 Cash 1,200,000
Share premium 200,000 (Company Y has Financial asset in the form of
(Company X has an equity instrument in its shares of another Company)
books)

----------( 125 )----------

Ordinary vs. preference shares
Companies issue two main types of shares:
▪ Ordinary Shares
▪ Preference Shares
• Irredeemable Preference shares
• Redeemable Preference shares
Comparison of ordinary shares and irredeemable preference shares

Ordinary shares Irredeemable Preference shares

Dividend rate Variable – higher in a good year, Fixed per annum
lower in a bad year
Dividend distribution Paid only if there are spare funds Receives the dividend before
after the payment of preference ordinary shareholders (therefore
dividend lower risk)
Liquidation The last to be repaid in a Repaid before (in preference to) the
liquidation ordinary shareholders
Voting rights Receive the right to vote on major No right to vote on company
decisions. Each ordinary share decisions.
would attract one vote.
Dividend presentation In equity In equity (before ordinary dividend)
Amount of capital In equity In equity
presentation

Comparison of redeemable preference shares and irredeemable preference shares

Irredeemable preference shares Redeemable Preference shares
Dividend rate Fixed per annum Fixed per annum

Dividend distribution Paid only if there are spare funds Receives the dividend before
after the payment of a redeemable Irredeemable preference shareholders
preference dividend in preference and ordinary shareholders (therefore
to ordinary shareholders lower risk)
Liquidation The last to be repaid in a liquidation Repaid before (in preference to)
but before ordinary shareholders. Irredeemable preference shareholders
and the ordinary shareholders
Voting rights No right to vote on company no right to vote on company decisions
decisions
Dividend presentation In equity (before ordinary dividend) In financial charges in statement of
profit or loss
Amount of capital In equity In non-current liabilities
presentation

Comparison of ordinary shares and redeemable preference shares

Ordinary shares Redeemable Preference shares

Dividend rate Variable – higher in a good Fixed per annum
year, lower in a bad year
Dividend distribution Paid only if there are spare Receives the dividend before
funds after the payment of Irredeemable preference shareholders
preference dividend and ordinary shareholders (therefore
lower risk)
Liquidation The last to be repaid in a Repaid before (in preference to)
liquidation Irredeemable preference shareholders
and the ordinary shareholders
Voting rights Receive the right to vote on no right to vote on company decisions
major decisions. Each
ordinary share would attract
one vote.
Dividend presentation In equity In financial charges in statement of profit
or loss
Amount of capital In equity In non-current liabilities
presentation

----------( 126 )----------

Example: Financial Assets
Discuss whether any of the following are financial assets:
a. Inventory
b. Debtors
c. Balance in bank
d. Property, plant and equipment
e. Prepaid rent

Solution
a. No, there is no contractual right to receive cash.
b. Yes, there is a contractual right to receive cash from the debtor.
c. Yes, there is a contractual right to receive a cash from the bank.
d. No, there is no contractual right to cash by owning property, plant and equipment.
e. No, there is a contractual right to receive services and not a right to receive cash.

Example: Financial liabilities

Discuss whether any of the following are financial liabilities:
a. Creditors
b. Redeemable preference shares
c. Warranty obligations
d. Bank loans
e. Current tax payable

Solution
a. Yes, the entity is contractually obligated to settle the creditor with cash.
b. Yes, the entity must, in the future, redeem the preference shares with cash.
c. If the entity has to pay the warranty obligation in cash, it is a financial liability. If the entity merely has
to repair the goods, then since there is no obligation to pay cash, it is not a financial liability.
d. Yes, there is a contractual obligation to repay the bank for the amount of cash received plus interest
on respective due date.
e. No, a contractual obligation does not exist, only a statutory obligation exists.

Accounting for Financial Assets: An entity shall recognize a financial asset when it become a party to
the contractual provisions of the instrument.
There are two types of Financial Assets;
1. Financial Asset in the form of a Debt instrument [means a contract in which debentures or
bonds are purchased]
2. Financial Asset in the form of an Equity instrument [means a contract in which shares are
purchased]
1. Financial Asset in the form of a Debt instrument
Example:
Suppose Honda limited invested in 100 debentures of company X @ 10 each on 1-1-2015; it carries interest
@15% receivable in arrears. It has a five year term. These debentures are listed and therefore tradable in
market.
Total investment 100 x 10 = 1,000
1-1-2015: Investment in debentures (F.A) 1,000
Bank 1,000
31-12-2015: Lets assume on reporting date market price per debenture is 15.
Now question is whether the financial asset is to appear in statement of financial position at cost of 1,000
(means cost basis measurement) or at its fair value which is 100 x 15 = 1,500 (means fair value basis
measurement)
Lets discuss what will be implication of choosing the above two alternates.
If the Fair value basis is used then our statement of financial position will reflect changed figure of this
investment from year to year (because of increase/decrease in prices as a result of market factors), until
disposed off.
If cost basis is used, then figure in statement of financial position will be 1,000 (cost) from year to year
until disposed off.

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 ALLAH is sufficient for us.
BASIC PRINCIPAL OF MEASUREMENT:
The IFRS-9 recommends the use of fair value unless conditions are met for measurement at cost.

Conditions for cost basis of measurement:

i) Business model of the entity is to hold the investment to recover contractual cash flows arising
on specific dates; and
ii) The contractual cash flows comprise recovery of solely principle and interest.

The key aspect in above points is that irrespective of changes in fair value of the financial asset, entity’s
intention is to hold the investment and wait for those dates on which contractual cash flows will arise; i.e
the date on which interest and principal will be received according to the agreement. In such a case, cost
basis measurement can be used; means instrument should remain at 1,000 in statement of financial
position. Interest income is recognized in profit or loss and fair value changes are simply ignored.

If however entity’s intention is to sell the financial asset as the market values increase then it means entity
is not interested with contractual cash flows of principal and interest on specific dates. In such a case,
investment is re measured at each reporting date to fair value; i.e at 100 x 15 = 1,500 as on 31.12.2015
onwards until disposal. Interest income is recognized in profit or loss.

Example of a debt instrument:

Company X invested Rs. 1,000 in a fixed deposit @ 10% for 2 years on 1-1-2015.

This arrangement includes:

A principal amount of 1,000; and

Interest of Year-1 100

31-12-2015 1,100

Interest of Year-2 110

31-12-2016 1,210 (this balance is sum of principal; 1,000 and interest; 210)

If the objective of the company is to hold the investment and then receive contractual cash flows then
following accounting treatment will be adopted:

Accounting entries:

1-1-2015: Investment -Financial Asset 1,000

Bank 1,000

31-12-2015: Investment -Financial Asset 100

Interest Income 100

31-12-2016: Investment -Financial Asset 110

Interest Income 110

End of 31-12-2016 (on maturity date after two years)

Bank 1,210

Investment -Financial asset 1,210

Point to remember: IFRS 9 uses word of Amortized cost for cost basis measurement of debt instruments.

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 No one can help you get through your problems But ALLAH.

Important terms used in questions:

Bond simply means loan
Coupon rate means actual interest rate
1. If today’s invested amount is similar to redemption amount than actual rate (means coupon
rate) and effective rate will be same.

Example of a debt instrument

Company X invests in a bond of company Y on 1-1-2015 carrying interest of 6%.

Assume conditions of using cost method are met.

Investment amount is 3,000 which will be redeemed after four years..

Effective Interest @ 6 % Interest received @ 6% Balance

1.1.2015 3,000
31.12.2015 180 180 3,000
31.12.2016 180 180 3,000
31.12.2017 180 180 3,000
31.12.2018 180 180 3,000
Total 720 720

2. If today’s invested amount is dissimilar to redemption amount than actual rate (means coupon
rate) and effective rate will be different.

Example of a debt instrument

Company X invests in a bond of company Y on 1-1-2015 carrying interest of 6%.

Assume conditions of using cost method are met.
Investment amount is 3,000 and the redeemed amount will be 3,400 after four years..

Effective Interest @ % Interest received @ 6% Balance

1.1.2015 3,000
31.12.2015 180
31.12.2016 180
31.12.2017 180
31.12.2018 180 3,400(3,000+1,120-720)
Total 1,120 (400+720) 720

3. Zero coupon bond

Example of a debt instrument

Company X invests in zero-coupon bond of company Y on 1-1-2015.

Zero coupon bond means a debt instrument in which all investor gain will arise on maturity at the end of
the bond period; and no interest is received during the period.
Assume conditions of using cost method are met.
Investment amount is 6,000.

After 3 years company Y will pay 8,000 to company X. Year ended 31-12 each year.
Effective rate of interest is 10.064 %

Effective Interest @ 10.064 % Interest received Balance

1.1.2015 6,000
31.12.2015 604 - 6,604
31.12.2016 665 - 7,269
31.12.2017 731 - 8,000
Total 2,000

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 Kindness is a mark of faith, and whoever is not kind has not faith.

Accounting entries:
1-1.2015: Investment 6,000
Bank 6,000
31-12-2015: Investment 604
Interest income 604
31-12-2016: Investment 664
Interest income 664
31-12-2017: Investment 731
Interest income 731
31-12-2017: Cash 8,000
Investment 8,000
4. If there is a transaction cost associated with debt instrument (e.g. documentation charges or
brokers fee)
Example of a debt instrument
Company X invests in a bond of company Y on 1-1-2015 carrying coupon of 6%.
Assume conditions of using cost method are met.

Investment amount is 3,000 and the redeemed amount will be 3,400 after four years. The associated
transaction costs are 200.

a) If transaction cost is recognized as an expense in the year in which it is incurred:

Transaction cost expense 200

Cash 200

In this case the expense will be recognized in the first year and income of 1,120 will be recognized over
the four years.
Effective Interest @ % Interest received @ 6% Balance
01.01.2015 3,000
31.12.2015 180
31.12.2016 180
31.12.2017 180
31.12.2018 180 3,400(3,000+1,120-720)
Total 1,120 (400+720) 720

b) If transaction cost is capitalized in the cost of investment if effective interest rate is 7.05%.

Investment 200
Cash 200

In this case the expense will be recognized over the four years in the form of reduced interest income.

Effective Interest @ 7.05% Interest received @ 6% Balance

01.01.2015 3,200(3,000+200)
31.12.2015 226 180 3,246
31.12.2016 229 180 3,295
31.12.2017 232 180 3,347
31.12.2018 236 180 3,403(3,200+920-720)
Total 920 (400+720-200) 720

Conclusion: As per IFRS 9 transaction costs should be capitalized in case of debt instrument measured
at amortized cost.

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 If Jannah is your dream, HOLD TIGHT to your deen!

Concept of profit or loss portion and other comprehensive income portion in statement of
comprehensive income

If the business model for debt instruments is to:

• Collect contractual cash flows; and

• Selling financial assets whenever a favorable opportunity arises then:

In this case the IFRS-9 does not allow to use Amortized cost method. In such a case then entity should
use FV through OCI method for debt instruments. Under this approach, any interest based on effective
rate will be taken to P.L but changes in fair value (either gain/loss) are recognized in other comprehensive
income.

For example:

Company X has purchased debentures of Rs. 1,000 at Par redeemable at par; which are listed on an
exchange on 01.01.2016

It carries interest rate of 6% receivable in arrears; i.e. annual interest of 60.

Fair value on 31.12.2016 is 1,020

Assume the business model for debt instruments is to:

• Collect contractual cash flows comprise solely of principal and interest; and
• Selling financial assets whenever a favorable opportunity arises then:

Total Income for the year ended 31.12.2016 is

60 20 (1,020 – 1,000)
Interest income Fair value gain

Accounting entries:

Investment 1,000
Bank 1,000
Investment 60
Interest income 60
Bank 60
Investment 60
Investment 20
OCI (Gain) 20

In this case, changes in fair value are recognized in OCI rather than profit or loss because the business
model is to hold the investment to earn interest as well selling it whenever a favorable opportunity arises
(rather than selling in the short term)

If the business model for debt instruments is trading means selling in the short term as soon as the
favorable opportunity arise. The objective of the investment is not to hold the investment and receive
contractual cash flows on specific dates of the contract.

Even in this case the IFRS-9 does not allow to use Amortized cost method. In such a case then entity
should use FV through PL method for debt instruments. Under this approach, any actual interest
(means coupon) based on face value as well as changes in fair value (either gain/loss) are recognized in
profit or loss. There is no need of any amortization table.

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Recognition and Measurement of Financial Assets (Debt instruments):

Example: On 1-1-2011, Abacus Co. purchased a debt instrument (e.g. debentures) at its fair value of 1,000
(from stock market). The debt instrument is due to mature on 31-12-2015. The instrument has a face value
of 1,250 (which is receivable at maturity) and the instrument carries fixed interest rate of 4.72% that is paid
annually (not mentioned then always arrears). The effective rate of interest is 10%.Fair value as on
31.12.2011 of debt instrument is 1,080.

Required:
1. How should Abacus Co. account for the debt instruments ? Assume Abacus Co. decided to hold the
investment till maturity and receive contractual cash flows comprising principal and interest therefore
use Amortized cost method.
2. How should Abacus Co. account for the debt instrument? Suppose Abacus Co.’s investment objective
is to collect contractual cash flow as well as selling when an opportunity arises at a good price therefore
this investment is carried at Fair value through other comprehensive income rather than Amortized
cost.
3. How should Abacus Co. account for the debt instrument? Suppose Abacus Co.’s investment objective
is trading in the short term (means speculation) rather than to collect the contractual cash flows up to
maturity; therefore this investment is carried at Fair value through profit or loss rather than Fair value
through other comprehensive income or Amortized cost.

Answer:

1. Amortized cost

Abacus will receive interest of 59 (1,250 x 4.72%) each year for five years in arrears and 1,250 when the
instrument matures on 31.12.2015.

Effective Interest income @ 10% Cash flows Balance

(P.L) Interest received 1,250 x 4.72% (SOFP)
1.1.2011 1,000
31.12.2011 100 (59) 1,041
31.12.2012 104 (59) 1,086
31.12.2013 109 (59) 1,136
31.12.2014 113 (59) 1,190
31.12.2015 119 (59) 1,250
Every year the carrying amount of the financial asset is increased by the interest income for the year and
reduced by the interest actually received during the year. Fair value is simply ignored.

2. Fair value through other comprehensive income (FVTOCI)

In this case, fair value changes will go through OCI. Interest income measured at amortized cost will
go to profit or loss (other income) just as above. In addition, as on 31-12-2011 difference in fair value
39 (1,080 – 1,041) would go to OCI and the investment would be shown in statement of financial
position at 1,080 as on 31-12-2011.

3. Fair value through profit or loss (FVTPL)

In this case, fair value changes will go to P.L. Actual Interest income of Rs. 59 will go to profit or loss
(other income). In addition, as on 31-12-2011 difference in fair value of Rs. 80 (1,080 – 1,000) will go
to P.L and the investment would be shown in statement of financial position at 1,080 as on 31-12-2011.

Amortized cost criteria: The rules try to limit the use of amortized cost method to those situations where
it best reflects the substance of transaction. Therefore it can only be used by an entity whose business
model is to purchase debt instruments and collect contractual cash flows in the form of principlal and
interest.

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 When there is no way, Allah will make a way.

Decision Tree for Classification:

Financial asset is Debt Instruments [e.g. debentures or bonds]

“Contractual cash flow characteristics” test (at debt instrument level)

(means cash flows under the contract comprise solely payment of principal and interest)

Pass

Business model test (at an aggregate level means at entity level) [Link]
Business models can be: instrument
Held for
trading
(speculation
purpose)
1. Debt Instruments Held 2. Debt Instruments Held to collect contractual
to collect contractual cash cash flows as well as selling it when an opportunity
flows till maturity arises at a good price.

YES
YES
Conditional fair value
through PL option Conditional fair value
elected? YES
through PL option elected?
NO
NO
O
Classify at
Classify at FVTPL
Amortized cost
FVTOCI
[any changes in FV
are simply ignored] (Changes in fair value are
recognized in OCI)

YES

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In summary, debt instruments are classified as either:

1. At amortized cost if both conditions of measurement at amortized cost are met (and FVTPL option is
not elected)
2. At FV through OCI if conditions of FVTOCI are met (and FVTPL option is not elected)
3. At FV through PL if entity made an irrevocable* election at initial recognition for any of the debt
instrument; or if held for trading
*(Means cannot subsequently change)

2. Financial Asset in the form of an Equity instrument:

E.g. Honda ltd purchased ordinary shares in Google of Rs. 5,000,000. In this case, the share price will
change in stock exchange on daily basis. Google may or may not pay dividends. It depends upon
availability of profits and decision of management and Google will only repay the initial investment if there
are surplus funds at the time of liquidation; so, this is not an investment in which contractual cash flows will
be received on specific dates. (Honda Ltd. may or may not receive dividends. Dividend on ordinary shares
is discretion of management; and if no surplus funds at liquidation Honda ltd will not get the invested
amount as well) Therefore, these equity shares should not be measured on cost basis (means at
amortized cost).

Example of an equity instrument:

Company X invested in 1,000 ordinary shares of company Y on 1.1.2016 at 10 per share (it is a financial
asset for company X and equity instrument of company Y)

Investments in ordinary shares neither results into contractual cash flows on specific dates nor recovery of
solely principal or interest. This type of investment will always be shown at Fair value (not at cost) as the
conditions for cost basis measurement are not fulfilled. [Please remember there is a choice of cost basis
for debt instruments]

Let’s assume at 31.12.2016; Fair value is 15 per share therefore fair value of investment will be 1,000x15
= 15,000.

At 31.12.2017; Fair value is 8 per share therefore fair value of investment will be 1,000x8 = 8,000.

If we use fair value; then next discussion is whether to recognize gain/loss on re measurement to fair value
in profit or loss or in other comprehensive income.

If investment in shares is for speculative or If investment in shares is for long term

short term trading purposes purposes
(means purpose is to earn immediate gain by (for future dividend)/or strategic (e.g. to obtain
selling shares as soon as the favorable control or significant influence over the long term;
opportunity arises) in other words no plan to sell in the short term)
then Recognize gain or loss in profit or loss then recognize gain or loss in OCI.

On 31.12.2016 On 31.12.2016
Investment 5,000 Investment 5,000
P. L (gain) 5,000 OCI (gain) 5,000
[15,000-10,000=5,000] On 31.12.2017
On 31.12.2017 OCI (loss) 7,000
P. L (loss) 7,000 Investment 7,000
Investment 7,000
[15,000-8,000=7,000]

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 “You will die the way you lived” – Prophet Muhammad SAW

Decision Tree for Classification:

Financial asset is an Equity Instruments [e.g. investment in ordinary shares of another

company]

“Contractual cash flow characteristics” test (at equity instrument level)

(means cash flows under the contract comprise solely payment of principal and interest)
[This test will most likely fail in case of equity instruments]

FAIL

NO
Held for trading
(means for short term speculation)

Irrevocable FVTOCI option

elected

YES
YES

NO
Classify as FVTOCI
[Changes in fair value are
Then no choice classify as FVTPL recognized in OCI]
[Changes in fair value are recognized in
profit or loss]

In summary, equity instruments are classified as either:

1. Held for trading FVTPL is Mandatory

2. Not held for trading means a long term investment entity can make an irrevocable election at the
initial recognition to measure at FVTOCI; otherwise even then FVTPL.
3. Never at amortized cost.

Trade receivables are measured by using the requirements of IFRS 15.

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Recognition and Measurement of Financial Assets (Equity instruments):

At FVTPL for Equity Instruments:

Example:

On 1-1-2018, Honda ltd acquires 1,000 ordinary shares of Nestle ltd for Rs. 100,000.

On 31-12-2018, the fair value of shares in Nestle ltd is 60,000.

On 31-12-2019, the fair value of shares is increased to 110,000.

On 3 Jan, 2020; Honda ltd sold the shares for 105,000.

Required:
Prepare accounting entries; if the investment in shares is accounted for at FVPTL?

Answer:

1-1-2018: Investment 100,000

Bank 100,000

31-12-2018: Profit or loss 40,000

Investment 40,000
[100,000 – 60,000]

31-12-2019: Investment 50,000

Profit or loss 50,000
[60,000 -110,000]

3-1-2020: Cash/Bank 105,000

P.L 5,000
Investment 110,000
FV TOCI for Equity Instruments:

Example:

On 1-1-2018, Honda ltd acquires 1,000 ordinary shares of Nestle ltd for Rs. 100,000.

On 31-12-2018, the fair value of shares in Nestle ltd is 60,000.

On 31-12-2019, the fair value of shares is increased to 110,000.

On 3 Jan, 2020; Honda ltd sold the shares for 105,000.

Required: Prepare accounting entries; if the investment in shares is accounted for at FVTOCI?
1-1-2018: Investment 100,000
Bank 100,000

31-12-2018: FV loss (OCI) 40,000

Investment 40,000

31-12-2019: Investment 50,000

FV gain (OCI) 50,000

After this the FV Reserves has a credit balance of 10,000.

3-1-2020: Cash/Bank 105,000

P.L 5,000
Investment 110,000

3-1-2020: FV Reserve 10,000

Retained earnings 10,000

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(On sale of Investment; reclassification is allowed through statement of changes in equity but not through
profit or loss)

Transaction costs
Transaction costs are incremental costs that are directly attributable to the acquisition, issue or Disposal
of a financial instrument (means the cost that would not have been incurred if the entity had not acquired,
issued or disposed of the financial instrument). Examples of transaction costs are:
1. Fees and commissions paid to agents, advisers, brokers and dealers;
2. Levies by regulatory agencies and securities exchanges;
3. Transfer taxes and duties;
4. Credit assessment fees;
5. Registration charges and similar costs.

Cost that do not qualify as transaction costs are financing costs (means interest costs), internal
administration costs and holding costs. These costs are expensed when incurred.

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 Islam does not dismiss desires rather it disciplines them.
Accounting treatment of Financial Assets:
1. Accounting treatment of Debt Instruments:
At Amortized Cost At Fair value through other At Fair value through profit or
comprehensive loss( FVTPL)
income(FVTOCI)
Initial Recognition Initial Recognition Initial Recognition
Fair value + Transaction cost Fair value + Transaction cost Fair value + (NO) [any
transaction cost is expensed]
Subsequent measurement: Subsequent measurement: Subsequent measurement:
1. Interest income in P.L by 1. Interest income in P.L using 1. Interest income in P.L using
using effective interest rate effective interest rate nominal (actual) rate.

2. Changes in FV - Ignored 2. Changes in FV in Other 2. Changes in FV directly in

Comprehensive income and P.L whether there is gain or
accumulated in fair value loss.
reserve.
Question at the end of Chapter
Important Note: Trade receivables are measured at the relevant transaction price as defined by IFRS 15
Revenue from contracts with customers. (means IFRS 15 is not applicable)
2. Accounting Treatment of Equity Instruments:
At Amortized Cost At Fair value through other At Fair value through profit or
comprehensive loss( FVTPL)
income(FVTOCI)
Equity instruments are never Initial recognition Initial recognition
classified here. Fair value + Transaction costs Fair value + (No) [any
transaction cost is expensed]
Subsequent measurement
1. Dividend Income in P.L Subsequent measurement
2. Changes in FV is taken to 1. Dividend income P/L
OCI and accumulated in fair 2. Change in FV P/L
value reserve.

Default classification: fair value through PL.

Allowed alternative: fair value through OCI.

Example: In February 2018, company XYZ purchased 20,000 Rs. 10 listed equity shares at a price of Rs.
40 per share. Transaction costs were Rs. 2,000. At the year ended 31-12-2018 these shares were traded
at Rs. 55 per share. A dividend of Rs. 2 per share was received on 30th Sept. 2018.

Required:
Show how the financial statements extracts of company XYZ as on 31-12-2018 relating to this investment
assuming separately that:
a) The shares were acquired for trading (therefore carried at FVTPL).
b) The shares were not acquired for trading and company has made an irrevocable FVTOCI election at
initial recognition.

Answer:
a) Statement of profit or loss:
Gain on Investment [20,000 x (55 – 40)] 300,000
Dividend income [20,000 x 2] 40,000
Transaction cost expense (2,000)
Statement of financial position:
Investment in shares [20,000 x 55] 1,100,000
b) Statement of profit or loss:
Dividend income [20,000 x 2] 40,000
Other comprehensive income:
Gain on investment 298,000
[(20,000 x 55) – (20,000 x 40 + 2,000)]
Statement of financial position:
Investment in shares [20,000 x 55] 1,100,000
----------( 138 )----------
An application of cash flow characteristics test and business model test means that equity investments can
not be classified as measured at amortized cost and must be measured at fair value. This is because
contractual cash flows on specified dates are not a characteristic of equity instruments. They are held at
fair value, with changes going through profit or loss unless investment is not held for trading and the entity
makes an irrevocable election at initial recognition to recognize it at fair value through other comprehensive
income (FVTOCI). If this option is selected, only dividend income will be recognized in profit or loss.

Financial liabilities:

Classification

On recognition, IFRS-9 requires that financial liabilities are classified as;

1. At Amortized cost; or
2. At fair value through profit or loss FVTPL.

Accounting Treatment of Financial

Liabilities

2. Financial Liabilities At Fair

1. Financial Liabilities At
value through profit or loss
amortized cost (FVTPL)

Applies to: Financial liabilities

Applies to: held for trading

All financial liabilities other

than FVTPL

Measurement:
Measurement:
• Record at fair value less
• Record at fair value
transaction costs (net
proceeds received) • Expense transaction costs
in P.L
• Measurement
subsequently at • Restate to fair value at
amortized cost. each reporting date
• Interest expense is • Any gain or loss is taken to
calculated at effective profit or loss (one
interest rate and exception discussed next)
recognized in P.L • Interest expense
• No fair value adjustment calculated at nominal
(actual) rate will be
• On derecognition any
recorded in P.L
gain or loss is taken to
P.L.

----------( 139 )----------

 “None of you will have true faith till he wishes for his
(Muslim) brother what he likes for himself.” [Bukhari]
1. Financial liabilities at Amortized cost:
Initial measurement:

Initially recognize at Fair value net of transaction costs (net proceeds) [means cash received – issuance
costs incurred]

[It simply means transaction costs are not expensed when incurred; rather over the term of the liability]
There is as such no business model test for financial liabilities like as was in financial assets.

1. Debentures of Rs. 100,000 carrying interest @ 10%, issued on 01.01.2015 at Par and redeemable at
Par after four years. Transaction cost is 1,000.

a) If transaction cost is recognized as an expense in the year in which it is incurred:

Cash 100,000
Debentures 100,000
Transaction cost expense 1,000
Cash 1,000

Effective Interest @ % Interest paid @ 10% Balance

01.01.2015 100,000
31.12.2015 10,000
31.12.2016 10,000
31.12.2017 10,000
31.12.2018 10,000 100,000
Total 40,000 40,000

In this case the transaction cost expense will be recognized in the first year and interest expense of 40,000
will be recognized over the four years.

b) If transaction cost is deducted from financial liability

Cash 100,000
Debentures 100,000
Debentures 1,000
Cash 1,000

Effective Interest @ % Interest paid @ 10% Balance

01.01.2015 99,000
31.12.2015 10,000
31.12.2016 10,000
31.12.2017 10,000
31.12.2018 10,000 100,000
Total 41,000 (40,000+1,000) 40,000

In this case the transaction cost expense will be recognized over the four years included within interest
expense.

Conclusion: As per IFRS 9 transaction costs should be deducted from fair value of financial liability so
that expense is recognized over four years.

2. Debentures of Rs. 100,000 carrying interest @ 10%, issued on 01.01.2015 at Par and redeemable at
a premium of 25,000. Transaction cost is 1,000.

Cash 100,000
Debentures 100,000
Debentures 1,000
Cash 1,000

----------( 140 )----------

 Effective Interest @ % Interest paid @ 10% Balance
01.01.2015 99,000
31.12.2015 10,000
31.12.2016 10,000
31.12.2017 10,000
31.12.2018 10,000 125,000
Total 66,000 (40,000+1,000+25,000) 40,000

De recognition (settlement)
Financial liabilities are derecognized when they have been paid in full or transferred to another party (e.g.
bank has sold its individual customers deposits portfolio to another bank to focus only on suppose
corporate customers or its investment activities).

2. A financial liability is classified at fair value through profit or loss if:

1. It is held for trading (means e.g. liability incurred for the purpose of selling (e.g. to another bank) or
repurchasing in the near future (repurchase of debentures from market before maturity); or

[Link] initial recognition it is designated at fair value through profit or loss. Any such designation is
irrevocable.

This designation is only allowed if it eliminates or significantly reduce a measurement or recognition

inconsistency.

Accounting Treatment of Financial liabilities at FVTPL:

• Record at fair value.

• Transaction costs are recognized as an expense.
• Restate to fair value at each reporting date.
• Any gain or loss is recognized in profit or loss except as a result of own credit risk then to OCI
(discussed next).
• Interest expense is recognized in P.L calculated on the basis of nominal rate.

Example: Mousse limited issued 100,000 debentures on the 1 January 2015. Proceeds totaling 200,000.
• On the 31 December 2015 the debentures had a fair value of 300,000.
• Mousse limited designated these debentures to be held at ‘fair value through profit or loss’
• Transaction costs incurred by Mousse limited came to 1,000.

Required:
Provide the necessary journals to show how Mousse limited should account for the debentures during the
year ended 31.12.2015.

Answer:
1 January 2015:
Transaction costs expense 1,000
Bank 1,000
(Transaction costs on the issue of debentures)

Bank 200,000
Debenture (liability) 200,000
(Issue of debenture)

31 December 2015:
Fair value loss (P/L)100,000
Debentures (liability) 100,000
(Re-measurement of debentures at year end)
[300,000 – 200,000]

----------( 141 )----------

Credit risk means the risk that one party to the contract will fail to discharge its obligation under the
contract.

Own Credit Risk:

For example debentures of Rs. 100,000 are issued on 01.01.2018, trading on an exchange. Assume
financial liability is held for trading and therefore measured at FVTPL.
Cash 100,000
Debentures 100,000

Fair value of debentures is suppose 10,000 as on 31.12.2018.

Debentures 90,000
Gain 90,000
( 100,000 - 10,000)

In this case, the gain or loss in a period must be classified into:

i) Gain or loss resulting from credit risk; and
ii) Other gain or loss (because of changes in market conditions).

Changes in an entity’s credit risk affect the fair value of that financial liability. This means that when an
entity’s credit worthiness deteriorates, the fair value of its issued debt will decrease (and vice versa). For
Financial liabilities measured at fair value, this causes a gain (or loss) to be recognized.
The problem is that a company which is in a severe financial trouble can record a large profit based on its
ability to buy back its own financial liability (e.g. a debenture) at a reduced fair value.

Therefore, IFRS-9 requires the gain or loss as a result of credit risk to be recognized in other
comprehensive income. The other gain or loss (not as a result of credit risk) is recognized in profit or loss.
1-1-2015: Issuance of debentures
Cash 500,000
Debentures 500,000

31-12-2015: Fair value is 270,000

Therefore, a total gain is 230,000 [500,000 – 270,000]. Suppose:

200,000 due to 30,000 Otherwise due to

deterioration of own market forces
credit risk.

Debentures 230,000
OCI 200,000
PL 30,000

Presentation In Statement of Comprehensive Income

Profit due to change in fair value 30,000
(Other Income)

Other Comprehensive Income:

Fair value gain on financial liability attributable to
change in credit risk 200,000

Important point: the credit risk referred to is the risk relating to that liability rather than entity as a whole.
This means credit risk of a liability that has been collateralized would be lower than a liability for which no
collateral has been offered.

----------( 142 )----------

ICAP Question bank
Q.1 On 1 January 2011 Ahmad Ltd has the following capital and reserves.

Equity Rs.
Share capital (Rs. 10 ordinary shares) 1,000,000
Share premium 200,000
Retained earnings 5,670,300
6,870,300

During 2011 the following transactions took place.

An issue of Rs. 100,000 8% Rs. 1 redeemable preference shares at a premium of
60%. Issue costs are Rs. 2,237. Redemption is at 100% premium on 31 December
1 January 2015. The effective rate of interest is 9.5%. This financial liability is not designated
as FVTPL.

An issue of 30,000 ordinary shares at a price of Rs. 13 per share. Issue costs were
31 March Rs. 20,000
30 June A 1 for 4 bonus issue of ordinary shares by first utilizing the share premium.

Profit for the year, before accounting for the above, was Rs. 508,500. The dividends paid on the
redeemable preference shares for the year have been charged to retained earnings.
Required
• Prepare relevant accounting entries for the year ended 31.12.2011.
• Prepare extracts from statement of financial position as on 31.12.2011.

Q 2. On 15 October 2016, Rashid Industries Limited (RIL) made the following investments:
Name of Investees No. of shares Percentage of *Cost of investment(Rs.
shareholding acquired in million)
Karim Limited (KL) 155,000 4% 20
Bashir Limited (BL) 135,000 2% 65

* including brokerage commission.

Investment in KL was made with no intention to sell the shares while investment in BL was made with the
intention to sell the shares.
The market price of shares of KL and BL as on 31 December 2016 was Rs. 80 and Rs. 621 respectively.
RIL’s broker normally charges transaction costs of 2%.
Required:
Explain the accounting treatment of above transactions in accordance with International Financial
Reporting Standards.

----------( 143 )----------

 May Allah make us those who fear HIM and often repent.

2. Investment in KL
Initial measurement
According to IFRS 9, at initial recognition, RIL may make irrevocable election to present subsequent
changes in fair value in equity investment in other comprehensive income instead of profit or loss account.
If RIL opted as above, investment in KL would initially be recognized at fair value plus transaction costs
i.e. Rs. 20 million.
However, if RIL opted to measure the investment at fair value through profit and loss (FVTPL),
investment should initially be measured at Rs. 19.61 million (20/102 x 100) and transaction costs of Rs.
0.39 million (20–19.61) should be charged to profit and loss.
Subsequent measurement
On 31 December 2016, if fair value through other comprehensive income has been opted, investment in
KL should be measured at fair value of Rs. 12.4 million (155,000 x 80) and a loss of Rs. 7.6 million [20–
12.4] should be recorded through other comprehensive income.

If fair value through profit or loss has been opted, then RIL should account for the loss of Rs.
7.21 million (19.61–12.4) through profit and loss.

Investment in BL
Initial measurement
It is as held for trading therefore measure at fair value through profit or loss .The investment in BL should
be recognized at Rs. 63.73 million (65÷102 x 100) and transaction cost of Rs. 1.27 million should be
charged to profit and loss account.
Subsequent measurement
As at 31.12.2016, the investment should be re-measured to fair value at the market price of Rs. 83.835
million (135,000×621) and a gain of Rs. 20.105 million (83.835–63.73) shall be recorded in the profit and
loss.

----------( 144 )----------

Extra practice questions:
Q.1
On 1 July 2018, Gypsum Limited purchased 5,000 debentures issued by Iron Limited at par value of Rs.
100 each. The transaction cost associated with the acquisition of the debentures was Rs. 24,000. The
coupon interest rate is 11% per annum payable annually on 30 June. On 1 July 2018, the effective interest
rate was worked out at 9.5% per annum whereas the market interest rate on similar debentures was 11%
per annum.
As on 30 June 2019, the debentures were quoted on Pakistan Stock Exchange at Rs. 96 each.

Required:
Prepare journal entries for the year ended 30 June 2019 if the investment in debentures is subsequently
measured at:
(a) amortized cost (03)
(b) fair value through profit or loss (03)
(c) fair value through other comprehensive income (03)

Q. Debt Instrument at FV through P/L

H Limited has invested in a debt instrument, details of which are as follows: Face Value of the instrument
=100,000
Premium paid on the investment of the instrument =8000 Transaction cost paid on the investment of the
instrument=5800
Coupon rate of the Instrument =12%
Term of the instrument =3 years
H Limited has a policy to classify investment in debt instrument at Fair Value through P/L.
IRR of the Instrument [means effective rate] =8.848%
Market value of the Instrument at the end of year 1 =107,000 The relevant entries for 1st year shall be
prepared as follows:

A. Entries

Yr 0 Financial Asset 108,000

Transaction cost 5,800
Cash/Bank 113,800
Yr 1 Cash/Bank 12,000
Interest income (100,000
x 12%) 12,000

Yr 1 Loss (P/L) [108,000- 1,000

107,000] Financial Asset 1,000

Financial instrument
Substance over form [IAS 32: 15]
Some financial instruments have the legal form of equity but are, in substance, liabilities. For example, an
issuer (company) has contractual obligation to deliver cash in case of redeemable preference shares.
Therefore, dividend on redeemable preference shares is treated as finance cost in profit or loss while
dividend on ordinary shares is presented in statement of changes in equity.

⯈ Example:

Item Financial instrument or otherwise

Trade payable A financial liability (to be settled in cash)
Investment in loan notes of another entity A financial asset
Bank loan obtained A financial liability
Ordinary shares issued An equity instrument
Irredeemable preference shares issued An equity instrument
----------( 145 )----------
 Unfavourable forward currency contract A financial liability
Redeemable preference shares issued A financial liability
Investment in redeemable preference shares A financial asset
Prepaid rent A non-financial asset
Current tax payable A non-financial liability (statutory obligation)
Inventory A non-financial asset

Recognition [IFRS 9: 3.1.1]

An entity shall recognize a financial asset or a financial liability in its statement of financial position, when,
and only when, the entity becomes party to the contractual provisions of the instrument.
A financial asset might be an investment in debt or in equity.
Example:
Identify the classification of following financial assets:
a) Investments in shares held for trading purposes.
b) Investment in equity shares. The entity has no intention of selling these shares in foreseeable
future.
⯈ ANSWER:
a) Fair value through profit or loss
b) Fair value through other comprehensive income
Example:
XYZ Limited makes a large bond issue to the market. Three companies (A Limited, B Limited and C Limited)
each buy identical Rs. 10,000,000 bonds. The following further information is available:
a) A Limited holds bonds for the purpose of collecting contractual cash flows to maturity.
b) B Limited holds bonds for the purpose of collecting contractual cash flows but sells them on the
market when prices are favorable.
c) C Limited buys bonds to trade in them.

Required:
How A Limited, B Limited and C Limited should classify their financial asset based on their respective
business model?
Answer:
a) Classification by A Limited: Amortized Cost
b) Classification by B Limited: Fair value through OCI
c) Classification by C Limited: Fair value through PL

Example:

Identify the classification of following financial assets?

a) Investment in interest bearing debt instruments. The instrument is redeemable in five years. The
intention is to collect cash flows (which are interest and principal amounts only).
b) Investment in interest bearing debt instruments. The instrument is redeemable in five years. The
intention is to collect cash flows (which are interest and principal amounts only). However, the entity
may sell the loan notes earlier if any good offer is received.
c) Investment in loan notes. The objective is to collect contractual cash flows which consist of interest,
changes in oil prices in next five years and principal amount at the end of year 5.
d) Investment in loan notes. The objective is to collect contractual cash flows which consist of interest,
changes in oil prices in next five years and principal amount at the end of year 5. However, the entity
may sell the loan notes earlier if any good offer is received.

Answer
a) Amortised Cost (Business model is to hold for collection of cash flows solely consisting of principal and
interest)
b) Fair value through OCI (Business model is to hold for collection of cash flows solely consisting of
principal and interest or to sell)
c) Fair value through PL (contractual cash flows also include payments other than principal and interest)
d) Fair value through PL (contractual cash flows also include payments other than principal and interest)
----------( 146 )----------
Example:
Identify the classification of following financial liabilities?
a) A 12% bank loan obtained by A Limited payable in 5 years’ time.
b) 8% loan notes issued by C Limited.
c) A short term currency swaps agreement entered into by B4-Bank Limited which is currently
unfavourable. These types of transactions are usual feature of B4-Bank Limited’s business.
d) Trade payable.

Answer:
a) Amortised Cost
b) Amortised Cost
c) Fair value
d) Amortised Cost

Example:
An equity investment is purchased for Rs. 30,000 plus 1% transaction costs on 1 January 2016. It is
classified as at fair value through other comprehensive income. At the end of the financial year (31
December 2016) the investment is revalued to its fair value of Rs. 40,000. On 31 December 2017, the
fair value had declined to Rs. 38,000.

Required: Prepare journal entries from acquisition to 31 December 20X7.

Answer:

Date Particulars Debit Rs. Credit Rs.

1 Jan 2016 Financial asset [Rs. 30,000 + 1%] 30,300

Bank 30,300

31 Dec 2016 Financial asset [Rs. 40,000 – 30,300] 9,700

Gain (OCI & FV reserve) 9,700

31 Dec 2017 Loss (OCI & FV reserve) 2,000

Financial asset [Rs. 38,000 – 40,000] 2,000

⯈ Example:

Momin Limited (ML) purchased 5000 shares for Rs. 100 each on 1st January 2009. Transaction costs are
2% (in both buying and selling). Fair values at different dates are as follows:

1 January 2009 Rs.100

31 December 2009 Rs.108

30 June 2010 Rs.111

31 December 2010 Rs.110

Dividend amounting Rs. 4 per share was declared on 30 June 2010. ML year-end is 31 December.

Required: Prepare necessary entries assuming ML classifies the shares under:

a) Fair Value Through PL
b) Fair Value Through OCI

----------( 147 )----------

 Answer:
Part (a) Classified and measured at fair value through profit or loss

Debit Rs. Credit Rs.

Date Particulars

1 Jan 2009 Financial asset [5,000 shares x Rs. 100] 500,000

Profit or loss [Rs. 500,000 x 2%] 10,000

Bank 510,000

31 Dec 2009 Financial asset [5,000 x Rs. (108 – 100)] 40,000

Gain (profit or loss) 40,000

30 Jun 2010 Dividend receivable [5,000 x Rs. 4] 20,000

Dividend income (PL) 20,000

31 Dec 2010 Financial asset [5,000 x Rs. (110 – 108)] 10,000

Gain (profit or loss) 10,000

Part (b) Classified and measured at fair value through other comprehensive income
Date Debit Rs. Credit Rs.

Particulars
1 Jan 2009 Financial asset [5,000 x Rs. 100 x 102%] 510,000
Bank 510,000
31 Dec 2009 Financial asset [5,000 x Rs. (108 – 102)] 30,000
Gain (OCI) 30,000
30 Jun 2010 Dividend receivable [5,000 x Rs. 4] 20,000
Dividend income (PL) 20,000
31 Dec 2010 Financial asset [5,000 x Rs. (110 – 108)] 10,000
Gain (OCI) 10,000

⯈ Example:
Jalal Limited invested in a debt instrument with a nominal value of Rs.10,000. The instrument is
redeemable in two years at a premium of Rs.2,100 and has been classified as ‘at amortised cost’. The
coupon rate is 0% while the effective interest rate is 10%.
Required: How will this be reported in the financial statements of Jalal Limited over the period to
redemption?

⯈ ANSWER:

Effective Cash @ 0% Closing balance

Opening interest 10%
Year balance [PL] [cash flows] [SFP]
Rs.
1 10,000 1,000 0 11,000
2 11,000 1,100 0 12,100

----------( 148 )----------

Example:

Bilal Limited invested in a debt instrument with a nominal value of Rs.10,000. The instrument is redeemable
in two years at a premium of Rs. 1,680 and has been classified as ‘at amortised cost’. The coupon rate is
2% while the effective interest rate is 10%.

Required: How will this be reported in the financial statements of Bilal Limited over the period to
redemption?

⯈ ANSWER:

Effective Cash @ 0% Closing balance

Opening interest 10%
Year balance [PL] [cash flows] [SFP]
Rs.
1 10,000 1,000 (200) 10,800
2 10800 1080 (200) 11,680
⯈ Example:
MK Limited has invested in a debt instrument, details of which are as follows:
Face Value Rs.
10,000

SPOTLIGHT
Premium paid on the investment Rs. 800
Transaction cost paid on the investment Rs. 200
Coupon rate of the Instrument 12%
Term of the instrument 4 years
MK Limited has a policy to classify investment in debt instruments at Amortized Cost. Effective rate of
instrument is approximately 8.92%.

Required: Calculate initial and subsequent measurement amounts of above investment and prepare the
journal entries.

Initial recoginition Rs.

Par value 10,000
Add: premium 800
Fair value 10,800
Add: Transaction costs 200
11,000

Opening Effective Cash @ 12% Closing balance

Year balance interest 8.92%
[PL] [cash flows] [SFP]
Rs.
1 11,000 981 (1,200) 10,781
2 10,781 962 (1,200) 10,543
3 10,543 940 (1,200) 10,283
4 10,283 917 (1,200) 10,000

Journal entries:
Date Particulars Debit Rs. Credit Rs.
Acquisition Financial asset 11,000
Bank 11,000
Year 1 Financial asset 981
Interest income (PL) 981
Bank 1,200
Financial asset 1,200
Year 2 Financial asset 962
Interest income (PL) 962
----------( 149 )----------
 Bank 1,200
Financial asset 1,200
Year 3 Financial asset 940
Interest income (PL) 940
Bank 1,200
Financial asset 1,200
Year 4 Financial asset 917
Interest income (PL) 917
Bank 11,200
Financial asset 11,200
Example:

Kaalaam Limited has invested in a debt instrument on 1.1.2021, details of which are as follow:

Face Value of the Instrument Rs. 10,000

Premium paid on the investment Rs. 1,245
Transaction cost paid on the investment Rs. 325
Coupon rate of the instrument 16%
Term of the instrument 4 years
IRR of the Instrument (Effective Rate) 10.95%
Kaalaam Limited has a policy to classify Investment in debt instruments at fair value through other
comprehensive income. It is redeemable after 4 years at face value.

Fair values of the instrument at each year end is as follows:

31.12.2021 Rs. 11,500

31.12.2022 Rs. 11,200
31.12.2023 Rs. 10,700
Required: Prepare journal entries for each of four years.

ANSWER :

Initial recognition Rs.

Par value 10,000
Add: premium 1,245
Fair value 11,245
Add: Transaction costs 325
Initial amount 11,570

Date Interest Income @ Interest @ Balance

10.95% 16%
1.1.2021 11,570
31.12.2021 1,267 1,600 11,237
31.12.2022 1,230 1,600 10,867
31.12.2023 1,190 1,600 10,457
31.12.2024 1,145 1,600 10,000

Date Particulars Debit Credit

Rs. Rs.
Acquisition Financial asset 11,570
Bank 11,570
2021 Financial asset 1,267
Interest income (PL) 1,267
Bank 1,600
Financial asset 1,600
----------( 150 )----------
 Financial asset 263
Gain (OCI) [11,500 – 11,237] 263

2022 Financial asset 1,230

Interest income (PL) 1,230
Bank 1,600
Financial asset 1,600
Financial asset 70
Gain (OCI) 70
Carrying Amount [11,500 + 1,230 –
1,600] = 11,130
Fair value: 11,200
Gain 70
2023 Financial asset 1,190
Interest income (PL) 1,190
Bank 1,600
Financial asset 1,600
Loss (OCI) 90
Financial asset 90
Carrying Amount [11,200 +1,190 –
1,600] = 10,790
Fair value 10,700
Loss (OCI) 90
2024 Financial asset 1,145
Interest income (PL) 1,145
Bank 1,600
Financial asset 1,600
Bank 10,000
Financial asset 10,000
Loss (OCI) 245
Financial asset 245
Carrying Amount [10,700 +1,145 – 1,600 – 10,000] = 245
Fair value 0
Loss (OCI) 245
(After that there is no net Gain/Loss in OCI)
⯈ Example:
On 1 January 2021, Kashif Limited (KL) issued a deep discount debenture with a Rs. 100,000 nominal
value. The discount rate was 16% of nominal value, and the costs of issue were Rs. 4,000.
Interest of 5% on par value is payable annually in arrears. The debenture must be redeemed on 31
December 2025 (after 5 years) at a premium of Rs. 9,223. The effective interest rate is 12% per annum.
Required: Calculate the amounts to be reported in the financial statements of KL over the period to
redemption?

Effective Cash @ 5% Closing balance

Opening interest 12%
Year balance [PL] [cash flows] [SFP]

2021 [100,000- 9,600 (5,000) 84,600

16,000-
4,000] 80,000
2022 84,600 10,152 (5,000) 89,752
2023 89,752 10,770 (5,000) 95,522
2024 95,522 11,463 (5,000) 101,985
2025 101,985 12,238 (5,000) 109,223

Total 54,223 25,000

----------( 151 )----------
Example:

Adeel Limited (AL) regularly invests in assets that are measured at fair value through profit or loss. On
January 1, 2018 AL issued 9% debentures at nominal value of Rs. 80,000 to finance a similar investment
in assets. The management has decided to classify these debentures to be measured at fair value
through profit or loss in order to avoid accounting mismatch.

The fair value of debentures was Rs. 88,000 on 31 December 2018, there was no change in own credit
risk of AL in this time period.

The fair value of debentures was Rs. 82,000 on 31 December 2019, and AL has estimated that it
includes Rs. 4,000 due to change in own credit risk as AL’s credit rating was dropped during the year.

Required: Prepare journal entries.

ANSWER:

Date Particulars Debit Credit

Rs. Rs.
1 Jan 2018 Bank 80,000
Debentures (financial liability) 80,000
31 Dec 2018 Interest expense [9% x Rs. 80,000] 7,200
Cash 7,200
31 Dec 2018 FV loss (Profit or loss) 8,000
Debentures (financial liability) 8,000
(88,000 – 80,000)
31 Dec 2019 Interest expense [9% x Rs. 80,000] 7,200
Cash 7,200
31 Dec 2019 Debentures (financial liability) 6,000
FV gain (Other comprehensive income) 4,000
FV gain (Profit or loss) 2,000
(88,000 – 82,000) = 6,000

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 IFRS 9- FINANCIAL INSTRUMENTS
Classification of Financial Asset
Is the asset an equity No Are the asset’s contractual Yes Is the business model’s objective to
investment? cash flows solely principal hold to collect contractual cash flows?
and interest?
Yes No No
Is it held for trading? Yes No Is the business model’s objective achieved
both by collecting contractual cash flows and
selling financial assets?
Yes
Has the entity elected the OCI Yes Yes
option (irrevocable)? No
Yes
Accounting Treatment FVTOCI FVTPL FVTPL FVTOCI Amortized Cost
Initial Measurement FV + TC Fair Value Fair value FV + TC FV + TC
Transaction Cost (TC) Capitalized Expensed out Expensed out Capitalized Capitalized
Subs. measurement Fair Value Fair Value Fair Value Fair Value Amortized cost
Change in FV OCI P/L P/L OCI No FV adjustment
Dividend/Interest P/L P/L P/L (at coupon rate) P/L (at effective P/L (at effective
rate) rate)

Classification of Financial Liability

Yes
Is the Financial liability held for trading?
No Yes
Is it designated under the fair value option?
No
Accounting treatment Amortised Cost FVTPL
Initial measurement FV + TC FV
Transaction cost Deduct from FV Expensed out
Subs. measurement Amortized Cost Fair Value
Change in Fair Value Not Applicable P/L (except change in fair value
due to change in Credit risk-OCI)
Interest expense P/L (effective rate) P/L (coupon rate)

----------( 153 )----------

 Summary of IFRS-09

Bond means = Loan

Coupon rate = actual rate or nominal rate

IRR of investment = effective rate

Financial Instrument: Contract between two parties in which :

Another party has a Financial

One party has a Financial Asset in
Liability (obligation to pay) or
its books.
Equity instrument in its books.
“Contractual right to receive cash” or
“obligation to pay”
equity instrument of another entity

Debt Instrument
Equity Instrument of another entity
For example “Debenture
For example “Ordinary share
purchased”
purchased”

IFRS-09 Recommends fair value

Cost Model
IF (i) hold investment to recover contractual cash flows

(ii) Contractual cashflows comprise Principal and Interest

• Transaction Cost Capitalize in case of debt instrument in Amortized Cost and FVTOCI Method
• FVOCI if business model is to;
I. Collect contractual cashflows and
II. Selling Financial Assets when favorable Opportunity arise

(FVTPL) if business model is trading (selling in short term) not to hold investment and receive contractual
cashflows.

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Debt instrument

At Amortized Cost At Fair value through other At Fair value through profit or
comprehensive income loss( FVTPL)
Initial Recognition (FVTOCI)
Fair value + (NO) [any
Fair value + Transaction cost Initial Recognition transaction cost is expensed]
Fair value + Transaction cost

Subsequent measurement: Subsequent measurement: Subsequent measurement:

1. Interest income in P.L by 1. Interest income in P.L using 1. Interest income in P.L using
using effective interest rate effective interest rate nominal (actual) rate.

2. Changes in FV - Ignored 2. Changes in FV in Other 2. Changes in FV directly in P.L

Comprehensive income and whether there is gain or loss
accumulated in fair value reserve

Transaction cost “directly attributable to acquisition “

• Credit assessment fee
• Fee and commissions paid to agents,advisers,brokers and dealers
• Transfer taxes and duties
• Registration charges
• Levies by regulatory agencies and security agencies

However transaction cost does not include : Financing cost, internal administrative cost and holding cost
they are expense out when incurred.

Equity instruments e.g. Ordinary shares

• Cannot be measured on Amortized cost basis. (always at fair value)

For short term trading (Speculative) For long term purpose

Recognize Gain/Loss P/L Gain /loss OCI

Equity Instrument

At Amortized Cost At Fair value through other At Fair value through profit or
comprehensive income loss( FVTPL)
(FVTOCI)
Equity instruments are never Initial recognition Initial recognition
classified here. Fair value + Transaction costs Fair value + (No) [any
transaction cost is expensed

Subsequent measurement Subsequent measurement

1. Dividend Income in P.L 1. Dividend income P/L
2. Changes in FV is taken to 2. Change in FV P/L
OCI and accumulated in fair
value reserve.

----------( 155 )----------

 • Entity can make irrevocable election at initial recognition to measure at FVTOCI; otherwise,
FVTPL (for long-term investment)

Financial Liabilities

At Amortized cost At FVTPL

Applies to;

All financial liabilities other than FVTPL Financial liabilities held for trading
In order to eliminate the inconsistency; Financial
liability can initially recognized be at FVTPL.
(Irrevocable)

Measurement: Measurement:
• Record at fair value less transaction costs (net • Record at fair value
proceeds received) • Expense transaction costs in P.L
• Measurement subsequently at amortized cost. • Restate to fair value at each reporting date
• Interest expense is calculated at effective • Any gain or loss is taken to profit or loss (one
interest rate and recognized in P.L exception discussed next)
• No fair value adjustment • Interest expense calculated at nominal (actual)
• On derecognition any gain or loss is taken to rate will be recorded in P.L
P.L. In case of financial liability ;(Gain/loss) due to;
• Own credit risk OCI
• Other market forces P/L

----------( 156 )----------

 We must try our best to surrender to the will of Allah, May
Allah Almighty help us, guide us and give us success.
IAS-41 [Agriculture]
Biological Asset: are living plant and animals.
Biological Asset Agricultural Produce Products that result from
processing after harvest
Sheep Wool Carpet
Dairy Cattle Milk Cheese
Cotton plant Harvested cotton Thread, Cloth
Tea bushes Picked leaves Tea
Fruit trees Picked fruit (Orange etc.) Processed fruit
Palm oil trees Picked fruit Palm Oil
Sugar cane Harvested cane Sugar

Point to remember:
Sometimes trees are physically attached to particular piece of land, in that case only the tree is a biological
asset while land is not a biological asset. (land is to be measured under IAS 16)

Objective: The objective of this standard is to prescribe the accounting treatment and disclosures related to
agricultural activity.
[Para 5]
1. Agricultural Activity is the management of the biological transformation of a biological asset for the
purpose of sale of that asset; or
2. Agricultural activity is the management of biological transformation (reproduction) of a biological asset
for the purpose of creating additional biological asset; or
3. Agricultural activity is the management of biological transformation of a biological asset for the
purpose of harvesting agricultural produce from that asset.
Agricultural Produce:
It is the harvested produce from the biological assets, e.g milk, meat, eggs, fruits etc.
Harvest:
Harvest is the detachment of produce from a biological asset(milking a cow or picking the fruits from trees) or
the cessation of a biological assets useful life (meat of cows and sheeps).
Biological Transformation: Results into the following types of outcomes:
a) Asset changes through
i) Growth (an increase in quantity or improvement in quality of an animal or plant e.g. lambs grow into
sheep);
ii) Degeneration (a decrease in the quantity or deterioration in quality of an animal or plant e.g. death,
cut down and old age); or
iii) Reproduction or procreation (creation of additional living animals or plants), or
b) Production of agricultural produce such as tea leaf, milk and wool etc.

Illustration: Definitions
• A farmer has a herd of lambs (‘biological assets’).
• As the lambs grow they go through biological transformation.
• As sheep they are able to procreate or reproduce and lambs will be born (additional biological assets)
and the wool from the sheep provides a source of revenue for the farmer (‘agricultural produce’).
• Once the wool has been sheared from the sheep (‘harvested’).it is an agricultural produce (measure it
according to IAS 41 at the point of harvest and after that IAS 2 will be applied for any future measurement)

----------( 157 )----------

 If you obey Allah then your heart will find peace and happines
but if you obey Dunya then your heart will find sadness.

Recognition and Measurement: [Para 10]

Recognition Criteria of biological asset or agricultural produce:
An entity shall recognize a biological asset or agricultural produce when, and only when:
a) The entity controls the asset as a result of past events; (e.g you have purchased cow and it is in your
control; suppose afterwards it has given birth to a baby calf and it is also in your control)
b) There is a probable future inflow of economic benefit (means you can either sell the cow or sell its
meat or sell its milk); and
c) The fair value or cost of asset can be measured reliably.

Measurement of biological Asset: [Para 12]

• Biological asset is measured at fair value (means market price) less cost to sell initially and at the end
of each reporting date. Any gain or loss on initial recognition and from subsequent changes in fair value
less cost to sell at the end of each reporting date are recorded in profit or loss for the period in which it
arises.
• If an entity has thousands of cows /sheeps or other biological assets then in order to measure fair value
you do not need to check market price for individual biological asset rather entity can group biological
assets based on their significant attributable e.g age or quality and measure their fair value in aggregate(
group of biological assets is an aggregation of similar living animals or plant)
• Sometimes cost of biological asset approximates fair value
(a) if little biological transformation has taken place since initial cost incurrence (e.g. for seedings planted
immediately prior to the end of reporting period or new purchased livestock) [Para 24(a)].
(b) The impact of biological transformation on price is not expected to be material e.g. the initial growth
in 30year pine plantation life cycle.

Cost to sell: are incremental costs direcly attributable to the disposal of asst, excluding finance cost and
income taxes. Examples include commission to brokers, non refundable transfer taxes and duties.

Grouping of Assets
Some biological assets are physically attached to land, for example tree plantations, and it is necessary to
value the land and biological assets together as one asset, even though agricultural land is not within the scope
of IAS 41. To obtain the fair value of the biological assets, the fair value of the land element should be deducted
from the combined fair value.
Example
A farmer wishing to value an apple orchard, in circumstances where there is no separate valuation for the
orchard from that for the land on which it is grown, would value it at the combined fair value of the land and
orchard, less the estimated fair value of land.

If fair value is not initially reliably measureable then biological asset is measured at cost less
accumulated depreciation and impairment (cost model of IAS-16). However, depreciation can only be
started after the asset is matured.

Point to remember:
These above biological assets are not revalued under IAS-16. If fair value subsequently is reliably measurable
then entity must measure these biological assets from that point at fair value less cost to sell as per IAS-41.

According to IAS-41, there is a presumption that fair value can be measured reliablly for a biological asset.
However that presumption can be rebutted only on initial recognition for a biological asset for which quoted
market price are not available.

----------( 158 )----------

1. Example:
An entity purchased a cow for Rs. 120,000. In addition there is a carriage cost of Rs. 2,000. The entity
estimates that if it sells the cow then the auctioneers charge a sale commission of 2% of market value and
there is a government levy based on market value of 3% on sales.

How the cow is measured initially?

Fair value less cost to sell = [120,000 –(120,000 x 2%) –(120,000 x 3%)] = 114,000

Accounting entry is:

Biological Asset(Cow) 114,000
Loss on initial recognition 6,000
Cash 120,000
Carriage expense 2,000
Cash 2,000
We have paid a cost of 120,000 against an asset having FV less CTS of 114,000 therefore there is a loss of
6,000 on initial recognition.
Rs. 2,000 carriage inwards is not capitalized it is recognized as an expense immediately

2. Example:
The entity’s cow has given birth to a baby calf today.
Estimated fair value of the baby calf is 10,000. In order to sell the calf entity will have to pay 200 in transfer
tax and sale commission of Rs. 1,500.

How the new born calf is initially measured?

Answer:
Fair value less cost to sell : [10,000 – 200 – 1,500] = 8,300

Accounting entry is:

Biological Asset 8,300
Gain on initial measurement 8,300
(As we have not paid anything)

Measurement of Agricultural Produce:[Para 13]

At the point of harvest (means detachment from biological asset) agricultural produce is measured at Fair
value less costs to sell.

In all cases, an entity measures agricultural produce at the point of harvest at its fair value less cost to sell.
The standard is of the view that fair value can always be measured. [Para 32]

Any gain or loss on initial recognition is presented in profit or loss for the period in which it arises. [Para 28]
After initial measurement, agricultural produce is transferred to inventory (and therefore IAS-2 is applied from
there on). It means FV less costs to sell will be deemed as cost when transferred to inventory. [Para 13]

At the end of reporting period, this agricultural produce should be measured by applying IAS-2 (i.e. lower of
cost and NRV) rather than IAS-41 (i.e at FV less cost to sell).

Example: Accounting treatment

• Using the earlier example of a sheep farmer, lambs should initially be measured when they are born at
their fair value less costs to sell.
• As they grow and their value changes, this gain or loss should be reflected in the biological asset value
and also in profit and loss.
• The sheep may be used for obtaining wool. Once the wool has been sheared from the sheep, as an
agricultural produce the wool should be valued at fair value less costs to sell.
• If the wool still in inventory at the end of the reporting period, then apply IAS 2 for measurement.

----------( 159 )----------

Bearer Plants: [para 5 to 5C]
A living plant that:
i) Is used in production or supply of agricultural produce;
ii) Is expected to bear produce for more than one year; and
iii) is unlikely(means no intention) that entity will (e.g. cut down the plant and) sell it as agricultural
produce, except for scrap sale (at the end of its useful life when they are no longer used to bear
produce).
Some Plants such as tea bushes, grape yards, oil palms and rubber trees, usually meet the definition of a
bearer plant and are within the scope of IAS 16 Property, Plant and equipment. However, the produce growing
on bearer plants, for example, tea leaves, grapes, oil palm fruit and latex, is within the scope of IAS 41.

“Produce growing on bearer plants is an Agricultural produce e.g Mangoes on a Mango tree. It means
mangoes (which is agricultural produce) must be measured separately from the mango tree (which is bearer
plant). [Para 5C]

Note that there is no “animal” equivalent of a bearer plant (means there is no concept of bearer animal).
Thus, cows kept for milk are within the scope of IAS 41.

The followings are not bearer plants: [Para 5A]

a) Plants cultivated to be harvested as agricultural produce (e.g trees grown for use as lumber (wood).
b) Plants cultivated for agricultural produce but there is a likelihood that the entity will also harvest e.g
cut and sell the plant as agricultural produce, other than scrap sale (at the end of useful life) [e.g
trees that are cultivated for both the fruit and their lumber(wood)].
c) Annual crops (e.g maize, wheat, rice, potatoes etc).

Measuring bearer plant:

Bearer plants are very similar to machinery in a manufacturing business and are therefore measured by using
requirements of IAS-16 just like properly, plant and equipment (PPE).

A bearer plant is initially measured at cost.

The cost based measurement is continued till plant grows to maturity. (Means it is considered to be matured
if it is capable of sustaining regular harvest means e.g tree is capable of producing fruit every season onwards)

As per IAS-16 Para 22A, Bearer plants are accounted for in the same way as self-constructed items of
property, plant and equipment before they are in the location and condition necessary to be capable of
operating in a manner intended by management.

Consequently references to “Construction” in this standard should be read as bearer plants before they are in
the location and condition necessary to be capable of operating in a manner intended by management
(therefore depreciation should start when they are available for use)

Subsequently it is measured by using:

a) Cost less accumulated depreciation and impairment; or
b) Revaluation model.

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 Peace comes in the heart with the remembrance of Allah

Government grants related to biological asset [IAS 41: 34 to 38]

Unconditional grant
It shall be recognised in profit or loss when, and only when, the government grant
becomes receivable.
Conditional grant
Biological assets Such grant shall be recognised in profit or loss when, and only when, the conditions
measured at fair attaching to the government grant are met.
value less cost to Partial recognition for conditional grants
sell Terms and conditions of government grants vary. For example, a grant may require
(IAS 41 is an entity to farm in a particular location for five years and require the entity to return
applicable) all of the grant if it farms for a period shorter than five years. In this case, the grant is
not recognised in profit or loss until the five years have passed. However, if the terms
of the grant allow part of it to be retained according to the time that has elapsed, the
entity recognises that part in profit or loss as time passes.
Biological assets
measured at cost The grant shall be recognised in accordance with IAS 20.
or bearer plants

⯈ Example: Multan Limited (ML) operates a large cow and buffalo dairy farm. On 1 January 2022, ML
received a government grant of Rs. 15 million on the condition that ML adopts organic cattle feed system and
continues to do so for five years. If ML discontinues organic cattle feed system any time during five years, it
will have to repay the whole amount of grant.

ML has already implemented organic feed system and it is reasonably certain that ML will meet the conditions
of grant. ML year end is 31 December.

Required: Briefly discuss the recognition of government grant in the financial statements of ML.

Answer: ML shall recognise the grant of Rs. 15 million in profit or loss on 31st December 2026 only when the
conditions attaching to the government grant are met.

⯈ Example: Peshawar Limited (PL) operates a large cow and buffalo dairy farm. On 1 Jan 2022, PL received
a government grant of Rs. 15 million on the condition that PL adopts organic cattle feed system and continues
to do so for next five years. If PL discontinues organic cattle feed system any time during five years, it will
have to repay the proportionate amount of grant.

PL has already implemented organic feed system and it is reasonably certain that PL will meet the conditions
of grant. PL year end is 31 December.

Required: Briefly discuss the recognition of government grant in the financial statements of PL.

Answer: PL shall recognise the grant of Rs. 3 million (i.e. Rs. 15 million / 5 years) in profit or loss each year
on 31st December from 2022 to 2026 as the time passes provided that PL is complying the conditions of the
government grant.

Presentation and Classification:

• Biological assets are presented separately from other non-current assets.(before property plant and
equipment)
• Biological assets should also be sub-classified (either on face of statement of financial position or in notes
to financial statements)
i) Animal or Plant
ii) Bearer Plant
iii) Mature or Immature.
• Agricultural produce after harvest is presented in inventory.

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Disclosure requirements
The IAS 41 disclosure requirements include the following:
• The aggregate gain or loss arising during the current period on initial recognition of biological assets and
agricultural produce and from the change in fair value less costs to sell of biological assets.[para 40 ]
• A description of each group of biological assets; [para 41 ]
• Information about biological assets whose title is restricted or that are pledged as security[para 49 (a)]
• Commitments for development or acquisition of biological assets[para 49 (b)]
• Financial risk management strategies[para 49 (c)]
• Reconciliation of changes in the carrying amount of biological assets, showing separately changes in
value, purchases, sales, harvesting, business combinations, and foreign exchange differences; [para 50 ]

If fair value cannot be measured reliably, additional required disclosures include: [Para 54]
• Description of the biological assets
• An explanation of the circumstances why fair value can not be measured reliably.
• If possible, a range within which fair value is highly likely to lie
• Depreciation method

• Useful lives or depreciation rates

• Gross carrying amount and the accumulated depreciation, at the beginning and end of the period.

If the fair value of biological assets previously measured at cost now becomes available, certain additional
disclosures are required. [Para 55]

Disclosures relating to government grants include the

• nature and extent of grants,
• unfulfilled conditions, and
• significant decreases expected in the level of grants. [Para 57]

Scope Paragraph:
IAS 41 Agriculture covers the following agricultural activities:[Para 1]
• Biological assets, except for bearer plants;
• Agricultural produce at the point of harvest; and
• Government grants for agriculture (in certain situations).

IAS 41 does not apply to: [Para 2]

• The harvested agricultural product (IAS 2 Inventory applies);
• Land relating to the agricultural activity (IAS 16 or IAS 40 applies);
• Bearer plants related to agricultural activity (however, IAS 41 does apply to the produce on those bearer
plants) (IAS 16)
• Intangible assets related to agricultural activity (IAS 38 Intangible assets applies).

Important disclosure:
Changes to fair value can arise due to both physical changes in asset and price changes in market. Entities
are encouraged to make separate disclosure of these two elements in order to facilitate performance
evaluation.

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 If you truly believe in Allah, obey Him and rely on
him then Allah will never let you down.

Q.1
Zahid started running a farm that is involved in Dairy farming whereby it buys dairy (milk) producing cows. The
objective is not to slaughter them and sell the meat rather production and sale of milk. At the start of the
financial year, Zahid purchased 1,000 dairy cows, with an average age of 2 years old, for 150,000,000 which
is equal to FV less cost to sell at that date.

Zahid has the following data of fair values.

FV less CTS
Start of the period End of the period
Two years old Cows 150,000,000 155,000,000
Three year old Cows 159,000,000 165,000,000

Required:
Explain the accounting treatment of the above in the financial statements.

Calculation of price change: requires comparison of prices (without physical change) which were at initial
date and reporting date.

Calculation of physical change: requires comparison of prices after physical change on reporting date.

Q.2
The following example illustrates how to separate physical change and price change. Separating the change
in fair value less costs to sell between the portion attributable to physical changes and the portion attributable
to price change is encouraged by this Standard.

A herd of 10, 2 year old animals was held at 1 January 2011. One animal aged 2.5 years was purchased on
1 July 2011 for 108,000, and one animal was born on 1 July 2011. No animal were sold or disposed for during
the period. Per-unit fair values less costs to sell were as follows:
Rs.000
2 year old animal at 1 January 2011 100
New born animal at 1 July 2011 70
2.5 year old animal at 1 July 2011 108
New born animal at 31 December 2011 72
0.5 year old animal at 31 December 2011 80
2 year old animal at 31 December 2011 105
2.5 year old animal at 31 December 2011 111
3 year old animal at 31 December 2011 120

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 Don’t lose hope nor be sad, remain united. Worship to only Allah

IAS 41 other related issues:

Question #1: Is it agriculture?
The first and primary question when dealing with living plants and animals is – what is agricultural activity?

It is the management of the biological transformation (e.g. growth) of biological assets for (IAS 41.5):

• Sale, or
• into agricultural produce, or
• into additional biological assets.

You have to make your best effort to answer that question correctly, because the accounting and reporting
depends on it.

Why?
Imagine you have a dog.
Logically, it is a living animal, and therefore it is a biological asset. You might think: “well, biological assets are
governed by IAS 41, so I need to measure the dog at fair value at the end of each year”.

Not so fast.
Why do you have that dog?
Is it a guard dog, protecting your property and barking at everyone passing by?
If yes, then you should NOT apply IAS 41, but IAS 16 Property, plant and equipment and measure the dog at
cost less accumulated depreciation.

The reason is that protecting the property is NOT an agricultural activity and IAS 41 does NOT apply.
Or, do you have that dog in order to produce and raise puppies and sell the puppies?

In this case, IAS 41 applies, because breeding and selling puppies is an agricultural activity.

So, if you think that OK, I’m not a farmer, so I don’t need to bother with IAS 41, you might be surprised where
the agriculture can hide.
Just a few examples:
• Pharmaceutical companies
Some pharma companies grow their own plants in order to produce drugs. Yes, this is an agricultural
activity and IAS 41 applies.

• Diary producers
If a company grows its own bacteria and cultures and then adds them to its yoghurts, well – this is an
agricultural activity and IAS 41 applies.

• Jewelry producers
Some big jewelry producers produce their own pearls by planting foreign objects (such as pieces of shells
or parasites) into the soft bodies of living oysters. Then, the oyster produces a pearl by secreting crystalline
substance around the object to protect itself. Yes, this is an agricultural activity and IAS 41 applies.

On the other hand, not everything involving living plants or animals is agricultural activity.

Again, few examples:

• ZOO
The main purpose of the ZOO (and safari, recreational park etc.) is to make money from showing the
animals off to the public – this is NOT an agricultural activity and IAS 41 does NOT apply (IAS 16 does).
Yes, animals living in the ZOO sometimes pair and produce a baby – but if it’s a natural process, not
managed by the ZOO, it is NOT an agricultural activity.

The situation would be different when the ZOO would implement an active program of reproduction and
managed that program. In this case, breeding animals would NOT be an incident and ZOO would have to
apply IAS 41.

----------( 164 )----------

• Fishing
All fishermen catching fish in the ocean can breathe with relief. If you are NOT actively farming fish, but
you’re merely harvesting the fish from the ocean, it’s NOT an agricultural activity.
•
The reason is that fish grew naturally in the ocean, which was NOT an agricultural activity.

• “Working animals”
When you hold an animal primarily to do some work, such as cart-horses, guard dogs, elephant taxis, etc.,
then you do NOT apply IAS 41, because all these activities do NOT represent agricultural activities.
Instead, IAS 16 is the right way to go.

Question #2: Is it a biological asset?

Very common misconception in the agriculture accounting is the belief that everything coming out of agriculture
is a biological asset.

Not true.

Biological assets are only living plants and animals.

The harvested products of biological assets are agricultural produce.
Apples, palm oil, pearls, milk, coffee beans, tea leaves – all this is agricultural produce.

Why do we bother?
Well, once you detach the agricultural produce from a biological asset, in other words – once you harvest the
produce, it becomes your inventories and you apply IAS 2 Inventories.

At the moment of harvest, you should measure your new inventories at their fair value less costs to sell and
subsequently, you measure them under IAS 2 at lower of cost and net realizable value.
You do NOT remeasure agricultural produce to fair value less cost to sell.

Question #3: Are biological assets always measured at fair value less costs to sell?

No, they are not.

It is true that the general rule in IAS 41 Agriculture is to measure all biological assets at fair value less costs
to sell.

However, there are few exceptions:

1. The biological asset is NOT a part of agricultural activity.

I’ve explained it above – guard dogs, fish caught in the ocean, etc.

2. The biological asset is a bearer plant.

A bearer plant is a living plant used in production or supply of agricultural produce that is expected to
produce for more than 1 period.

The examples are fruit trees, tea bushes etc.

you can keep these assets at cost less accumulated depreciation under IAS 16.

3. The fair value is not reliably measurable

When the fair value cannot be measurable, you can measure the asset at its cost less accumulated
depreciation and impairment. (IAS 16)

This exemption is available ONLY at initial recognition, never later.

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 If someone continuously reminding you of Allah then
know that his/her love for you is true.
Question bank
MISHALL LIMITED
Mishall Limited a public limited company, Dairy, produces milk on its farms. It produces 30% of the country’s
milk that is consumed. Dairy owns 450 farms and has a stock of 210,000 cows and 105,000 heifers. At
December 31, 2018, the herds are:

210,000 cows (3 years old), all purchased before January 1, 2018

75,000 heifers, average age 1.5 years, purchased on July 1, 2018
30,000 heifers, average age 2 years, all purchased before January 1, 2018

No animals were born or sold in the year.

The unit values less estimated point-of-sale costs were Rs.000

1-year-old animal at December 31, 2018: 32
2-year-old animal at December 31, 2018: 45
1.5-year-old animal at December 31, 2018: 36
3-year-old animal at December 31, 2018: 50
1-year-old animal at January 1, 2018 and July 1, 2018: 30
2-year-old animal at January 1, 2018: 40

Required:
Advise the directors on how the biological assets should be accounted for under IAS 41 for the year ended
31.12.2018 and present the figures including reconciliation by segregating price and physical change..

Example: F Limited
Question: F Limited on adoption of IAS 41 has reclassified certain assets as biological assets. The total value
of the group’s forest assets is Rs.3,400 million comprising:
Rs. in million
Freestanding trees 2,500
Land under trees 500
Roads in forests 400
3,400
Required:
Show how the forests would be classified in the financial statements.

Answer:
F Limited
Extracts of Statement of Financial Position as at 31 December 2018
Rs. in million
Non current assets:
Biological assets: Freestanding trees 2,500
Property, plant and equipment: Land under trees 500
Forest roads 400

3,400

Example: M Limited
Question: M Limited has provided following information from its financial records:
Rs.
million
Initial recognition of biological assets (on acquisition at start of 2018) 600
Fair value of biological assets as at 31 December 2018 700
Increase in fair value of biological assets due to physical growth during 2019 100

----------( 166 )----------

 Increase in fair value of biological assets due to price fluctuations during
80
2019
Decrease in fair value of biological assets due to harvest of agriculture
produce (The fair value of harvested agriculture produce at point of harvest 56
was Rs. 60 million)
The costs to sell are negligible. No agriculture produce was harvested in 2018 and the agriculture produce
harvested during 2019 has not been sold yet.
Required:
Show how these values would be incorporated into the statement of financial position and statement of
comprehensive income at December 31, 2019 (including comparative).

Answer:
M Limited
Statement of financial position (Extracts) 2019 2018
As at 31 December 2019 Rs. in million
Non-current asset: Biological assets [700+100+80–56] 824 700

Current assets: Inventory 60

Statement of comprehensive income (Extracts)
For the year ended 31 December 2019
Fair value gain on biological assets [100+80-56] 124 100
Fair value gain on initial recognition of agricultural produce 60 -

AGRICULTURE
⯈ Example:
Discuss whether IAS 41 shall be applied in each of the following circumstances:
(i) A zoo has bought two lions and one tiger for exhibition in zoo cages for earning ticket revenue.
(ii) Peacock kept by a restaurant in their open dining area to attract more customers.
(iii) Mules kept for transportation of luggage of tourists by a company which provides camping and hiking
services to foreign tourists.
(iv) A small business using horses in horse-wagons for tourists to travel around historical places.
(v) Parrots kept for breeding by a bird shop so that their offspring can be sold.
(vi) Horses kept in stable for breeding and to be trained and sold later.
⯈ ANSWER:

Although all circumstances indicate the existence of biological assets i.e. living animals, the item
(i) to (iv) do not fall under the scope of IAS 41 as those biological assets are not for agricultural activity.
IAS 41 shall be applied on item (v) and (vi) since these biological assets relate to agricultural activity (i.e.
for sale or for having additional biological assets by breeding).
Agricultural activity covers a diverse range of activities; for example, raising livestock, forestry, annual or
perennial cropping, cultivating orchards and plantations, floriculture and aquaculture (including fish
farming).

Certain common features exist within this diversity

a) Capability to change. Living animals & plants are capable of biological transformation;
b) Management of change. Management facilitates biological transformation by enhancing, or at least
stabilising, conditions necessary for the process to take place (for example, nutrient levels, moisture,
temperature, fertility, and light). Such management distinguishes agricultural activity from other activities.
For example, harvesting from unmanaged sources (such as ocean fishing and deforestation) is not
agricultural activity; and
c) Measurement of change. The change in quality (for example, genetic merit, density, ripeness, fat cover,
protein content, and fibre strength) or quantity (for example, progeny, weight, cubic metres, fibre length or
----------( 167 )----------
 When we repair our relationship with ALLAH,He repairs everything else for us.

diameter, and number of buds) brought about by biological transformation or harvest is measured and
monitored as a routine management function.
Note that there is no animal-equivalent of bearer plant. Thus, cows kept for milk only are within the scope of
IAS 41.
⯈ Example:
XYZ Limited owns a large area of farmland nearby a wild forest. Employees of XYZ Limited have noticed that
a herd (or a parade) of wild elephants is living permanently on the farmland of XYZ Limited. If sold in
international market, the whole herd can fetch a fair value less costs to sell of Rs. 58 million.
Required: How should XYZ Limited recognise the herd of elephants in its financial statements?

⯈ ANSWER:
It is unlikely that XYZ Limited controls these wild animals and/or able to sell them and obtain the future
economic benefits. Therefore, XYZ Limited should not recognise the herd of elephants in its financial
statements.
Measurement [IAS 41: 12 to 25]

Biological asset
A biological asset shall be measured on initial recognition and at the end of each reporting period at its fair
value less costs to sell, except where the fair value cannot be measured reliably.

⯈ Example:
Adeel Limited (AL) operates a goat breeding farm. AL sells goats to local meat businesses and goats-milk to
cosmetics companies. They also use goat milk for making premium cheese for sale. On 1 March 2022, AL
bought 10 goats for Rs. 25,000 each (i.e. fair value) from a nearby market. The market broker charges 2%
commission from buyer and 3% from seller on each transaction.
On 15 June 2022, two kids were born having fair value of Rs. 7,000 each.
On 30 June 2022, the year-end of AL, each goat has a fair value of Rs. 33,000 and each kid has a fair value
of Rs. 9,000.
Required: Calculate the cost of purchase and the amount at which the above biological assets should be
measured at initial recognition and on 30th June 2022.
⯈ ANSWER:
The cost of 10 goats purchased:
[10 goats x Rs. 25,000 x 102%] = Rs. 255,000
Measurement at initial recognition (at fair value less costs to sell):
[10 goats x Rs. 25,000 x 97%] = Rs. 242,500
[2 goat kids x Rs. 7,000 x 97%] = Rs. 13,580
Measurement at year-end (at fair value less costs to sell):
[10 goats x Rs. 33,000 x 97%] = Rs. 320,100
[2 goat kids x Rs. 9,000 x 97%] = Rs. 17,460

Agricultural produce
Agricultural produce harvested from an entity’s biological assets shall be measured at its fair value less costs
to sell at the point of harvest. Such measurement is the cost at that date when applying IAS 2 Inventories or
another applicable Standard.
⯈ Example:
Kashif Limited (KL) operates a goat breeding farm. KL sells goats to local meat businesses and goats-milk to
cosmetics companies. They also use goat milk for making premium cheese for sale.
During the year ended 30 June 2022, KL could get 980 litre of milk which had fair value less costs to sell of
Rs. 170 per litre on the day goats were milked.

----------( 168 )----------

The 900 litre of milk was sold to cosmetics companies for Rs. 160,000 and remaining 80 litre was converted
into making cheese which was later sold for Rs. 24,000. KL had to incur a cost of Rs. 5,000 to convert the milk
into cheese.
Required: Briefly discuss the accounting treatment of (milk) obtained from goats. IAS 41 →IAS 2

⯈ ANSWER:
The harvested milk shall be recognised at Rs. 166,600 (980 litres x Rs. 170 per litre) at the point of harvest.
This amount will be deemed cost of inventory of milk subsequently. The excess of sale price over this cost of
inventory shall result in profit in the statement of comprehensive income of KL.
Biological assets attached to land
Biological assets are often physically attached to land (for example, trees in a plantation forest).
There may be no separate market for biological assets that are attached to the land, but an active market may
exist for the combined assets, that is, the biological assets, raw land, and land improvements, as a package.
An entity may use information regarding the combined assets to measure the fair value of the biological assets.
The fair value of raw land and land improvements may be deducted from the fair value of the combined assets
to arrive at the fair value of biological assets.
⯈ Example:

ABC Limited has a fruit orchard over fifteen acres area of land. The separate value of orchard from the land
could not be determined, however, combined value of land and orchard has been determined to be Rs. 336
million. The similar agricultural land (but without any crop or orchard) in the area is valued at Rs. 10 million
per acre.
Required: Advise ABC Limited as to how they may value their fruit orchard.

⯈ ANSWER:
Use the combined fair value of the land and orchard, less the estimated fair value of land. So the orchard’s
fair value might be determined at Rs. 186 million (i.e. Rs. 336 million – Rs. 10 million x 15 acres).
Grouping of assets
The fair value measurement may be facilitated by grouping biological assets or agricultural produce according
to significant attributes; for example, by age or quality as used in the market as a basis for pricing.
Future contract prices
Future contract prices are not necessarily relevant in measuring fair value because fair value reflects the
current market conditions in which market participant buyers and sellers would enter into a transaction. The
fair value is not adjusted because of existence of such contract. IAS 37 is applied if such contract is onerous.

Gains and losses [IAS 41: 26 to 29]

Biological assets:
A gain or loss arising on initial recognition of a biological asset at fair value less costs to sell and from a change
in fair value less costs to sell of a biological asset shall be included in profit or loss for the period in which it
arises.
A loss may arise on initial recognition of a biological asset, because costs to sell are deducted in determining
fair value less costs to sell of a biological asset. A gain may arise on initial recognition of a biological asset,
such as when a calf is born.

⯈ Example:
Adeel Limited (AL) operates a goat breeding farm. AL sells goats to local meat businesses and goats-milk to
cosmetics companies. They also use goat milk for making premium cheese for sale. On 1 March 2022, AL
bought 10 goats for Rs. 25,000 each (i.e. fair value) from a nearby market. The market broker charges 2%
commission from buyer and 3% from seller on each transaction.
On 15 June 2022, two goat kids were born having fair value of Rs. 7,000 each.
On 30 June 2022, the year-end of AL, each mature goat has now fair value of Rs. 33,000 and each goat kid
has fair value of Rs. 9,000.

Required: Journal entries.

----------( 169 )----------

⯈ ANSWER:

Date Particulars Debit Rs. Credit

Rs.
1 Mar 2022 Biological assets [10 goats x Rs. 25,000 x 97%] 242,500
Loss on initial recognition (PL) 12,500
Bank [10 goats x Rs. 25,000 x 102%] 255,000
15 Jun 2022 Biological assets [2 goat kids x Rs. 7,000 x 97%] 13,580
Gain on initial recognition (PL) 13,580
30 Jun 2022 Biological assets W1 81,480
Gain on re-measurement (PL) 81,480

W1: Gain on re-measurement of Biological assets Rs.

At year end
[10 goats × Rs. 33,000 × 97%] 320,100
[2 goat kids x Rs. 9,000 x 97%] 17,460
337,560
Already measured at [Rs. 242,500 + 13,580] (256,080)
81,480

Agricultural Produce
A gain or loss arising on initial recognition of agricultural produce at fair value less costs to sell shall be included
in profit or loss for the period in which it arises.
A gain or loss may arise on initial recognition of agricultural produce as a result of harvesting.

⯈ Example:
Kashif Limited (KL) operates a goat breeding farm. KL sells goats to local meat businesses and goats-milk to
cosmetics companies. They also use goat milk for making premium cheese for sale.
During the year ended 30 June 2022, KL could get 980 litre of milk which had fair value less costs to sell of
Rs. 170 per litre on the day goats were milked.
The 900 litre of milk was sold to cosmetics companies for Rs. 160,000 and remaining 80 litre was converted
into making cheese which was later sold for Rs. 24,000. KL had to incur a cost of Rs. 5,000 to convert the milk
into cheese.
Required: Journal entries (perpetual inventory system).

⯈ ANSWER:
Sr. # Particulars Debit Rs. Credit Rs.
(i) Milk (agricultural produce) [980 litres x Rs. 170] 166,600
Gain on harvest (PL) 166,600
(ii) Milk inventory 166,600
Milk (agricultural produce) 166,600
(iii) Cash/Receivables 160,000
Revenue: Milk 160,000
Cost of sales 153,000
Milk inventory [900 litres x Rs. 170] 153,000
(iv) Cheese inventory [5,000 + 13,600(80x170)] [Note 1] 18,600
Cash/Bank (conversion cost) 5,000
Milk inventory [80 litres x Rs. 170] 13,600
(v) Cash/Receivables 24,000
Revenue: cheese 24,000
Cost of sales 18,600
Cheese inventory 18,600
Note 1: it is neither agriculture produce nor biological asset.
----------( 170 )----------
DISCLOSURE

An entity discloses the basis for making any such distinctions.

Group Type Explanation

Consumable biological Consumable biological assets are those that are to be harvested as
assets agricultural produce or sold as biological assets. Examples include livestock
intended for the production of meat, livestock held for sale, fish in farms, crops
such as maize and wheat, and trees being grown for lumber.

Bearer biological assets Bearer biological assets are those other than consumable biological assets;
for example, livestock from which milk is produced and fruit trees from which
fruit is harvested.

Mature biological assets Mature biological assets are those that have attained harvestable
specifications (for consumable biological assets) or are able to sustain regular
harvests (for bearer biological assets).

⯈ Example:

Nawabpur Farming Limited (NFL) owned a dairy herd. On 1st January 2022, the herd had 100 animals that
were two years old and 50 newly born calves. On 31 December 2022 (year-end), a further 30 calves were
born. None of the herd died during the period. NFL incurred total farm maintenance cost of Rs. 1.2 million.

Relevant fair value less costs to sell per animal were:

1st January 2022 31 December 2022

Rupees
Newly born calves 30,000 50,000
One year old animals 45,000 60,000
Two year old animals 65,000 75,000
Three year old animals 75,000 80,000
Required: Prepare reconciliation of change in fair value (price change and physical change) and extracts of
financial statements for the year ended 31st December 2022.
⯈ ANSWER:
Reconciliation
Rs. 000 Rs. 000
On 1st January 2022
2 year old [100 x Rs. 65] 6,500
Newly born [50 x Rs. 30] 1,500 8,000
Addition due to new born (30 x 50) 1500
Increase due to price change*
2 year old [100 x (Rs. 75 - 65)] 1,000
Newly born [50 x (Rs. 50 - 30)] 1,000 2,000

Increase due to physical change**

2 year old to 3 year old [100 x (Rs. 80 - 75)] 500
Newly born to 1 year old [50 x (Rs. 60 - 50)] 500 1,000
On 31 December 2022
3 year old [100 x Rs. 80] 8,000
1 year old [50 x Rs. 60] 3,000
Newly born [30 x Rs. 50] 1500
12,500
*age at beginning of period or on initial recognition
** prices at year-end

----------( 171 )----------

 Statement of financial position (extracts) as at 31 December 2022
Rs. 000
Non-current assets
Biological assets 12,500
Statement of profit or loss (extracts ) for the year ended 31 December 2022
Rs. 000
Income
Gain on measurement of biological assets [2,000 + 1,000 + 1,500] 4,500
Expenses:
Maintenance cost of herd (1,200)

⯈ Example:
The Dairy Company (TDC) owns three farms and has a stock of 3,200 cows. During the year ended 30 June
2015, 300 animals were born, all of which survived and were still owned by TDC at year-end.
Of those, 225 are infants whereas 75 are nine month old having market values of Rs. 26,000 and Rs. 53,000
per animal respectively. The incidental costs are 2% of the transaction price.
Required: Discuss how the gain in respect of the new born cows should be recognized in TDC’s financial
statements for the year ended 30 June 2015. (Show all necessary computations)

Answer:
The new born cows are biological assets and should be measured at fair value less costs to sell both on initial
recognition and at each reporting date.

The gains on initial recognition and the gains from change in this value should be recognized in profit or loss
for the period in which it arises. The total gains in respect of new born cows to be recognized in the year ended
30 June 2015 is as follows:

New born [26,000 × 225 × 98 %] 5,733,000

9 month old [53,000 × 75 × 98 % ] 3,895,500
9,628,500

----------( 172 )----------

Question 1.

Numbers Ltd prepares financial statements for 30 September each year. On 1 October 2012, Numbers Ltd
carried out the following transactions:
• Purchased a large piece of land for Rs. 47 million (subsequently measured at cost model)
• Purchased 10,000 dairy cows (average age at 1 October 2012 two years) for Rs. 2.35 million
• Received a grant of Rs. 940,000 towards the acquisition of the cows. This grant was unconditional.

During the year ending 30 September 2013, Numbers Ltd incurred the following costs:
• Rs. 1,175,000 to maintain the condition of the animals (food and protection).
• Rs. 705,000 in breeding fees to a local farmer

On 1 April 2013, 5,000 calves were born. There were no other changes in the number of animals during the
year ended 30 September 2013

During the period, 30,000 litres of milk was produced at an average, FV less CTS of Rs. 1.29. Up to 30
September 2013 20,000 litres were sold for Rs. 1.3 per litre.

At 30 September 2013 Numbers Ltd had 10,000 liters of unsold milk in inventory.

Information regarding fair values is as follows:

Fair value less cost to sell

Item 01 October 01 April 30 September
2012 2013 2013
Land (in millions) 47 51.7 55.4
Newborn calves (per calf) 47 49.35 51.7
Six-month-old calves (per calf) 54.05 56.4 58.15
Two-year-old cows (per cow) 211.5 216.2 220.9
Three year old cows (per cow) 218.5 223.25 227.95
Milk (per litre) 1.41 1.29 1.29

Required:
(a) Discuss how the IAS 41 requirements regarding the recognition and measurement of biological assets
and agricultural produce are consistent with the IFRS Framework for the Preparation and Presentation
of Financial Statements. (5 marks)
(b) Prepare journal entries for the year ended 30/9/2013. (5 marks)
(c) Prepare extracts from the statement of profit or loss and the statement of financial position that shows
how the transactions entered into by Numbers Limited in respect of the purchase and maintenance of
the dairy herd would be reflected in the financial statements of the entity for the year ended 30
September 2013. (10 marks)
(d) Prepare a reconciliation of changes in the carrying amount of biological assets by segregating the
change due to price and physical change. (7 marks)

----------( 173 )----------

Answer No. 1

(a) IAS 41 states that an entity should recognize agricultural produce or a biological asset when the
following characteristics apply:

• the entity controls the asset as a result of past events and

• it is probable that future economic benefits associated with the asset will flow to the entity and
• the fair value or cost of the asset can be reliably measured

These are the same characteristics that apply to any asset to be recognized:

Agricultural produce and biological assets are normally measured at fair value less estimated costs of
sale. It is assumed that the fair value of agricultural produce and biological assets can be
measured reliably.

That presumption can only be rebutted for biological assets where market prices or values are not
available and alternative measures of fair value are ‘clearly unreliable’.
Such rebuttal must be made on initial recognition of the asset.

Historic cost is the most frequently used basis for reliable measurement in other standards.

In the context of measuring the value of many assets, historic cost is appropriate but in the context of
biological assets (for example, newly born livestock) the concept of ‘cost’ is not an easy one to apply
and so fair value could well be more appropriate.

b) Journal entries for the year ended 30/9/2013: Rs ‘000’ Rs ‘000’

Date Particulars Debit Credit
1/10/12 Land 4,700
Cash 4,700
1/10/12 Biological asset (10,000 x 211.5 ) 2,115
Loss on initial recognition (bal.) 235
Cash 2,350
1/10/12 Cash 940
Grant income 940
1/4/13 Biological asset ( 49.35 x 5000 ) [Newborn] 246.75
Gain (P.L) 246.75
30/9/13 Maintenance cost 1175
Cash 1175
30/9/13 Breading cost 705
Cash 705
During Agricultural produce ( 30,000 x 1.29 ) 38.7
2013
Gain ( P.L ) 38.7
Cash 26
Sales [20,000 x 1.3 ] 26
Cost of Sales 25.8
Agricultural produce
[ 38.7/30,000 x 20,000 ] 25.8
30/9/13 Stock ( 38.7/30,000 x 10,000 ) 12.9
Agricultural Produce 12.9
30/9/13 Biological asset 164.5
( 2,115 – ( 10,000 x 227.95 ))
Gain 164.5
30/9/13 Biological asset – calves 44
( 5,000 x 58.15 )- 246.75
Gain 44

----------( 174 )----------

c) Extracts from the statement of profit or loss and the
statement of financial position

Income ’000 ’000

Change in fair value of purchased herd (164.5 – 235 ) (70.50)
Government grant ( unconditional ) 940.00
Change in fair value of newly born calves (246.75 + 44 ) 290.75
Fair value of milk 38.76
Profit on sale of milk ( 26 – 25.8 ) 0.2
Total income 1199.21
Expense
Maintenance costs (Given)
1,175.00
Breeding fees (Given) 705.00
Total expense (1,880.00)
Net loss (680.79)

Extracts from the statement of financial position

Property, plant and equipment:
Land (Note 1)
47,000.00
Mature herd [ 10,000 x 227.95 } 2,279.5
Calves ( 5000 x 58.15 ) 290.75

Inventory:
Milk 12.90

d) Reconciliation of changes in the carrying amount of biological assets:

Rs ‘000’
Fair value less costs to sell of herd at 1 October 2012 ( No information )
-
Fair value less costs to sell of herd at 30 September 2013:
From Opening: -
Purchased: (10,000 x 227.95) [3 years old] 2279.5
Newborn on 1.4.2013 (5000 x 58.15) [0.5 years old] 290.75
2570.25
Total increase 2570.25

Reconciliation:
Fair value less costs to sell of herd at 1 October
2012 -
Purchased on 01.10.2012(10,000 x 211.5) 2115
Newborn on 1.4.2013 (5000 x 49.35) 246.75
Increase in fair value less cost to sell due to price change:
Opening - -
Purchased 10000 x (220.9 – 211.5) 94
Newborn 5000 x (51.7 – 49.35) 11.75 105.75

Increase in fair value less costs to sell due to physical change:

Opening - -
Purchase 10000 x (227.95 – 220.9) 70.5
Newborn 5000 x (58.15 – 51.7) 32.25
102.75
2,570.25
Fair value less costs to sell of herd at 31 October 2013

Note 1:
The land is not depreciable and in the given data Fair value of land is not given.
Fair value less point of sale cost given, is irrelevant.
So, stated at cost i.e.: 47,000 ----------( 175 )----------
 Without Allah We are nothing. We should surrender to the will of Allah.

Final Accounts
Part 2
COMPANIES ACT, 2017: FOURTH SCHEDULE
General Requirements
a) All listed companies and their subsidiaries shall follow the International Financial Reporting Standards in
regard to financial statements as notified by the Commission, under Section 225 of the Companies Act,
2017 (Act);
b) The disclosure requirements, as provided in this schedule, are in addition to the disclosure requirements
prescribed in International Financial Reporting Standards notified by the Commission unless specifically
required otherwise;
c) In addition to the information expressly required to be disclosed under the Act and this schedule, there
shall be added such other information as may be considered necessary to ensure that required disclosure
is not misleading.

Example 1: Statement of Compliance

These financial statements have been prepared in accordance with the accounting and reporting standards
as applicable in Pakistan. The accounting and reporting standards as applicable in Pakistan comprise of:
–International Financial Reporting Standards (IFRS Standards), issued by the International Accounting
Standards Board (IASB) as notified under the Companies Act, 2017; and
–Provisions of and directives issued under the Companies Act, 2017.
Where the provisions of and directives issued under the Companies Act, 2017 differ from IFRS Standards, the
provisions of and directives issued under the Companies Act, 2017 have been followed.

d) The following shall be disclosed in the financial statements, namely:

i. General information about the company comprising the following:
▪ Geographical location and address of all business units including mills/plant;
▪ Particulars of company’s immovable fixed assets, including location and area of land;
▪ The capacity of an industrial unit, actual production and the reasons for shortfall (comparative as
well);
▪ Number of persons employed as on the date of financial statements and average number of
employees during the year ([opening + closing]/2);
▪ Name of associated companies or related parties or undertakings along with the basis of
relationship describing common directorship and percentage of shareholding.

Example 2: Legal Status and nature of business

MT Limited (the Company) is a public limited company and was incorporated in Pakistan in 1995 under the
Companies Ordinance, 1984 (now the Companies Act, 2017), and is listed on the Pakistan Stock Exchange
Limited. The registered office and factory of the Company is situated at Multan Road, Lahore. The Company
also has regional offices located in Karachi, Multan, Sukkur and Islamabad.
The Company is principally engaged in assembling and manufacturing of agricultural machinery and
applications.

Example 3: Property, plant and equipment (Disclosed in sub-note)

The freehold land and building on owned land of the company are as follows:
- 202,343 square meters of factory land situated at Multan Road, Lahore;
- 697 square meters of land in sector F-6/1 Islamabad;

- Corporate office floors in Corporate Centre Lahore.

----------( 176 )----------

 Life is a journey from Allah to Allah.

Example 4: Property, plant and equipment (Disclosed in sub-note)

Following are particulars of the Company’s immovable fixed assets:
Location Usage Total area (in Acres)

Shahrah-e-Roomi, Lahore Plant site and administrative offices 34.02

Herdo Sehari, Kasur Administrative offices 34.84

Lakho Baryar, Kasur Administrative offices 50.63

Example 5: Production Capacity

(Urea manufacturing Company)
Design Capacity Production

2018 2017 2018 2017

Urea Tonnes ‘000 Tonnes ‘000

Lahore – Plant I 695 695 688 692

Faisalabad – Plant II 635 635 635 635

Peshawar – Plant III 718 718 714 703

2,048 2,048 2,037 2,030

The shortfall in actual production are insignificant and considered normal in the industry.

Example 6: Capacity and production

(Electricity Generation Company)
2018 2017

MWh

Installed capacity (based on 8,760 hours) 1,086,240 1,086,240

Actual energy delivered 387,435 645,395

Under-utilisation of available capacity is due to less demand by WAPDA.

Example 7: Number of employees

2018 2017

Total number of employees at end of the year 3,357 3,364

Average number of employees for the year 3,369 3,384

----------( 177 )----------

 Example 8: Associated companies and undertakings

Percentage of Common
Name shareholding Basis of relationship directorship

ABC Limited 58% Subsidiary Ms. S

Mr. A
Mr. B

XYZ Limited 25% More than 20% Mr. B

shareholding

KLM Limited 6% Common directors Mr. K

Mr. M

Example 9: Associated companies and undertakings

The names of related parties with whom the Company has entered into transactions or had agreements /
arrangements in place during the year and whose names have not been disclosed elsewhere in these financial
statements are as follows:
Percentage of
Name of the related party Basis of relationship
Shareholding %

Toyota Tsusho Corporation Associated company 20%

Tomen Power (Singapore) (Private) Limited Associated company 16%

Red Communication Arts (Private) Limited Common directorship -

Kohinoor Power Company Limited Common directorship -

Pak Elektron Limited Common directorship -

Pel Marketing (Private) Limited Common directorship -

Wartsila Pakistan (Private) Limited Common directorship -

Kohinoor Energy Limited Employees Gratuity

Common control 0.23%
Fund

All transactions with related parties are carried out on mutually agreed terms and conditions.

ii. In respect of associated companies, subsidiaries or holding companies incorporated outside Pakistan with
whom the company has entered into transactions during the year, following shall be separately disclosed;
o Name of undertaking and country of incorporation;
o Basis of association; and
o Aggregate percentage of shareholding, including shareholding through other companies or entities;

Example 10: Related party disclosure (Disclosed in sub note)

Following particulars relate to associated companies incorporated outside Pakistan with whom the company
had entered into transactions during the year:
Name of undertaking Pakistan Maroc Phosphore S.A.
Country of incorporation Morocco
Basis of association Joint venture of OCP Group and Fauji Group
Aggregate %age of shareholding 12.5% Equity investment by the company

----------( 178 )----------

 May Allah guide us and forgive us for hurting others knowingly or unknowingly.

Example 11: Related party disclosure (Disclosed in sub note)

Following particulars relate to associated companies incorporated outside Pakistan with whom the company
had entered into transactions during the year:
Name of company Toyota Tsusho Corporation
Country of incorporation Japan
Basis of association Associated undertaking
Aggregate %age of shareholding 20%

iii. General nature of any credit facilities available to the company, other than trade credit available in the
ordinary course of business, and not availed at the date of the statement of financial position;
Note: This is not required in fifth schedule.

Example 12: Facilities of letters of credit and letters of guarantee (Disclosed in sub note)
Facilities of letters of credit and letters of guarantee amounting to Rs 17,395,000 thousand and Rs 239,293
thousand (2017: Rs 13,580,000 thousand and Rs 101,655 thousand) respectively are available to the
company against lien on shipping / title documents, US $ Term Deposit Receipts and charge on assets of
the company.

Utilisation of proceeds from public offering (fourth schedule only)

In financial statements issued after initial or secondary public offering(s) of securities or issuance of debt
instrument(s) implementation of plans as disclosed in the prospectus/offering document with regards to
utilization of proceeds raised shall be disclosed till full implementation of such plans.

⯈ Illustrative disclosure 14: Utilization of proceeds from Initial Public Offering (IPO)
The Company raised the funds through IPO for expansion and modernization of its production facilities, in
order to meet the expected increase in demand for tyres and tubes and to achieve higher level of
automation in their existing production facilities to bring in cost efficiencies.
Out of net IPO proceeds of Rs. 1,874 million, the expenditure of Rs. 1,466 million (78%) has been incurred
by 30 June 2021.

Loans/advances/investments in foreign companies

In cases where company has given loans or advances or has made investments (both short term and long
term) in foreign companies or undertakings following disclosures are required to be made:
i. Name of the company or undertaking along with jurisdiction where it is located;
ii. Name and address of beneficial owner of investee company, if any;
iii. Amount of loan/investment (both in local and foreign currency);
iv. Terms and conditions and period for which loans or advances or investments has been made;
v. Amount of return received;
vi. Details of all litigations against the Investee company in the foreign jurisdictions;
vii. Any default/breach relating to foreign loan or investment; and
viii. Gain or loss in case of disposals of foreign investments. (Note: The information (ii) to (viii) is not
required in fifth schedule).

⯈ Illustrative disclosure: Investment in foreign companies

Following particulars relate to investment made in the foreign company:
Particulars
Name and jurisdiction of associated Pakistan Maroc Phosphore S.A., Morocco
company
Name and address of beneficial Fauji Fertilizer Company Limited located at 156, The Mall
owners Rawalpindi Cantt, Pakistan
Fauji Foundation located at 68 Tipu Road, Chaklala, Rawalpindi
Cantt, Pakistan
Fauji Fertilizer Bin Qasim Limited located at FFBL Tower Plot No
C1/C2, Sector B, Jinnah Boulevard Phase II DHA Islamabad,
Pakistan
Office Cherifien Des Phosphates located at Hay Erraha. 2, Rue Al
Abtal, Casablanca, Morocco
Amount of investment Rs 705,925 thousand (MAD 100,000 thousand)
Terms and conditions of investment Equity investment
----------( 179 )----------
 Amount of return received Dividends of Rs. 1,262,969 thousands (from 2009 to 2020)
Details of litigations None
Details of default / breach relating to None
investment
Gain / loss on disposal of Not applicable
investment

iv. Foreign trade debtors: In cases where company has made export sales following disclosures are
required to be made in respect of outstanding trade debts;
o Name of company or undertaking in case of related party; and
o Name of defaulting parties, relationship if any, and the default amount.
Note: This is not required in fifth schedule.

Example 14: Trade debts (Disclosed in sub note)

Included in due from export customers is an amount of Rs. 2.021 million (2017: 1.765 million) receivable from
ABC Shoe Company, Peru against export sales made by the Company. During the year, the Company made
export sales amounting to Rs. 6.332 million (2017: Rs. 4.077 million) to ABC Shoe Company, Peru through
bank contracts.

Sharia compliance (fourth schedule only)

Sharia complaint companies and the companies listed on Islamic index shall disclose:
i. Loans/advances obtained as per Islamic mode;
ii. Shariah compliant bank deposits/bank balances;
iii. Profit earned from shariah compliant bank deposits/bank balances;
iv. Revenue earned from a shariah compliant business segment;
v. Gain/loss or dividend earned from shariah compliant investments;
vi. Exchange gain earned from actual currency;
vii. Mark up paid on Islamic mode of financing;
viii. Relationship with shariah compliant banks; and
ix. Profits earned or interest paid on any conventional loan or advance.

⯈ Illustrative disclosure 17: Short term borrowing (in sub-note)

Short term financing – under mark-up/profit arrangement 2020 2019

Rs. 000

Islamic finances 1,521,967 1,127,639

The facility for running musharkah available from banks amounted to Rs. 2.5 billion (2019: 2.5 billion) out of
which the amount unused at the year-end was Rs 0.98 billion (2019: Rs 0.37 billion). Rates of profit ranges
from three month KIBOR plus 0.05% (2019: one month KIBOR plus 0.3%) to one month KIBOR plus 0.5%
(2019: three months KIBOR plus 0.2%) per annum.
The mark up on Islamic financing during the year was Rs. 98,529 thousands (2019: Rs. 263,903 thousands).

Requirements as to Statement of Financial Position

1. Sundry Requirements
Following items shall be disclosed as separate line items on the face of the financial statements;
(i) Revaluation surplus on property, plant and equipment;
(ii) Long term deposits and prepayments;
(iii) Unpaid dividend;
(iv) Unclaimed dividend; and
(v) Cash and bank balances.

2. Fixed Assets
Where any property or asset acquired with the funds of the company and is not held in the name of the
company or is not in the possession and control of the company, this fact along with reasons for the property
or asset not being in the name of or possession or control of the company shall be stated; and the description
and value of the property or asset, the person in whose name and possession or control it is held shall be
disclosed;
----------( 180 )----------
Example 15: Property, plant and equipment (Disclosed in sub note)
Land measuring 2 kanals and 2 marlas in possession of the Company, acquired in 2014 at a cost of Rs.
57,800 thousand is not in the name of the Company due to pending legal case.

Example 16: Property, plant and equipment (Disclosed in sub note)

Land measuring 10 kanals is neither in the name of the Company nor in possession of the Company. The
Company paid Rs. 75,000 thousand in July 2017 for land to be acquired from Pakistan Railways through open
auction. The auction was later challenged in Lahore High Court and legal case is stilling pending.

Land and building shall be distinguished between free-hold and leasehold;

Forced sale value shall be disclosed separately in case of revaluation of Property, Plant and Equipment.
In the case of sale of fixed assets, if the aggregate book value of assets exceeds five million rupees, following
particulars of each asset, which has book value of five hundred thousand rupees or more, shall be disclosed,
(i) Cost or revalued amount, as the case may be;
(ii) The book value;
(iii) The sale price and the mode of disposal (e.g. By tender or negotiation);
(iv) The particulars of the purchaser;
(v) Gain or loss; and
(vi) Relationship, if any of purchaser with Company or any of its directors.
Example 17: Disposal of operating fixed assets
Book Sale Gain /
Cost
Particulars value proceeds (loss) Mode of
Sold to

of assets disposal
(Rupees in thousand)

Book value greater than Rs. 500,000

Vehicle Employee: Mr. Ayaz 1,973 524 524 -

Company

Scheme
Car
Vehicle Employee: Mr. Sikandar 2,503 1,608 1,608 -
Vehicle Employee: Mr. Amir 1,124 884 884 -
Book value less than Rs. 500,000 29,952 9,366 12,948 3,582
Year ended: June 30, 2019 35,552 12,382 15,964 3,582
Year ended: June 30, 2018 31,532 17,128 17,128 -

3. Long term loans and advances

With regards to loans and advances to directors following shall be disclosed:
(i) the purposes for which loans or advances were made; and
(ii) reconciliation of the carrying amount at the beginning and end of the period, showing disbursements
and repayments;
Note: this disclosure is only required in fourth schedule. [MCQ 12]
In case of any loans or advances obtained/provided, at terms other than arm‘s length basis, reasons thereof
shall be disclosed
In respect of loans and advances to associates and related parties there shall be disclosed,
1. the name of each associate and related party;
2. the terms of loans and advances;
3. the particulars of collateral security held, if any;
4. the maximum aggregate amount outstanding at any time during the year calculated by reference to
month-end balances;
5. provisions for doubtful loans and advances; and
6. loans and advances written off, if any.

----------( 181 )----------

 Allah’s plans are better than our dreams.

Example 18: Long Term Loans and advances -

Secured

2018 2017
Rs‘000 Rs’000
Loans and advances – considered good, to:
Executives 763,000 691,000
Other employees 719,000 618,000

1,482,000 1,309,000
Less: Amount due within twelve months 368,000 343,000

1,114,000 966,000

Reconciliation Executive Other 2018 2017

Rs‘000 Rs‘000 Rs‘000 Rs‘000
Balance at January 1 691,000 618,000 1,309,000 1,269,000
Disbursement 339,000 308,000 647,000 570,000

1,030,000 926,000 1,956,000 1,839,000

Repayments (267,000) (207,000) (474,000) (530,000)

Balance at December 31 763,000 719,000 1,482,000 1,309,000

These subsidized and interest free loans and advances are granted to employees as per the Company’s
policy and are repayable within one to ten years. House building loans carry mark-up at 4% per annum and
are secured against the underlying assets.
The maximum amount of loans and advances to executives outstanding at the end of any month during the
year was Rs 805,865 thousand (2017: Rs 772,548 thousand).

4. Current assets
In respect of debts/receivables from associates and related parties there shall be disclosed.
(i) the name of each associate and related party;
(ii) the maximum aggregate amount outstanding at any time during the year calculated by reference to
month-end balances;
(iii) receivables, that are either past due or impaired, along with age analysis distinguishing between trade
debts, loans, advances and other receivables;
(iv) debts written off as irrecoverable, distinguishing between trade debts and other receivables;
(v) provisions for doubtful or bad debts distinguishing between trade debts, loans, advances and other
receivables; and
(vi) justification for reversal of provisions of doubtful debts, if any;

Example 19: Trade debts - Unsecured

2018 2017

Considered good Rs‘000 Rs’000

Due from customers 2,165,093 1,561,668

Due from associated undertakings 2,021 1,765
2,167,114 1,563,433
Considered doubtful
Due from customers 30,362 30,527
Less: Provision for doubtful debts (30,362) (30,527)

- -
2,167,114 1,563,433

----------( 182 )----------

These customers have no recent history of default.
2018 2017
Due from associated undertaking Rs‘000 Rs’000
ABC Shoe Company, Peru 2,021 1,765

Maximum aggregate amount due from associated undertakings at the end of any month in the year was Rs.
3.319 million (2017: Rs. 1.967 million). No interest has been charged on the amounts due from associated
undertakings.

In respect of loans and advances, other than those to employees as per company’s human resource policy or
to the suppliers of goods or services, the name of the borrower and terms of repayment if the loan or advance
exceeds rupees one million, together with the particulars of collateral security, if any, shall be disclosed
separately;
Note: The requirements in above para relate to fourth schedule only and not required in fifth schedule.

Provision, if any, made for bad or doubtful loans and advances or for diminution in the value of or loss in
respect of any asset shall be shown as a deduction from the gross amounts;

Example 20: Loans and advances

2018 2017
Rs‘000 Rs’000
Current portion of long term loans and advances 368,000 343,000
Loans and advances to employees - unsecured 27,000 17,000
Advance to suppliers – considered good 82,000 150,000
Advance to subsidiary company – interest bearing 582,000 1,122,000

1,059,000 1,632,000
Advance to subsidiary company
This represents aggregate unsecured advance to, ABCEL, subsidiary company under a revolving credit facility
upto an amount of Rs 1,500,000 thousand to meet debt servicing obligations and other working capital
requirements. This carries mark-up at 1 month KIBOR + 0.60%. The maximum outstanding amount at the end
of any month during the year was Rs 671,261 thousand (2017: Rs 1,336,386 thousand).
5. Share capital and reserves
Capital and Revenue reserves shall be clearly distinguished. Any reserve required to be maintained under the
Act shall be separately disclosed. Any legal or other restrictions, on the ability of the company to distribute or
otherwise, shall be disclosed for all kind of reserves maintained by the company;

Example 21: Reserves

Capital Reserves 2018 2017

Rs‘000 Rs’000
Share premium 5.1 40,000 40,000
Capital redemption reserve 5.2 120,000 120,000

160,000 160,000
5.1 This represents premium of Rs. 5 per share received on public issue of 8,000,000 ordinary
shares of Rs. 10 each in 1991.
5.2 This represents reserve set up on redemption of preference shares of Rs. 120,000
thousands in 1996.

Revenue Reserves 2018 2017

Rs‘000 Rs’000
General reserve 8,802,360 8,802,360
Unappropriated profit 11,720,153 7,374,114

20,522,513 16,176,474
----------( 183 )----------
In respect of issued share capital of a company following shall be disclosed separately:
(i) shares allotted for consideration paid in cash;
(ii) shares allotted for consideration other than cash, showing separately shares issued against property
and others (to be specified);
(iii) shares allotted as bonus shares; and
(iv) treasury shares;

Shareholders agreements for voting rights, board selection, right of first refusal and block voting shall be
disclosed.

Example 22: Share Capital

Authorised share capital

2018 2017 2018 2017

Number of shares ‘000 Rs’000
10,000 10,000 Ordinary shares of Rs. 10 each 100,000 100,000

Issued, subscribed and paid up capital

2018 2017 2018 2017

Number of shares ‘000 Rs’000
1,890 1,890 Ordinary shares of Rs. 10 each 18,900 18,900
Fully paid in cash
300 300 Ordinary shares of Rs. 10 each 3,000 3,000
Issued for consideration other than
Cash
5,370 5,370 Ordinary shares of Rs. 10 each 53,700 53,700
Issued as fully paid bonus shares

7,560 7,560 75,600 75,600

Shares issued for consideration other than cash were issued against plant and machinery.

All ordinary shares rank equally with regard to the Company’s residual assets. Holders of the shares are
entitled to dividends from time to time and are entitled to one vote per share at the general meetings of the
Company.

6. Non-current liabilities

Amount due to associated companies and related parties shall be disclosed separately

7. Current liabilities

Following items shall be disclosed as separate line items:

(i) Payable to provident fund;
(ii) Deposits, accrued liabilities and advances;
(iii) Loans from banking companies and other financial institutions, other than related parties;
(iv) Loans and advances from related parties including sponsors and directors along with purpose and
utilization of amounts; and
(v) Loans and advances shall be classified as secured and unsecured.

----------( 184 )----------

 Fear Allah Almighty and follow the path of truth.

Example 23: Current liabilities

Note 2018 2017

Rs‘000 Rs’000

Trade and other payables 9 60,599,330 38,781,144

Mark-up and profit accrued 10 300,574 190,707
Short term borrowings - secured 11 28,526,484 11,539,083
Unclaimed dividend 638,783 437,291
Current portion of long term borrowings - secured 7 7,237,742 6,831,804
Taxation 2,641,779 1,229,780

99,944,692 59,009,809

In respect of security deposit payable, following shall be disclosed:

(i) Bifurcation of amount received as security deposits for goods/services to be delivered / provided, into
amounts utilizable for company business and others;
(ii) Amount utilized for the purpose of the business from the security deposit in accordance with
requirements of written agreements, in terms of section 217 of the Act; and
(iii) Amount kept in separate bank account;

Example 25: Long Term Deposits

2019 2018
Rs‘000 Rs’000
Long term deposits from dealers 12,731 12,691

These represent security deposits received from dealers which, by virtue of agreement, are interest free.
These are repayable on cancellation of dealership contract with dealers and cannot be utilized for the purpose
of the business. These have been kept in separate bank account in accordance with the requirements of the
section 217 of the Companies Act, 2017.

8. Contingencies and commitments

In describing legal proceedings, under any court, agency or government authority, whether local or foreign,
include name of the court, agency or authority in which the proceedings are pending, the date instituted, the
principal parties thereto, a description of the factual basis of the proceeding and the relief sought.

Example 26: Contingencies and Commitments

Penalty of Rs 5.5 billion imposed by the Competition Commission of Pakistan (CCP) in 2013, for alleged
unreasonable increase in urea prices, had been set aside by the Competition Appellate Tribunal with
directions to the CCP to decide the case under guidelines provided by the Tribunal. No petition was filed by
the CCP for review of the decision within the stipulated time, and this option has thus become time barred
for the CCP. However, the CCP can file fresh case under the guidelines provided by the Tribunal, but the
Company remains confident of successfully defending these unreasonable claims in future as well.
2018 2017
Commitments in respect of: Rs‘000 Rs’000
Capital expenditure 1,919,124 2,498,658
Purchase of stores, spares and other items 1,528,517 2,821,573
Investment in an associated company – ABC Limited 500,000 640,000
Investment in a Joint Venture XYZ Energy Limited 3,685,374 -
Contracted out services 392,100 221,390
Rentals under lease agreements:
Premises 254,827 312,656
Vehicles 88,226 83,674

----------( 185 )----------

3.3 Requirements as to Statement of Profit or Loss Account
Following items shall be disclosed as deduction from turnover as separate line items:
(i) trade discount; and
(ii) sales and other taxes directly attributed to sales.

Example 29: Turnover

2018 2017
Rs‘000 Rs’000
Manufactured urea – local 74,462,673 67,095,578
Manufactured urea – export - 5,066,304
Purchased and packaged fertilizers 32,930,082 27,031,569

109,392,755 99,193,451

Sales tax (3,381,261) (5,101,021)

Trade discount (47,023) (3,378,316)

(3,428,284) (8,479,337)
105,964,471 90,714,114

Auditors’ remuneration: The aggregate amount of auditors’ remuneration, showing separately fees,
expenses and other remuneration for services rendered as auditors and for services rendered in any other
capacity and stating the nature of such other services. In the case of joint auditors, the aforesaid information
shall be shown separately for each of the joint auditors;

Example 30: General

Auditors’ remuneration 2019 2018

Rs‘000 Rs’000
Audit fee 1,650 1,650
Fee for half yearly review, audit of consolidated financial
statements, review of Code of Corporate Governance and other 899 899
certifications in the capacity of external auditors
Out of pocket expenses 160 160

2,709 2,709

----------( 186 )----------

Donation:
In case, donation to a single party exceeds 10 per cent of company’s total amount of donation or Rs. 1 million,
whichever is higher, name of donee(s) shall be disclosed and where any director or his spouse has interest in
the donee(s), irrespective of the amount, names of such directors along with their interest shall be disclosed;

Example 31: Donations

Other expenses include donations amounting to Rs 60,176 thousand (2017: Rs 64,125 thousand) and Rs
24,515 thousand (2017: Rs 25,289 thousand) respectively. These are disbursed through ABC Welfare
Foundation (associated undertaking). Interest of CEO Mr. Tariq in ABC Welfare Foundation is limited to the
extent of his involvement in ABC Welfare Foundation as Chairman.

Complete particulars of the aggregate amount charged from the company shall be disclosed separately for
the directors, chief executive and executives together with the number of such directors and executives such
as:
(i) fees;
(ii) managerial remuneration;
(iii) commission or bonus, indicating the nature thereof;
(iv) reimbursable expenses which are in the nature of a perquisite or benefit;
(v) pension, gratuities, company's contribution to provident, superannuation and other staff funds,
compensation for loss of office and in connection with retirement from office;
(vi) other perquisites and benefits in cash or in kind stating their nature and, where practicable, their
approximate money values; and
(vii) amount for any other services rendered.

Definition of executive: employee which has a basic salary of 1,200,000 in a financial year.

Example 32: Remuneration of Chief Executive, Directors and Executives

The aggregate amounts charged in these financial statements in respect of remuneration including benefits
applicable to the chief executive, directors and executives of the company are given below:

2018 2017
Chief Chief
Executives Executives
Executive Executive

Rs‘000 Rs‘000 Rs‘000 Rs‘000

Managerial remuneration 7,915 1,353,075 8,583 1,297,932
Contribution to provident fund 542 84,995 618 81,561
Bonus and other awards 2,783 - 3,703 561
Good performance awards - 1,458,366 - 1,394,652
Allowance and contribution to
9,030 1,186,791 11,113 1,068,165
retirement benefit plans

Total 20,270 4,083,227 24,017 3,842,871

Number of person(s) 1 339 1 336

The above were provided with medical facilities; the chief executive and certain executives were also
provided with some furnishing items and vehicles in accordance with the Company’s policy.

Gratuity is payable to the Chief Executive in accordance with the terms of employment while contributions
for executives in respect of gratuity and pension are based on actuarial valuations.

Leave encashment of Rs 4,431 thousand (2017: Nil) and Rs 57,380 thousand (2017: Rs 46,454 thousand)
were paid to chief executive and executives on separation, in accordance with the Company’s policy.

In addition, 18 (2017: 16) directors were paid aggregate meeting fee of Rs 6,075 thousand (2017: Rs 4,625
thousand).

----------( 187 )----------

Directors are not paid any remuneration except meeting fee.

In case of royalties paid to companies/entities/individuals, following shall be disclosed:

(i) Name and registered address; and
(ii) Relationship with company or directors, if any.

Example 33: Royalty payments

Distribution costs 2018 2017

Rs‘000 Rs’000

Salaries and benefits 840,000 813,000

Freight 270,000 239,000
Trademark license fee Note 635,000 388,000
Depreciation 165,000 146,000
Miscellaneous 1,000 500

1,911,000 1,586,500
The trademark license fee represents the royalty fee of ABC Brands S.A.R.L., Switzerland, an associated
company situated in Avenue d’Ouchy 6, 1006 Lausanne, Switzerland.
Sales Tax
According to sales tax act, every supplier has an obligation to collect 17% sales tax at time of sales.
Suppose a company purchases a raw material to convert it into finished goods for sale. Detail of a purchase
invoice is as follows:
Purchase price 100,000
+ 17% sales tax 17,000_
117,000
Suppose it is a credit purchase.
If sales tax is not refundable; then entry is
Purchases 117,000
Creditor 117,000
If sale tax is refundable/adjustable; then entry is:
Purchases 100,000
Sales tax receivable 17,000
Creditor 117,000
Now suppose the company converted the raw material into finished goods and sold it to a customer.
Detail of a sale invoice is as follows:
Sale price 200,000
+ 17% Sales Tax 34,000
234,000
Suppose it is a credit sale.
Debtor 234,000
Sales 200,000
Sale tax payable 34,000
As per sales tax act, sales tax receivables and sales tax payable can be adjusted against each other.
Therefore in the above scenario net Rs 17,000 is payable to sales tax department.
Alternative Entry
i) Cash 234,000
Sales 234,000
ii) Sales tax 34,000
Sales tax payable 34,000
 The amount of sales tax is deducted from sales just like sales return.
 If head of sales tax is appearing on debit side of trail balance then it is to be deducted from sales in income
statement.

----------( 188 )----------

 If you are blessed with Islam then never feel worthless. If you have Islam then you have everything.

Q. FIGS PAKISTAN LIMITED

Figs Pakistan Limited is a listed company engaged in the business of manufacturing and marketing of personal
care and food products. Following is an extract from its trial balance for the year ended 31 December 2017:
Debit Credit
Rs. in million
Sales - Manufactured goods 56,528
Sales - Imported goods 1,078
Scrap sales 16
Dividend income 12
Return on savings account 2
Sales tax - Imported goods 53
Sales tax - Manufactured goods 10,201
Sales discount 2,594
Raw material stock as on 1 January 2017 1,751
Work in process as on 1 January 2017 73
Finished goods (manufactured) as on 1 January 2017 1,210
Finished goods (imported) as on 1 January 2017 44

Purchases - Raw material 22,603

Purchases - Imported goods 658
Stores and spares consumed 180
Salaries, wages and benefits 2,367
Utilities 734
Depreciation and amortization 1,287
Stationery and office expenses 230
Repairs and maintenance 315
Advertisement and sales promotion 4,040
Outward freight and handling 1,279
Legal and professional charges 71
Auditor's remuneration 13
Donations 34
Workers Profit Participation Fund 257
Worker Welfare Fund 98
Loss on disposal of property, plant and equipment 10
Financial charges on short term borrowings 133
Exchange loss 22
Financial charges on lease 11

Additional information
The position of inventories as at 31 December 2017 was as follows:
Rs. m
Raw material 2,125
Work in process 125
Finished goods (manufactured) 1,153
Finished goods (imported) 66

The basis of allocation of various expenses among cost of sales, distribution costs and administrative
expenses are as follows:

Cost of Distribution Administrative

sales costs expenses
% % %
Salaries, wages and benefits 55 30 15
Depreciation and amortization 70 20 10
Stationery and office expenses 25 40 35
Repairs and maintenance / Utilities 85 5 10

----------( 189 )----------

Salaries, wages and benefits include contributions to provident fund (defined contribution plan) and gratuity
fund (defined benefit plan) amounting to Rs. 54 million and Rs. 44 million respectively.

Auditor’s remuneration includes taxation services and out-of-pocket expenses amounting to Rs. 4 million and
Rs. 1 million respectively.

Donations include Rs. 5 million given to Dates Cancer Foundation (DCF). One of the company’s directors, Mr.
Peanut is a trustee of DCF.

The tax charge for the current year after making all related adjustments is estimated at Rs. 1,440 million.
Taxable temporary differences of Rs. 3,120 originated in the year million, over the last year. The applicable
income tax rate is 35%.

Required
Prepare the statement of profit or loss for the year ended 31 December 2017 along with the relevant notes
showing required disclosures as per the Companies Act, 2017 and International Financial Reporting
Standards. Comparatives are not required.
Answer:
Figs Pakistan Limited
Statement of Profit or Loss by (Nature)
For the year ended 31 Dec 2015
[Link] Million
Sales 44,758
Other Income 30
44,788
Changes in Inventory of Finished Goods and Work in progress (N-1) 17
Raw Material Consumed 22,229
Staff Cost 2,367
Purchase of Import 658
Depreciation & Amortization 1,287
Other Expenses (N-2) 7,283
Finance Cost 144 (33,968)
Profit before Tax 10,837
Tax Expense (2,532)
Profit After Tax 8,305

N-1)
Opening Work in Progress 73
Closing Work in Progress 125
Opening Finished Goods 1,210
Closing Finished Goods 1,153
Opening Imported Goods 44
Closing Imported Goods 66
17
N-2) Other Expenses
Stores and Spares 180
Utilities 734
Stationary 230
Repair and Maintenance 315
Advertisement 4,040
Outward Freight 1,279
Legal and Professional Charges 71
Auditor Remuneration 13
Donation 34
Workers Profit Fund 257
Loss on Disposal 10
Workers Welfare Fund 98
Exchange Loss 22
7,283
----------( 190 )----------
 Follow the teaching of Quran and Sunnah and be friend of righteous people.

Final accounts extra practice questions

Q.1 Banana Limited (BL) is listed on Pakistan Stock Exchange and has registered office in Karachi. BL
engages in manufacturing and marketing of fertilizers. It operates a manufacturing plant at Nawabshah.

Summarized trial balance of BL as at 30 June 2018 is given below:

Description Rs. in million
Advance from customers 576
Cash and bank balances 831
Intangible assets 444
Investment in 3 months term deposit 500
Land and building – revaluation model 2,000
Long term deposits with utility companies 10
Long term investments 1,500
Ordinary share capital 6,000
Plant and equipment – cost model 3,086
Provision for doubtful receivables 80
Revaluation surplus on land and building 468
Running finance 800
Share premium 500
Stock-in-trade 2,670
Trade and other receivables 1,470
Trade payables 1,150
Un-appropriated profit 2,885
Unclaimed dividend 52

Additional information:
a) Trade and other receivables include receivables from BL’s associate i.e. Strawberry Limited (SL) and BL’s
subsidiary i.e. Pear Limited (PL) amounting to Rs. 50 million and Rs. 20 million respectively. Provision for
doubtful receivables includes provision of Rs. 10 million against receivables from SL.
b) Bad debts of Rs. 35 million were written off during the year. These include an amount of Rs. 8 million
receivable from SL.
c) Authorised share capital consists of 1 billion shares of Rs. 10 each.
d) 80 million shares were issued as bonus shares in the previous years whereas 20 million shares were
issued as a consideration for purchase of building at market price of Rs. 15 per share. Remaining shares
were allotted for consideration paid in cash.
e) Guarantees issued by BL to Cherry Bank Limited against loans granted to BL’s employees amounting to
Rs. 16 million.
f) During the year, BL produced 3 million tonnes of urea operating at 75% production capacity. The shortfall
was due to lower demand of product in the market.
g) Following decisions were taken by the board of directors in their meeting held on 16 August 2018:

Cash dividend of Rs. 3 per share for the year ended 30 June 2018 was proposed.
Financial statements for the year ended 30 June 2018 were approved.

Required:
Prepare BL's statement of financial position as at 30 June 2018 along with the relevant notes showing possible
disclosures as required under the IFRSs and the Companies Act, 2017.
(Comparative figures and note on accounting polices are not required)

----------( 191 )----------

Ans. 1 Banana Limited

Statement of financial position As on 30 June 2018

Rs. in million
Non-current Assets Note
Property, plant and equipment (2,000+3,086) 5,086
Intangible assets 444
Long term investments 1,500
Long term deposits 10
7,040

Current Assets
Stock-in-trade 2,670
Trade and other receivable 2 1,390
Short term investment 500
Cash and bank balances 831
2 5,391
12,431
Share capital and reserves:
Share capital 3 6,000
Share premium 500
Unappropriated profit 2,885
Revaluation surplus on property plant & equipment 468
9,853
Current liabilities
Trade and other payables (1,150+576) 1,726
Unclaimed dividend 52
Running finance 800
2,578
Contingencies 4
12,431

Banana Limited
Notes to the financial statements
For the year ended 30 June 2018
1. Legal status and nature of business
Banana Limited (BL) is listed on the Pakistan Stock Exchange having registered office in Karachi. BL operates
its plant located at Nawabshah. BL engages in manufacturing, and marketing of fertilizers.

2. Trade and other receivables Rs. in million

Gross amount 1,470
Provision for doubtful debts (80)
1,390
2.1 Trade receivables from related parties:
Name of related party Receivable Provision
Strawberry Limited (Associate) 50 10
Pearl Limited (Subsidiary) 20 -
70 10

2.2 During the year, trade receivable from Strawberry Limited amounting to Rs. 8 million were written off.

----------( 192 )----------

3. Share capital Rs.
in million
Authorized share capital
1,000 million ordinary shares of Rs. 10 each 10,000

Issued, subscribed and paid up capital

500 million shares allotted for consideration paid in cash (bal.) 5,000
20 million shares allotted for consideration other than cash 200
80 million shares allotted as bonus shares 800
6,000

3. Contingencies
BL has issued guarantees to Cherry Bank Limited against loans granted to BL’s employees amounting to
Rs. 16 million.

4. Production capacity
Durign the year BL produced 3 million units operating at 75% production capacity. The shortfall was due to
lower demand of product in the market.

5. Subsequent event
The Board of Directors in its meeting held on 16 August 2018 proposed cash dividend of Rs. 3 per share
amounting to Rs. 1.8 billion (600 x 3), subject to the approval of the members in the forthcoming annual
general meeting of the company (IAS 10)

6. Date of authorization for issue

These financial statements were approved and authorised for issue by the Board of Directors of the
Company on 16 August 2018 (IAS 10).

----------( 193 )----------

Presentation of expenses in statement of profit or loss:
Expenses should be presented by either:
• according to the function of the expense method; or
• according to the nature of expenses method

IAS 1 states that entities should choose the method that provides the more relevant or reliable information.
However, Companies’ Act 2017 requires classification by function with additional information on nature in
notes to the financial statements.
IAS 1 encourages entities to show the analysis of expenses by nature on the face of the statement of
comprehensive income rather than in notes to the financial statements.
Analysis of expenses by their function
When expenses are analyzed according to their function, the functions are commonly ‘cost of sales’,
‘distribution expenses’, ‘administrative expenses’ and ‘other expenses’. This method of analysis is also
called the ‘cost of sales method’.

Illustration: Statement of comprehensive income - Expenses

analyzed by function
Rs. m
Revenue 7,200
Cost of sales (2,700)
Gross profit 4,500
Other income 300
Distribution costs (2,100)
Administrative expenses (1,400)
Other expenses (390)
Finance costs (60)
Profit before tax 850
Income tax expense (250)
Profit for the period 600
IAS 1 also requires that if the analysis by function method is used, additional information about nature of
expenses must be disclosed in notes.
Analysis of expenses by their nature
When expenses are analyzed according to their nature, the categories of expenses will vary according to the
nature of the business. In a manufacturing business, expenses would probably be classified as:
• raw materials and consumables used;
• staff costs (‘employee benefits costs’);
• Depreciation.

Items of expense that on their own are immaterial are presented as ‘other expenses’.
There will also be an adjustment for the increase or decrease in inventories of finished goods and work-in-
progress during the period.

Illustration: Statement of comprehensive income - Expenses analyzed by nature

Rs. m Rs. m
Revenue 7,200
Other income 300
7,500
Changes in inventories of finished goods and 90
work-in-progress
Raw materials and consumables used 1,200
Staff costs (employee benefits expense) 2,000
Depreciation and amortization expense 1,000
Other expenses 2,300
Finance costs (interest cost) 60 6,650
Profit before tax 850
Income tax expense 250
Profit for the period 600
Note: Remember that opening stock will decrease the amount of profit while closing stock will increase the
amount of profit. ----------( 194 )----------
Q. MINGORA IMPORTS LIMITED
The trial balance of Mingora Imports Limited at 31 December 2015 is as follows:

Rupees in million
Dr. Cr.
Patent rights 60
Work-in-progress, 1 January 2015 125
Leasehold buildings at cost 300
Ordinary share capital 600
Sales 1,740
Staff costs 260
Accumulated depreciation on buildings, 1 January 2015 60
Inventories of finished games, 1 January 2015 155
Consultancy fees 44
Directors’ salaries 360
Computers at cost 50
Accumulated depreciation on computers, 1 January 2015 20
Dividends paid 125
Cash 340
Receivables 420
Trade payables 92
Sundry expenses 294
Accumulated profits, 1 January 2015 121
Investments 100
2,633 2,633

The following information is also relevant.

(1) Closing inventories of finished games are valued at Rs. 180 million. Work in progress has increased to
Rs. 140 million.
(2) The patent rights relate to a computer program with a three year lifespan.
(3) On 1 January 2015 buildings were revalued to Rs. 360 million. This has not yet been reflected in the
accounts. Computers are depreciated over five year. Buildings are now to be depreciated over 30 years.
(4) An allowance for bad debts (irrecoverable debts) of 5% is to be created.
(5) There is an estimated bill for current tax of Rs. 120 million which has not yet been recognised.
(6) the company has made an investment in B limited during the year and irrevocably elected at initial
recognition as measured at fair value through other comprehensive income (OCI). The fair value of
investment was 127 million at the year end.
Required:
Prepare an statement of comprehensive income (analysing expenses by nature) for the year ended 31
December 2015 and a statement of financial position as at that date.

----------( 195 )----------

A. MINGORA IMPORTS LIMITED
Statement of comprehensive income for the year ended 31 December 2015
Rs. in
million
Revenue 1,740
Change in inventories of finished goods and work-in-progress (W3) 40
Staff costs (W3) (620)
Depreciation and other amortisation expense (W3) (42)
Other expenses (W3) (359)
Profit before tax 759
Income tax expense (120)
Profit After tax 639
Other comprehensive income:
Revaluation gain 120
Fair value gain on investment (127-100) 27
Total comprehensive income 786

Statement of financial position as at 31 December 2015

Rs. in
Assets
million
Non-current assets
Property, plant and equipment (W1) 368
Intangible assets (W2) 40
Investment 127

Current assets
Inventories (180 + 140) 320
Trade and other receivables (420 × 95%) 399
Cash 340
1,059
Total assets 1,594
Equity and liabilities
Equity
Share capital 600
Revaluation surplus 116
Retained earnings 639
Fair value reserve 27
1,382
Current liabilities
Trade and other payables 92
Provision for taxation 120
212
Total equity and liabilities 1,594

----------( 196 )----------

Statement of changes in equity for the year ended 31 December 2015
Amounts in Rs. million
Share Fair
Revaluation Retained Total
capital value
on reserve earnings
reserves
Balance at 31 December 2014 600 121 - 721
Dividends paid (125) - (125)
Total comprehensive income 120 639 27 786
Transfer of surplus (4) 4 -
Balance at 31 December 2015 600 116 639 27 1,382

Workings
(1) Property, plant and equipment
Rs. in
million
Cost brought forward
Leasehold 300
Computers 50
Revaluation 60
Cost carried forward 410
Accumulated depreciation brought forward (60 + 20) 80
Revaluation (60)
Charge for the year
Leasehold (360 ÷ 30) 12
Computers (50 ÷ 5) 10
Accumulated depreciation carried forward 42
Carrying amount carried forward 368

(2) Intangible assets

Rs. in
million
Cost 60
Amortisation (60 ÷ 3) (20)
Carried forward 40

(3) Allocation of costs

Amounts in Rs. million
Change in Other
Depreciation
inventories Staff costs expenses
etc
Work-in-progress (140 – 125) (15)
Staff costs 260
Finished goods (180 – 155) (25)
Consultancy fees 44
Directors’ salaries 360
Doubtful receivables (420 × 5%) 21
Sundry expenses 294
Amortisation of patent (W2) 20
Depreciation (12 + 10) (W1) 22
(40) 620 42 359

----------( 197 )----------

Self-Test Questions
1. CLIFTON PHARMA LIMITED
The following trial balance relates to Clifton Pharma Limited, a public listed company, at 30 September 2015.
Rs. In ‘000’ Rs. In ‘000’
Dr. Cr.
Cost of sales 134,000
Operating expenses 35,000
Loan interest paid (see note (1)) 1,500
Rental (see note (2)) 8,600
Revenue 338,300
Investment income 2,000
Leasehold property at cost (see note (4)) 250,000
Plant and equipment at cost 197,000
Accumulated Depreciation: 1 October 2014
- leasehold property 40,000
- plant and equipment 47,000
Investments 92,400
Share capital 280,000
Share premium 20,000
Retained earnings at 1 October 2014 19,300
Loan notes (see note (1)) 50,000
Deferred tax balance at 1 October 2014 (see note (5)) 20,000
Inventory at 30 September 2015 23,700
Trade receivables 76,400
Trade payables 14,100
Bank 12,100
830,700 830,700
The following notes are relevant:
(1) The effective interest rate on the loan notes is 6% per year.
(2) There are two separate contracts for rental of vehicles and furniture. A recent review by the finance
department of these contracts has reached the conclusion that Rs. 7 million of the total rental cost
relates to a lease of vehicles.
The lease of vehicles was entered into on 1 October 2014 which was when the Rs. 7 million was paid.
The lease agreement is for a four-year period in total and there will be three more annual payments in
advance of Rs. 7 million, payable on 1 October in each year. The vehicles in the lease agreement had
a fair value of Rs. 24 million at 1 October 2014 and they should be depreciated using the straight line
method to a nil residual value. The interest rate implicit in the lease is 10% per year. The other contract
for furniture rental is a low value asset lease and therefore rental payment should be charged to
operating expenses, no a straight line basis.
Other plant and equipment is depreciated at 20% per year by the reducing balance method. All
depreciation of property, plant and equipment should be charged to cost of sales.
(3) The leasehold property has a 25-year life and is amortised at a straight-line rate. On 30 September
2015 the leasehold property was revalued to Rs. 220 million and the directors wish to incorporate this
re-valuation in the financial statements.
(4) The provision for income tax for the year ended 30 September 2015 has been estimated at Rs. 18
million. At 30 September 2015 there are taxable temporary differences of Rs. 92 million. The rate of
income tax on profits is 25%.
Required:
(a) Prepare an statement of comprehensive income for Clifton Pharma Limited for the year to 30 September
2015.
(b) Prepare a statement of financial position (balance sheet) for Clifton Pharma Limited as at 30 September,
2015.

----------( 198 )----------

 Q2. MOONLIGHT PAKISTAN LIMITED
Following is the summarized trial balance of Moonlight Pakistan Limited (MPL), a listed company, for the
year ended December 31, 2015:

Rs. in million
Debit Credit
Land and buildings - at cost 2,600 -
Plants - at cost 2,104 -
Trade receivables 702 -
Stock in trade at December 31, 2015 758 -
Cash and bank 354 -
Cost of sales 1,784 -
Selling expenses 220 -
Administrative expenses 250 -
Financial charges 210 -
Accumulated depreciation as on January 1, 2015 – Buildings - 400
Accumulated depreciation as on January 1, 2015 – Plants - 670
Ordinary shares of Rs. 10 each fully paid - 1,200
Retained earnings as at January 1, 2015 - 510
12% Long term loan - 1,600
Provision for gratuity - 8
Deferred tax on January 1, 2015 - 22
Trade payables - 544
Right subscription received - 420
Revenue - 3,608
8,982 8,982
Additional Information
i. The land and buildings were acquired on January 1, 2011. The cost of land was Rs. 600 million. On
January 1, 2015 a professional valuation firm valued the buildings at Rs. 1,840 million with no change in
the value of land. The estimated life at acquisition was 20 years and the remaining life has not changed
as a result of the valuation. 60% of depreciation on buildings is allocated to manufacturing, 25% to selling
and 15% to administration.
ii. Plant is depreciated at 20% per annum using the reducing balance method.
iii. On March 31, 2015 MPL made a bonus issue of one share for every six held. The issue has not been
recorded in the books of account.
iv. Right shares were issued on September 1, 2015 at Rs. 12 per share.
v. The interest on long term loan is payable on the first day of July and January. No accrual has been made
for the interest payable on January 1, 2016.
vi. MPL operates an gratuity scheme for all its eligible employees. The provision required as on December
31, 2015 is estimated at Rs. 23 million. Cost of gratuity is allocated to production, selling and
administration expenses in the ratio of 60%: 20%: 20%.
vii. The tax charge for the current year after making all related adjustments is estimated at Rs. 37 million.
The timing differences related to taxation are estimated to increase by Rs. 80 million, over the last year.
The applicable income tax rate is 35%.

Required
In accordance with the requirements of Companies Act , 2017 and International Financial Reporting
Standards, prepare the following:
a) Statement of Financial Position as of December 31, 2015.
b) Statement of profit or loss for the year ended December 31, 2015.
c) Statement of changes in equity for the year ended 31 December 2015 (22)
(Comparative figures and notes to the financial statements are not required)
Note: Right subscription received means amount received against issue of right shares.

----------( 199 )----------

Suspense account:
• If sum of debit column is more than the sum of credit column in the trial balance, a temporary
account called as suspense account will appear in the credit column of the trial balance.
• If sum of credit column is more than the sum of debit column in the trial balance, a temporary
account called as suspense account will appear on the debit column of the trial balance.
• If an entry is completely omitted then there will be no suspense account.
• If an entry is wrongly recorded but there is no violation of debit and credit rule even then there will be
no suspense account.

When it is assumed that depreciation/amortization has already been charged in trial balance:
• If depreciation expense is appearing on the debit side of the trial balance
• If it is mentioned in the question that depreciation is included in the relevant expense heads (like
cost of sales, administrative or selling expenses etc.)
• If closing date is mentioned against accumulated depreciation in trial balance or closing date is
mentioned against WDV of asset in the trial balance.
A.1
Statement of profit or loss for the year ended 30 September 2015
Rs. in ‘000
Revenue 338,300
Cost of sales: see working (1) (180,000)
Gross profit 158,300
Operating expenses: see working (2) (35,000)
Investment income 2,000
Finance costs: Loan notes – see working (3) (3,000)
Finance lease – see working (2) (1,700)
(4,700)
Profit before tax 120,600
Income tax expense: see working (4) (21,000)
Profit for the period 119,600

Statement of financial position as at 30 September 2015

Non-current assets
Property, plant and equipment: see working (5) 358,000
Investments 94,000
452,000
Current assets
Inventory 23,700
Trade receivables 76,400
Bank 12,100
112,200
Total assets 564,200
Equity and liabilities
Capital and reserves
Share capital 280,000
Share premium 20,000
Retained earnings: see working (6) 138,900
418,900
Non-current liabilities
3% loan notes: see working (3) 51,500
Deferred tax: see working (4) 23,000
Finance lease obligation: see working (2) 11,700
86,200
Current liabilities
Trade payables 14,100
Accrued lease finance costs: see working (2) 1,700
Finance lease obligation: see working (2) 5,300
Income tax payable 18,000
39,100
Total equity and liabilities 564,200
----------( 200 )----------
Workings:
(1) Cost of sales Rs. in ‘000
As given in the trial balance 134,000
Depreciation of plant and equipment: 20% (197,000 – 47,000) 30,000
Depreciation of leased vehicles: 24,000/4 years 6,000
Amortisation of leasehold property: 250,000/25 years 10,000
180,000
(2) Finance lease
Fair value of leased assets 24,000
Less: First rental payment, paid in advance 1 October 2014 (7,000)
Remaining obligation, 1 October 2014 17,000
Interest at 10% to 30 September 2015 (current liability) 1,700
Lease payment due 1 October 2015 7,000
Capital repayment due (= balance, current liability) (5,300)
Remaining lease obligation = non-current liability 11,700

(3) Loan notes

The effective interest rate is 6%. Actual interest paid was Rs.1,500,000 (in trial balance); therefore the
balancing Rs.1,500,000 should be added to the loan notes obligation, to make the total loan notes
liability Rs.50 million + Rs.1,500,000 = Rs.51.5 million.
(4)
Taxation
Deferred tax liability b/f 20,000
Deferred tax: credit in the statement of profit or loss 2,000
Deferred tax liability c/f (92,000 25%) 23,000
Tax expense
Income tax on profits for the year 18,000
Deferred tax movement 3,000
Tax charge in the statement of profit or loss 21,000

(5) Non-current assets and depreciation

Leasehold property Rs. in ‘000
Carrying value in the trial balance (250,000 – 40,000) 210,000
Amortisation charge for the year to 30 September 2015 (10,000)
200,000
Re-valued amount 220,000
Transfer to revaluation reserve 20,000
The annual depreciation charges for plant and equipment and the leased vehicles are shown in
workings (1)
Rs. in ’000
Cost or Accumulated Carrying
valuation depreciation amount
Leasehold property 220,000 0 220,000
Plant and equipment (non-leased) 197,000 77,000 120,000
Leased vehicles 24,000 6,000 18,000
441,000 83,000 358,000
(6) Retained profits
At 1 October 2014 (trial balance) 19,300
Profit for the year 119,600
Retained profits at 30 September 2015 138,900
----------( 201 )----------
A.2 Moonlight Pakistan Limited
Statement of Financial Position Rs. in
As at December 31,2015 million
ASSETS
Non-current assets
Property, plant and equipment (W2) 3,472
Current assets
Stocks in trade 758
Trade receivables 702
Cash and bank 354
1,814
5,286
EQUITY
Issued, subscribed and paid-up capital 1,750
Share premium 70
Retained earnings 891
Surplus on revaluation of fixed assets (240 - 15) 225
2,921

LIABILITIES
Non-current liabilities
Long term loan 1,600
Deferred tax (22 + 80 x 35%) 50
Provision for gratuity 23
1,673
Current liabilities
Creditor and other liabilities (544 + 96) 640
Income tax payable 37
677
5,286

(b) Moonlight Pakistan Limited Rs. in

Statement of comprehensive income million
For the year ended December 31,2015
Sales 3,608
Cost of sales (W1) (2,149)
Gross profit 1,459
Selling expenses (W1) 252
Administrative expenses (W1) 270
Financial charges (210 + 1,600 x 12% x 6/12) 306
Profit before taxation 631
Taxation –Current Tax 37
Deferred Tax 28 65
Profit after taxation 566
Other comprehensive income:
Gain on revaluation 240
Total comprehensive income 806

W1: Cost of sales/selling expenses/admin expenses

Cost of Selling expenses Admin expenses
sales
Rs. in million
As per trial balance 1,784 220 250
Depreciation - building (60% : 25% : 15%) (W2) 69 29 17
Depreciation – plant 287 - -
Provision for gratuity (23-8) x 60%:20%:20% 9 3 3
2,149 252 270

----------( 202 )----------

W2: Property, plant and equipment Land Building Plant Total

Rs. in million
Cost as at January 1,2015 600 2,000 2,104 4,704
Accumulated depreciation - (400) (670) (1,070)
Revaluation (1,840 - (2,000 - 400 )) - 240 - 240
Current year depreciation (1,840/16) - (115) (287) (402)
600 1,725 1,147 3,472

W3: Share Capital/Retained Earnings Share capital Premium Retained Revaluation

earnings surplus
Rs. in million
Balance as on 1 January 2015 1,200 - 510 -
Bonus issue (1200 6) 200 - (200) -
Right issue (420 x 10/12) 350 70 - -
Total comprehensive income for the year - - 566 240
Transfer of surplus to retained earnings - - 15 (15)
(240/16)
Balance as on 31-12-2015 1,750 70 891 225

----------( 203 )----------

Final Account
Q. The following information has been extracted from the draft financial statements of Shaheen
Limited (SL) for the year ended 31 December 2014:
Statement of Financial Position as at 31 December 2014
Rs. in Rs. In
Equity and liabilities Assets
million Million
Share capital (Rs. 100 each) 1,200 Property, plant and equipment 1,876
Retained earnings 618 Patents 28
Trade payables 645 Trade receivables 630
Accruals and provisions 395 Inventory 503
Taxation 215 Prepayments and other receivables 23
Cash and bank balances 13
3,073 3,073
Additional information:
(i) Closing inventory includes damaged goods costing Rs. 3 million which can be sold for
Rs. 2.5 million after repair and repacking at a cost of Rs. 0.4 million.
(ii) In December 2014, SL settled an old outstanding liability of Rs. 6 million by paying Rs.
4.5 million. The payment was debited to trade payables. The said liability had been written
back prior to 2014.
(iii) Fair value and value in use of patents as at 31 December 2014 amounted to Rs. 25
million and Rs. 27 million respectively.
(iv) Tax liability is net of deferred tax asset amounting to Rs. 12 million.
(v) On 1 January 2014, SL acquired five vehicles costing Rs. 8.5 million on lease. As per the
lease agreement, four annual installments of Rs. 2.5 million each are payable in advance
on 1 January, each year. The market rate of interest is 14%. While preparing the draft
financial statements, the installment paid was charged to rent expense. Ownership is
expected to be transferred at the end of the lease term.
(vi) SL depreciates its vehicles over a period of five years using straight line method.
(vii) Due to increasing bad debts, the management is of the view that provision for doubtful
debts need to be increased from 3% to 5% of trade receivables.
(viii) Applicable tax rate for the year is 34%.

Required:
Prepare a Statement of Financial Position as at 31 December 2014 in accordance with the International
Financial Reporting Standards and the Companies Act 2017.
(Show relevant calculations. Notes to the financial statements and comparative figures are not
required) (17)

----------( 204 )----------

Answer:
Shaheen Limited
Statement of Financial Position as at 31 December 2014
Assets Rs. in
Million
Non-current assets
Property, plant and equipment (1,876 + (8.3 x 80%) 1,882.64
Patents (28 – 1) 27.00
1,909.64
Deferred taxation (12 + W-3 4.75) 16.75
Current assets
Inventories 502.10
Trade receivables (503 – 3) + (2.5 – 0.4) 617.01
Prepayments and other receivables (630 4 97%) X 95% 23.00
Cash and bank balance 13.00
1,155.11
3,081.50
Equity and Liabilities
Share capital and reserves
Share capital 1,200.00
Retained earnings W-1 605.23
1,805.23
Non-current Liabilities
Liabilities against assets subject to finance lease W-5 (8.3 – 4.19) 4.11
Current Liabilities
Current maturity of finance lease liability W-5 1.69
Trade payables (645 + 4.5) 649.50
Accruals and provisions (395 + W-5 0.81) 395.81
Taxation (215 + 12-W-2 1.84) 225.16
1,272.16
3,081.50
W-1: Retained earnings
Rs. in Million
Balance before adjustments 618.00
(i) Damaged goods at lower of cost and NRV [3 – (2.5 – 0.4)] (0.90)
(ii) Old outstanding liability prev. written back, now paid (4.50)
(iii) Impairment of patents (28 – 27) (1.00)
(iv) Reversal of operating lease rent exp 2.50
Lease financial charges W-5 (0.81)
Depreciation on leased assets (8.3 ÷ 5) (1.66)
(v) Increase in prov. For doubtful debts 630 ÷ 97% x (5% - 3%) (12.99)
Decrease in retained earnings before tax (19.36)
Decrease in tax liability W-2 1.84*
Increase in deferred tax assets W-3 4.75*
Adjusted balance 605.23
*Another way of calculation
(19.36 x 34%) = 6.59
W-2: Current tax liability

Decrease in profit before tax W-1 (19.36)

Tax add backs/(allowances):
Impairment of patents 1.00
Operating lease rent (2.50)
Lease finance charges W-5 0.81
Depreciation on leased vehicles (8.3 ÷ 5) 1.66
Provision for doubtful debts 12.99
Decrease in taxable income (5.40)
Decrease in tax liability at 34% 1.84*
*Tax pay 1.84
Tax exp 1.84
----------( 205 )----------
W-3: Deferred tax (Balance sheet approach)
Decrease in C.A of Patent 1M D.T.D
Increase in C.A of leased asset (8.3 – 1.66) 6.64 M T.T.D
Increase in C.A leased liability 5.8 M D.T.D
Increase in C.A of financial charges payable 0.81 M D.T.D
Increase in C.A allowance Or Decrease in C.A of debtors 12.99 M D.T.D
13.96 M D.T.D
X 34% = 4.75 M D.T.A
A/P (19.36) + T/P (5.4) = 13.96 x 34% = 4.75 D.T.E reversal
D.T.A 475
D.T.E 475
W-4: Vehicles acquired on lease
*2.5 + 2.5 1 – (1 + 0.14)-3 = 8.3M
0.14
1/1/2014 8.3
1/1/2014 2.5 - 5.8
1/1/2015 2.5 1.69 0.81 4.11

Accounting Entries
(i) COS 0.9
Stock 0.9
[3 – (2.5 – 0.4)]
(Accounting & tax treatment is same)
(ii) Other Expenses 4.5
Trade Payable 4.5
(Accounting & tax treatment is same)
(iii) Impairment Loss 1M
Patents 1M
(Accounting & tax treatment is different)
(iv) D.T.A 12
Tax Payable 12
(No tax effect just a reclassification)
(v) (a) Leased Asset 8.3M
Lease Liability 8.3M
(PV of MLP)

(b) Lease Liability 2.5

Rent Expense 2.5
(Accounting & tax treatment is different)
(c) Interest Expense 0.81
Interest Payable 0.81
(8.3 – 2.5) × 14%
(d) Depreciation 1.66
Accumulated Depreciation 1.66
(8.3 ÷ 5)
(vi) Bad debts 12.99
Allowance for Bad Debts 12.99
630 ÷ 97 × 2%
(Accounting and tax treatment is different)
(vii) Provision for Tax 1.84
Current Tax Expense (W-2) 1.84
(viii) Differed Tax Liability 4.75
Differed Tax Expense (W-3) 4.75
Total effect of adjustments on PBT = 19.36↓ = Tax↓ = 6.582 (equal to 1.84 = 4.75)

----------( 206 )----------

FINAL ACCOUNT
Q.1 The following trial balance pertains to Hadi Limited (HL) for the year ended 31 December 2016:

Debit Credit

Description
------- Rs. in ‘000 -------
Capital work-in-progress 145,000
Plant and machinery – at cost 305,000
Trade receivables 61,400
Stock-in-trade 79,600
Cash and bank 33,444
Cost of sales 78,664
Administrative expenses 37,636
Ordinary share capital (Rs. 10 each) 241,000
Retained earnings 69,050
Accumulated depreciation – Plant and machinery 53,250
Trade payables 60,912
10% long term loan 75,000
Provision for warranty 10,000
Provision for bad debts 5,000
Deferred tax liability 25,125
Sales 201,407
740,744 740,744

While finalizing the financial statements of HL from the above trial balance, the following issues have been
noted:

1. No depreciation has been charged in the current year. Depreciation is provided at 10% per annum using
the straight line method.
2. A machine which was purchased on 1 January 2015 for Rs. 25 million was traded-in, on 1 July 2016 for
a new and more sophisticated machine. The disposal was not recorded and the new machine was
capitalized at Rs. 15 million being the net amount paid to supplier. The trade-in allowance amounted to
Rs. 20 million.
3. Taxation authorities allow initial and normal depreciation at 25% and 15% respectively using reducing
balance method. No tax depreciation is allowed in the year of disposal. The tax written down value of the
plant and machinery as on 1 January 2016 was Rs. 153 million.
4. HL maintains a provision for doubtful debts at 6% of trade receivables. On 1 February 2017, a customer
owing Rs. 10 million at year-end was declared bankrupt. HL estimates that 20% of the amount would be
received on liquidation.
5. The long term loan of Rs. 75 million was obtained on 1 January 2016, to finance the capital work-in-
progress. HL capitalizes the finance cost on such loan in accordance with IAS-23 ‘Borrowing cost’.
However, the financial charges are admissible as an expense, under the tax laws.
6. HL sells goods with a 1-year warranty and it is estimated that warranty expenses are 3% of annual
sales. Actual payments during the year, against warranty claims of the products sold during current and
previous years were Rs. 2.5 million and Rs. 8 million respectively. These have been debited to
administrative expenses.
7. On 1 January 2016, HL started research and development work for a new product. On 1 May 2016, the
recognition criteria for capitalization of internally generated asset was met. The product was launched on
1 November 2016.

HL incurred Rs. 20 million from commencement of research and development work till launching of the
product and charged it to cost of goods sold. It is estimated that the useful life of this new product will be 20
years. It may be assumed that all costs accrued evenly over the period.
On 31 December 2016, the recoverable amount of the development expenditure was Rs. 10 million. For tax
purposes, research and development costs are allowed to be amortized over 10 years.

Applicable tax rate is 30%.

Required:
i. Prepare statement of comprehensive income for the year ended 31 December 2016 in accordance with
the requirements of International Financial Reporting Standards. (11)
ii. Compute the current and deferred tax expenses for the year ended
----------( 207 )---------- 31 December 2016. (15)
Answer 1(a)
Hadi Limited
Statement of Comprehensive Income
For the year ended 31-12-2016
Rs. ‘000’
Sales 201,407
Cost of Sales (W-1) (88,164)
Gross Profit 113,243
Admin Expenses (W-2) (47,382)
Loss on exchange (1,250)
Profit before tax 64,611
Taxation: Current tax (Req. b) (17,527)
Deferred tax (Req. b) 2,643
(14,884)
Profit After tax 49,727
Workings:
(W-1) Cost of Sales:
As per trial 78,664
Research & Development wrongly charged to cost of sales (20,000)
Depreciation – Plant & Machinery 29,500
88,164
(W-2) Administrative Expenses:
As per trial 37,636
Bad debts expense 6,204
Warranty expenses (6,042 – 2,000) 4,042
Research expenses 8,000
Amortization of development expense 100
Impairment loss of development expense 1,900
Payment of warranty claims wrongly debited to admin expense (10,500)
47,382
Answer No. 6(b)
Computation of Tax Expense
Current Tax:
Profit before tax 64,611
Add: Accounting depreciation 29,500
Accounting loss on exchange 1,250
Tax gain on disposal 4,063
Accounting amortization 100
Impairment loss 1,900
Bad debts expense 6,204
Warranty expenses (6,042 – 2,000) 4,042
Research expenses 8,000
Less: Tax depreciation (33,247)
Tax amortization (20,000/10) (2,000)
Bad debts written off (8,000)
Interest Capitalized (75,000 × 10%) (7,500)
Payment for warranty claims (2,500 + 8,000) (10,500)
Taxable Profits 58,423
Current tax @ 30% 17,527
Deferred tax (Balance Sheet Approach)
Carrying Amount Tax Base Differences
Plant & Machinery (W-1) 221,000 138,815 82,185 TTD
Development Cost 10,000 18,000 8,000 DTD
(20,000 – 2,000)
Provision for bad debts 3,204 -- 3,204 DTD
Capital work in process – Interest 7,500 -- 7,500 TTD
Capitalized
Provision for Warranty 3,542 -- 3,542 DTD
74,939 TTD
× 30% 22,484 D.T.L
----------( 208 )----------
 D.T.L

D.T.E 2,643 b/d 25,125

c/d 22,484

D.T.L 2,643
D.T.E 2,643

(W-1) Plant & Machinery:

Carrying Amount:
Cost Given 305,000
Disposal of Machine (25,000)
Capitalization of Machine 20,000
Less: Accumulated Depreciation [53,250 + 29,500 – 3,750] (79,000)
221,000

Tax Base:
Opening WDV 153,000
Cost of Machine Acquired 35,000
WDV of Machine Disposed (15,938)
Tax depreciation for the year (33,247)
138,815

Not required for extra information:

In the above question; reconciliation of profit before tax with tax expense is not required; however it can be
prepared; e.g.

Profit before tax 64,611

Tax rate 30%
Expected tax expense 19,383.3
Actual tax expense (as in income statement) 14,884

It is not reconciled even if there are no permanent differences in the question. The reason is that opening
balance given in the question is not correct.

Correct opening balance can be calculated as follows:

C.A T.B Differences
PPE [305,000 – 15,000 – 53,250] 236,750 153,000 83,750 TTD
Provision for bad debts 5,000 -- 5,000 DTD
Provision for warranty 10,000 -- 10,000 DTD
68,750
× 30% 20,625 D.T.L
Based on this correct opening balance deferred tax expense for the year is:
D.T.L
b/d 20,625
D.T.E 1,857
c/d 22,482

D.T.E 1,857
D.T.L 1,857
Therefore: Tax expense for the year should be:
Current tax (17,527)
Deferred tax (1,857)
19,384
It is therefore reconciled.

----------( 209 )----------

Workings:
(ii) New Machine 20,000
*Accumulated Depreciation 3,750
Loss on exchange 1,250
Old Machine 25,000
*25 × 10% = 2.5 + 2.5 × 6/12 = 3,750
Depreciation for the year:
[305,000 – 25,000 – 15,000] × 10% = 26,500
25,000 × 10% × 6/12 = 1,250
35,000 × 10% × 6/12 = 1,750
To be included in cost of sales
29,500
(iii) Taxable Gain/Loss
Cost = 25,000
× 25% [Initial Allowance] (6,250)
18,750
× 15% (2,813)
WDV 15,938
Trade In Allowance 20,000
Taxable Gain 4,063
(iv) Tax Depreciation:
[153,000 – 15,938] × 15% = 20,559
Depreciation on Addition
Initial depreciation 35,000 × 25% = 8,750
Normal depreciation [35,000 – 8,750] × 15% = 3,938
33,247
(v) Provision
Debtor (10,000 × 80%) 8,000 Un-adjusted balance 5,000
Bad debts 6,204
c/d (53,400 × 6%) 3,204

Debtors
Un-adjusted balance 61,400 Provision 8,000

c/d 53,400
(vi) 75,000 × 10% = 7,500
(vii) Provision for warranty 10.5
Admin expenses 10.5
[2.5 + 8]
Provision for warranty
Admin expense 10,500 Un-adjusted balance 10,000
*Expenses (10,000 – 8,000) 2,000 Expense (201,407 × 3%) 6,042
c/d 3,542
*Net expense for the year (6,042 – 2,000) = 4,042
*Excess provision made last period now reversed.

(Viii) (a) Research Expense (20/10 × 4) 8,000

Development expenditure (20/10 × 6) 12,000
Cost of Sales 20,000
(b) Amortization (12 ÷ 20 × 2/12) 100
Accumulated Amortization 100
(c) Impairment Loss 1,900
Accumulated Impairment 1,900
Carrying amount [12,000 – 100] = 11,900
Recoverable amount = 10,000
Impairment loss 1,900
Tax Amortization: 20 ÷ 10 = 2,000

----------( 210 )----------

⯈ Example
Barry Limited has prepared the following draft financial statements for your review:
Statement of profit or loss for year to 31st August 2015
Rs. 000
Sales revenue 30,000
Raw materials consumed (9,500)
Manufacturing overheads (5,000)
Increase in inventories of work in progress and finished goods 1,400
Staff costs (4,700)
Distribution costs (900)
Depreciation (4,250)
Interest expense (350)
6,700
Statement of financial position as at 31st August 2015
Rs. 000
Assets
Non-current
Freehold land and buildings 20,000
Plant and machinery 14,000
Fixtures and fittings 5,600
39,600
Current assets
Prepayments 200
Trade receivables 7,400
Cash at bank 700
Inventories 4,600
12,900
Total assets 52,500

Rs. 000
Equity and liabilities
Equity shares of Rs. 1 each 21,000
Accumulated profit 14,000
Share premium 2,000
Total equity 37,000
Revaluation surplus 5,000
Current liabilities 5,300
Non-current liabilities
8% Debentures 2019 5,200
Total equity and liabilities 52,500
Additional information
(i) Income tax of Rs. 2.1 million has yet to be provided for on profits for the current year. An unpaid
under-provision for the previous year’s liability of Rs. 400,000 has been identified on 5th September 2015
and has not been reflected in the draft accounts. Tax rate is 30%.
(ii) There have been no additions to, or disposals of, non-current assets in the year but the assets
under construction have been completed in the year at an additional cost of Rs. 50,000. These related to
plant and machinery.
The cost and accumulated depreciation of non-current assets as at 1st September 2014 were as follows:
Cost Depreciation
Rs. in ‘000 Rs. in ‘000
Freehold land and buildings 19,000 3,000
(land element Rs. 10 million)
Plant and machinery 20,100 4,000
Fixtures and fittings 10,000 3,700
Assets under construction 400 -

----------( 211 )----------

(iii) There was a revaluation of land and buildings at the beginning of the year, creating the revaluation
surplus of Rs. 5 million (land element Rs. 1 million). The effect on depreciation has been to increase the
buildings charge by Rs. 300,000. Barry Limited adopts a policy of transferring the revaluation surplus
included in equity to retained earnings as it is realised.
(iv) Staff costs comprise 70% factory staff, 20% general office staff and 10% goods delivery staff
(v) An analysis of depreciation charge shows the following:
Rs. in ‘000
Buildings (50% production, 50% administration) 1,000
Plant and machinery 2,550
Fixtures and fittings (30% production, 70% administration) 700

Required:
Prepare the following information in a form suitable for publication for Barry Limited’s financial statements for
the year ended 31st August 2015:
• Statement of profit or loss
• Statement of financial position
• Reconciliation of opening and closing property, plant and equipment

Answer:
Barry Limited
Statement of profit or loss
For the year ended 31st August 2015
Rs. in ‘000
Revenue 30,000
Cost of sales (W1) (19,650)
Gross profit 10,350
Distribution costs (W1) (1,370)
Administrative expenses (W1) (1,930)
Profit from operations 7,050
Finance costs (350)
Profit before tax 6,700
Tax (W2) (2,410)
Profit after tax 4,290
Other comprehensive income
Gain on revaluation Rs. 5,000 x 70% 3,500
Total comprehensive income 7,790

Barry Limited
Statement of financial position As at 31st August 2015
ASSETS Rs. In 000
Non-current assets
Property, plant and equipment (reconciliation below) 39,600
Current assets
Inventory 4,600
Trade and other receivables (7,400 + 200) 7,600
Cash and cash equivalents 700
12,900
Total assets 52,500
.
EQUITY AND LIABILITIES
Capital and reserves
Equity shares 21,000
Share premium 2,000
Retained earnings (W3) 11,800
Revaluation surplus (3,500 – 210 (W3)) 3,290
38,090
Non-current liabilities
8% Debentures 5,200
Deferred tax liability (Rs. 5,000 x 30% - 90 W2] 1,410
6,610
----------( 212 )----------
 Current liabilities
Trade and other payables 5,300
Taxation (2,100 + 400) W2 2,500
7,800
52,500

Reconciliation of opening and closing property, plant and equipment

Land Buildings Plant & machinery Fixtures & fittings CWIP Total
Cost/ Valuation Rs. 000
At 1 Sept 2014 10,000 9,000 20,100 10,000 400 49,500
Additions - - - - 50 50
Transfer from CWIP - - 450 - (450) -
Revaluation-cancel - (3,000) - - - (3,000)
Revaluation (gain) 1,000 4,000 5,000
At 31 Aug 2015 (A) 11,000 10,000 20,550 10,000 - 51,550

Depreciation
At 1 Sept 2014 - 3,000 4,000 3,700 - 10,700
Revaluation - (3,000) - - - (3,000)
Charge for year - 1,000 2,550 700 - 4,250
At 31 Aug 2015 (B) - 1,000 6,550 4,400 - 11,950
Net book value
At 31 Aug 2015 (A-B) 11,000 9,000 14,000 5,600 - 39,600
At 1 Sept 2014 10,000 6,000 16,100 6,300 400 38,800

W1: Allocation of expenses Cost of sales Admin Distribution

Rs. 000
Raw materials consumed 9,500
Manufacturing overheads 5,000
Increase in inventories (closing is more) (1,400)
Staff costs (70%/20%/10%) 3,290 940 470
Distribution costs 900
Depreciation
Building 1,000 x (50%/50%) 500 500
Plant and machinery 2,550
Fixtures and fittings 700 x (30%/70%) 210 490
19,650 1,930 1,370

W2: Tax charge Rs. 000

Current year 2,100
Prior year charge 400
Current tax 2,500
Reversal of DTL due to incremental depreciation (90)
Tax expense 2,410

W3: Retained earnings Rs. 000

Closing Retained Earnings [unadjusted] 14,000
Tax expense W2 (2,410)
Transfer from revaluation Surplus ( 300 x 70%)[Net of tax] 210
11,800
Workings:
At the beg of the year Land and building 5,000
Revaluation surplus 5,000
Revaluation surplus 1,500
Deferred tax liability 1,500
(5,000 x 30%)
At the end of year Deferred tax liability 90
Deferred tax expense (300 x 30%) 90
As a result of extra depreciation charged after the revaluation

----------( 213 )----------

 ⯈ Example
The following trial balance related to Yasir Industries Limited (YIL) for the year ended June 30, 2017:

Dr Cr
Rs. in million
Ordinary share capital (Rs. 10 each) - 120.00
Retained earnings - 10.20
Sales - 472.40
Purchases 175.70 -
Production labour 61.00
Manufacturing overheads 39.00
Inventories (July 1, 2016) 38.90
Administrative expenses 40.00 -
AT A GLANCE

Distribution expenses 19.80 -

Financial charges 0.30 -
Cash and bank – 13.25
Trade creditors - 30.40
Accrued expenses - 16.20
10% redeemable preference shares - 40.00
Debentures – 80.00
Deferred tax (July 1, 2016) – 6.00
Suspense account 30.00 -
Leasehold property - at cost 230.00 -
Machines – at cost 168.60 -
Software – at cost 20.00 -
Acc. depreciation – Leasehold property (June 30, 2017) - 40.25
STICKY NOTES

Acc. depreciation – Machines (June 30, 2017) – 48.60

Acc. amortization – Software (June 30, 2017) - 12.00
Trade receivables 66.00 -
889.30 889.30
Additional Information
(i) Sales include an amount of Rs. 27 million, made to a customer under sale or return agreement. YIL
is uncertain whether the goods will be returned or not. The sale has been made at cost plus 20%
and the expiry date for the return of these goods is July 31, 2017.

(ii) The value of inventories at June 30, 2017 was Rs. 42 million other than the goods in possession of
third parties on sale or return basis.

(iii) A fraud of Rs. 30 million was discovered in October 2016. A senior employee of the company, who
left earlier, had embezzled the funds from YIL’s bank account. The chances of recovery are
remote. The amount is presently appearing in the suspense account.

(iv) On January 1, 2017 YIL issued debenture certificates which are repayable in 2020. Interest is paid
on these at 12% per annum.
(v) Financial charges comprise bank charges and bank commission.
(vi) The provision for current taxation for the year ended June 30, 2017 after making all the above
adjustments is estimated at Rs. 16.5 million. The carrying value of YIL’s net assets as on June 30,
2017 exceeds their tax base by Rs. 30 million. The income tax rate applicable to the company is
30%.
(vii) On July 1, 2016, the leasehold property having a useful life of 40 years was revalued at Rs. 238
million. Neither revaluation nor tax adjustment in this regard has been made in the books.
Depreciation of leasehold property is charged using the straight line method. 50% of depreciation is
allocated to manufacturing, 30% to administration and 20% to selling and distribution.

Required:
In accordance with the requirements of the Companies Act, 2017 and IFRSs, prepare the statement of
financial position as of June 30, 2017, statement of profit or loss for the year ended June 30, 2017, and
statement of changes in equity for the year then ended.

----------( 214 )----------

 ⯈ ANSWER:
Yasir Industries Limited
Statement of Comprehensive Income
For the year ended 30 June 2017
Rs m
Revenue 472.40 – 27 445.4
Cost of sales W1 (250.72)
Gross profit 194.68
Selling expense (19.80 + 1.25 W4 x 20%) (20.05)
Administrative expenses (40 + 1.25 W4 x 30%) (40.38)
Operating profit 134.25
Loss due to fraud (30)
Finance costs W2 (9.10)
Profit before tax 95.15
Income tax expense W3 (19.11)
PROFIT FOR THE YEAR 76.04
Other Comprehensive Income
Gain on revaluation of fixed assets 42.5 W4 x 70% 29.75
TOTAL COMPREHENSIVE INCOME 105.79
Yasir Industries Limited
Statement of Changes in Equity
For the year ended 30 June 2017
Share Capital Retained earnings Revaluation surplus Total
Rs. m Rs. m Rs. m Rs. m
At July 01, 2016 120 10.20 - 130.20
Total comprehensive income 76.04 29.75 105.79
Transfer 1.29 x 70% 0.90 (0.90) -
At June 30, 2017 120 87.14 28.85 235.99
Yasir Industries Limited
Statement of Financial Position
As at 30 June 2017
EQUITY AND LIABILITIES
Share capital and reserves Rs. m
Share capital 120
Revaluation Surplus 28.85
Retained earnings 87.14
235.99
Non-current liabilities
10% redeemable preference shares 40
SPOTLIGHT

Debentures 80
Deferred tax liability W3 21.36
141.36
Current liabilities
Trade and other payables (30.40+15.00+1.20) 46.6
Interest accrued W2 4.8
Preference dividend payable W2 4
Bank overdraft 13.25
Current tax payable 16.5
85.15
Total equity and liabilities 462.5
ASSETS
Non-current assets
Property, plant and equipment 231 W4 + (168.6 – 48.60) 351
Intangible assets (Software) 20-12 8
359
Current assets
Stock-in-trade 42 +(27 x 100/120) 64.5
Trade debts 66 – 27 39
103.5
Total assets 462.5
----------( 215 )----------
W1: Cost of sales Rs. m
Opening inventory 38.9
Purchases 175.7
Less: closing inventory 42 +(27 x 100/120) (64.5)
Direct labour 61
Manufacturing overheads (as given) 39
Additional depreciation due to revaluation/correction W2 0.62
250.72
W2: Finance costs Rs. m
As given 0.30
Interest on debentures Rs. 80 x 12% x 6/12 4.8
Dividend on redeemable Preference shares Rs. 40 x 10% 4
9.1

W3: Taxation Rs. m

Tax expense in PL
Current tax 16.5
Deferred tax Rs. 30 x 30% - 6 opening balance 3
Reversal of deferred tax due to incremental depreciation 1.29 x 30% (0.39)
19.11
Deferred tax liability
Taxable temporary difference due to revaluation Rs. 42.5 x 30% 12.75
Reversal of deferred tax due to incremental depreciation 1.29 x 30% (0.39)
Other taxable temporary differences Rs. 30 x 30% 9
21.36
W4: Leasehold property Rs. m
As given [230 – 40.25] 189.75
Add back: Annual depreciation charged on cost [230 / 40 years] 5.75
195.5
Revaluation gain (balancing) 42.5
Revalued amount as at 1 July 2016 238
Depreciation 238 / 34 years (7)
Carrying amount on 30 June 2017 231

Remaining useful life 40 years – [(Rs. 40.25 – 5.75) / 5.75] 34 years

Additional (incremental) depreciation 7 – 5.75 1.25

----------( 216 )----------

COMPREHENSIVE EXAMPLES
⯈ Example
The following balances have been extracted from the trial balance as at 30 June 2014 of Zee Trading
Limited (ZTL):
Description Debit Credit
------- Rs. in 000 -------
Sales 80,000
Other income 5,300
Opening inventory 4,000
Purchases 35,000
Selling and distribution expenses 15,000
Administrative expenses 9,700

AT A GLANCE
Financial charges 7,200
Investment at cost (50,000 shares of Rs. 100 each) 6,800
Trade receivables 10,000
Provision for doubtful debts 380
Lease liability 6,890

SPOTLIGHT
The following matters need to be considered in finalizing the financial statements of ZTL:
(i) As per store records, closing inventory as at 30 June 2014 amounted to Rs. 8,500,000. Physical
inventory taken on 30 June 2014 revealed the following information:

▪ Value of goods found short by Rs. 1,500,000.

▪ Goods costing Rs. 860,000 are obsolete. Their estimated net realizable value is Rs. 600,000.

(ii) As per the memorandum record of third party stock, stock in ZTL’s store ‘on sale or return’ as at 30
June 2014 amounted to Rs. 3,000,000. It also shows that previous year in June 2013, ZTL had sold
goods held by it on sale or return basis for Rs. 2,000,000. However, purchase of these goods was
accounted for in July 2013 on receipt of invoice amounting to Rs. 1,600,000.

(iii) Selling and distribution expenses include trade discounts allowed to customers amounting to Rs.
4,000,000.

(iv) Annual lease instalment of Rs. 5,000,000 due on 30 June 2014 was paid and debited to Lease
liability. However, interest thereon at 12.6% per annum due on the closing balance has not yet been
booked.

(v) Accounting depreciation on the leased assets amounting to Rs. 3,750,000 has been accounted for.

(vi) Tax depreciation on the company’s owned assets for the year ended 30 June 2014 exceeded the
accounting depreciation by Rs. 3,000,000.

(vii) In June 2014, ZTL received 18% cash dividend on its investments. The amount received net of 10%
tax was credited to other income.

(viii) bad debts written off Rs. 50,000. ZTL maintains a provision for doubtful debts at 5% of trade
receivables.
(ix) Applicable tax rate for business income is 34%.
Required:
(a) Prepare ZTL’s statement of comprehensive income for the year ended 30 June 2014 in accordance
with the requirements of the Companies Act and the International Financial Reporting Standards.
(b) Prepare a note to the statement of comprehensive income for the year ended 30 June 2014, relating
to taxation expense and tax reconciliation.

----------( 217 )----------

 Answer:
Part (a)
Zee Trading Limited
Statement of comprehensive income For the year ended 30 June 2014
Rs. 000
Sales [80,000 - 4,000] 76,000
Cost of sales W1 (29,160)
Gross profit 46,840
Other income [5,300 + 90] 5,390
Selling and distribution expenses [15,000 - 4,000 + 120] (11,120)
Administrative expenses [9,700 + 1,500] (11,200)
Operating profit 24,520
Finance cost [7,200 + 1,498] (8,698)
Profit before tax 21,212
Taxation (b) (6,996)
Profit for the year 14,760
Other comprehensive income 0
Total comprehensive income 14,760
W1: Cost of Sales Rs. 000
Opening Inventory 4,000
Purchases [35,000 - 1,500 - 1,600] 31,900
Less: Closing inventory (8,500 – 1,500 - 260) (6,740)
29,160

Part (b)
Zee Trading Limited
Notes to the financial statements For the year ended 30 June 2014
Tax expense Rs. 000
Current tax - Current year W1 6,084
Deferred tax W2 912
6,996
Tax Reconciliation
Relationship b/w Tax expense and Accounting profit Rs. 000
Tax at applicable rate [21,212 x 34%] 7,212
Less: Lower rate on dividend [900 x (34-10)%] (216)
Tax Expense [Current + Deferred] 6,996
STICKY NOTES

W1: Current Tax (Current year) Rs. 000

Accounting profit before tax (a) 21,212
Add: Interest on lease liability (iv) 1,498
Less: Lease rental paid (iv) (5,000)
Add: Accounting dep. on leased asset (v) 3,750
Less: Excess Tax depreciation (vi) (3,000)
Less: Dividend to be taxed at lower rate (vii) (900)
Add: Increase in provision for doubtful debts (viii) 120
Less: Bad debts actually written off (viii) (50)
Taxable Business Income 17,630

Current tax (current year):

On Dividend income [900 x 10%] 90
On Business income [17,630 x 34%] 5,994
6,084

----------( 218 )----------

 W2: Deferred Tax Expense (Credit) Rs. 000
Add: Interest on lease liability (iv) 1,498
Less: Lease rental paid (iv) (5,000)
Add: Accounting dep. on leased asset (v) 3,750
Less: Excess Tax depreciation (vi) (3,000)
Add: Increase in provision for doubtful debts (viii) 120
Less: Bad debts actually written off (viii) (50)
Add backs are less by 2,682
Increase in deferred tax expense [2,682 x 34%] 912
Or
Alternative approach [by using profits]
Profit before tax 21,212
Adjustment of permanent differences:
Dividend income taxable at different rate (900)
Profit before tax after adjustment of permanent differences 20,312
Taxable income 17,630
Differences 2,682
Deferred tax expense @ 34% 912

Workings:
Loss (Admin expenses) 1,500
Purchases 1,500
As cost of sales is not yet calculated therefore deduct 1,500 and 260 (860-600) from closing stock
Opening retained earnings 1,600
Purchases 1,600
Sales 4,000
Selling and distribution expenses 4,000
Interest expense 1,498
Lease liability 1,498
(6,890+5,000) x 12.6%
Advance tax 90
Other income 90
(5,000 x 18% = 900 x 10%)
Bad debts 120
Provision[10,000 x 5% = 500 - 380] 120

----------( 219 )----------

 I thank ALLAH for giving me birth as a Muslim and blessed me with Islam.

Presentation of Financial Statements (IAS 1)

Legal Background to the Preparation of Financial Statements

1. Accounting regulation in Pakistan

The objective of financial statements is to provide information about the financial position (balance sheet),
financial performance (profit and loss) and cash flows of an entity that is useful to a wide range of users in
making economic decisions.

The Securities and Exchange Commission of Pakistan

The Securities and Exchange Commission of Pakistan (SECP) was established under the Securities and
Exchange Commission of Pakistan Act, 1997 and became operational in 1999.

It is the corporate and capital market regulatory authority in Pakistan. Its stated mission is “To develop a fair,
efficient and transparent regulatory framework, based on international legal standards and best practices, for
the protection of investors and mitigation of systemic risk aimed at fostering growth of a robust corporate
sector and broad based capital market in Pakistan” (SECP website).

One of the roles of the SECP is to decide on accounting rules that must be applied by companies in Pakistan.
Companies must prepare financial statements in accordance with accounting standards approved as
applicable and notified in the official gazette by the Securities and Exchange Commission of Pakistan (SECP)
and in accordance with rules in the Companies’ Act 2017.

The Institute of Chartered Accountants in Pakistan (ICAP)

ICAP regulates the Chartered Accountancy profession. It is the body responsible for recommending
accounting standards for notification by the Securities and Exchange Commission of Pakistan.

2. Companies Act 2017: Introduction to the third, fourth and fifth schedules
The Companies Act 2017 contains a series of appendices called schedules which set out detailed
requirements in certain areas.

The third schedule

This schedule lists the classification criteria of the companies on the basis of company size and whether it is
commercial or non-profit. It also specifies which companies are required to follow requirements of fourth and
fifth schedule of the Act.

The fourth schedule

This schedule sets out the disclosure requirements that must be complied with in respect of the financial
statements of a listed company.

The schedule specifies that listed companies must follow International Financial Reporting Standards as
notified for this purpose in the Official Gazette.

The fifth schedule

This schedule applies to the balance sheets and profit and loss accounts of non-listed companies (including
large, medium and small sized entities) and their subsidiaries. It also applies to private and non-listed public
companies that are a subsidiary of a listed company.

3. International Financial Reporting Standards

The International Accounting Standards Committee (IASC) was established in 1973 to develop
international accounting standards with the aim of harmonising accounting procedures throughout the world.

The first International Accounting Standards (IASs) were issued in 1975. The work of the IASC was
supported by another body called the Standing Interpretation Committee. This body issued interpretations
of rules in standards when there was divergence in practice. These interpretations were called Standing
Interpretation Committee Pronouncements or SICs.

In 2001 the constitution of the IASC was changed leading to the replacement of the IASC and the SIC by new
bodies called the International Accounting Standards Board (IASB) and the International Financial
Reporting Interpretations Committee (IFRIC).

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 Islam is the most beautiful and perfect religion. Islam teaches us peace and the truth.

The IASB adopted all IASs and SICs that were extant at the time but said that standards written from that
time were to be called International Financial Reporting Standards (IFRS). Interpretations are known as
IFRICs.

The term IFRS is also used to refer to the whole body of rules (i.e., IAS and IFRS in total).
Thus IFRS is made up as follows:

Published by IASC up Published by the IASB

to 2001) (from 2001)
Accounting standards IASs IFRSs

Interpretations SICs IFRICs

Note that many IASs and SICs have been replaced or amended by the IASB since 2001.

International accounting standards cannot be applied in any country without the approval of the national
regulators in that country (e.g. SECP in Pakistan). All jurisdictions have some kind of formal approval process
which is followed before IFRS can be applied in that jurisdiction.

Adoption process for IFRS in Pakistan

The previous sections refer to the approval of IFRS by the SECP and notification of that approval in the Official
Gazette

Adoption of an IFRS involves the following steps:

• As a first step the IFRS/IAS is considered by ICAP’s Accounting Standards Board, which identifies any
issues that may arise on adoption.
• The Board also determines how the adoption and implementation of the standard can be facilitated. It
considers issues like how long any transition period should be and whether adoption of the standard would
requires changes in regulations.
• If the Board also identifies the need for changes to regulations it refers the matter to the Securities and
Exchange Commission of Pakistan (SECP) (and/or the State Bank of Pakistan (SBP) for matters
affecting banks and other financial institutions). This process is managed by the Coordination
Committees of ICAP and SECP (SBP).
• After the satisfactory resolution of issues the Board and the Council reconsider the matter of adoption.
• ICAP recommends the adoption to the SECP by decision of the Council. The decision to adopt the
standard rests with the SECP.

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Third schedule

Classification of Companies

Applicable schedule of
Classification criteria Accounting Companies
S. No. Framework Act 2017

1. Public Interest Company (PIC)

Sub-categories of PIC:

a) Listed Company International Fourth

Financial Reporting Schedule
Standards

b) Non-listed Company which is: International Fifth

Financial Reporting Schedule
(i) a public sector company as defined in
Standards
the Act; or
(ii) a public utility or similar company
carrying on the business of essential
public service; or
(iii) holding assets in a fiduciary capacity for
a broad group of outsiders, such as a
bank, insurance company, securities
broker/dealer, pension fund, mutual
fund or investment banking entity.
(iv) having such number of members
holding ordinary shares as may be
notified; or
(v) holding assets exceeding such value as
may be notified.

2. Large Sized Company LSC

Sub-categories of LSC

a) Non-listed Company with: International Fifth

(i) paid-up capital of Rs. 200 million or Financial Reporting Schedule
more; or Standards

(ii) turnover greater than 800 million; or

(iii) employees more than 750.
IFRS Fifth Schedule
b) Foreign Company with turnover of Rs. 1
billion or more.

c) Non-listed Company licensed / formed under International

Section 42 / Section 45 of the Act having Financial Reporting
annual gross revenue (grants / income / Standards and
subsidies / donations) including other income Accounting
/ revenue of Rs. 200 million and above. Standards for NPOs

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 3. Medium Sized Company (MSC)
Sub-categories of MSC:

a) Non-listed Public Company with: International Fifth

(i) paid-up capital less than Rs.200 million; Financial Reporting Schedule
Standards
(ii) turnover upto 800 million; and
(iii) Employees more than 250 but less than
750.

b) Private Company with:

(i) paid-up capital of greater than Rs. 10
million but not exceeding Rs. 200 million;
(ii) turnover greater than Rs. 150 million but
not exceeding Rs. 800 million; or
(iii) Employees more than 250 but less than
750.

c) A Foreign Company which has turnover less

than Rs. 1 billion.

d) Non-listed Company licensed / formed under Accounting

Section 42 or 45 of the Act which has annual Standards for NPOs
gross revenue
(grants/income/subsidies/donations)
including other income or revenue less than
Rs.200 million.

4. Small Sized Company (SSC)

A private company having: Revised AFRS for Fifth

(i) paid-up capital up to Rs. 10 million; SSEs Schedule
(ii) turnover not exceeding Rs.150 million;
(iii) Employees not more than 250.

IAS 1: Presentation of Financial Statements

General purpose financial statements [para 7]

Definition
General purpose financial statements (referred to as ‘financial statements’) are those intended to meet the
needs of users who are not in a position to require an entity to prepare reports tailored to their particular
information needs.

The financial statements published by large companies as part of their annual reports are general purpose
financial statements.

Purpose of financial statements [Para 9]

The objective of general purpose financial statements is to provide information about the financial position,
financial performance and cash flows of a company that is useful to a wide range of users in making economic
decisions.
Financial statements also show the results of the management’s stewardship of the resources entrusted
to it.

To meet this objective, financial statements provide information about an entity’s:

• Assets;
• Liabilities;
• Equity;
• Income and expenses, including gains and losses;
• Contributions by and distributions to owners in their capacity as owners; and
• Cash flows.
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 If your dream is Jannah then follow Quran and Sunnah

This information, along with other information in the notes, assists users of financial statements in predicting
the entity’s future cash flows and, in particular, their timing and certainty.

Complete set of financial statements [para 10 and 11]

IAS 1 Presentation of Financial Statements specifies what published ‘general-purpose’ financial
statements should include, and provides a format for a statement of financial position, statement of
comprehensive income, and statement of changes in equity.

A complete set of financial statements consists of:

• A statement of financial position (balance sheet) as at the end of the period;
• A statement of comprehensive income for the period;
• A statement of changes in equity for the period;
• A statement of cash flows for the period (covered in earlier studies); and
• Notes to these statements, consisting of a summary of significant accounting policies used by the entity
and other explanatory information.

A company can use other use titles for the above statements.

Identification of financial statements [para 49 to 51]

Listed companies usually publish financial statements as part of an annual report.
The financial statements must be clearly identified and distinguished from other information in the same
published document. This is very important as the financial statements are audited whereas other information
in the annual report is not. Users must be able to identify the information that has been audited.

Each component of the financial statements must be properly identified with the following information
displayed prominently:
• the name of the reporting entity;
• whether the financial statements cover an individual entity or a group (consolidated accounts for groups
are described in later chapters);
• the date of the end of the reporting period or the period covered by the statement, whichever is
appropriate;
• the currency in which the figures are reported;
• the level of rounding used in the figures (for example, whether the figures thousands of rupees or
millions of rupees).

GENERAL FEATURES OF FINANCIAL STATEMENTS

Disclosure of compliance [para 16]

An entity whose financial statements comply with IFRSs must disclose that fact.
Financial statements shall not be described as complying with IFRS unless they comply with all the
requirements of each applicable Standard and Interpretation.

Fair presentation [para 15]

Financial statements must present fairly the financial position, financial performance and cash flows of an
entity.
This means that they must be a faithful representation of the effects of transactions and other events in
accordance with the definitions and recognition criteria for assets, liabilities, income and expenses.
The application of IFRSs, with additional disclosure when necessary, is presumed to result in financial
statements that achieve a fair presentation.

Departure from IFRS [para 20 and 23]

In extremely rare circumstances, management might conclude that compliance with a requirement in IFRS
would be so misleading that it would conflict with the objective of financial statements set out in IFRS.
When an entity departs from a requirement in IFRS it must disclose:
• that management has concluded that the financial statements present fairly the entity’s financial
position, financial performance and cash flows;
• that it has complied with applicable IFRS except that it has departed from a particular requirement to
achieve a fair presentation;
• the Standard (or Interpretation) from which the entity has departed and:
• the nature of the departure (including the treatment
----------( that is required by IFRS);
224 )----------
 It is never too late to turn to Allah.

• the reason why that treatment would be so misleading in the circumstances that it would conflict with
the objective of financial statements set out in the “Framework”;
• the treatment adopted; and,
• for each period presented, the financial impact of the departure on each item in the financial
statements that would have been reported in complying with the requirement.

If the relevant regulatory framework prohibits departure from a requirement the entity must make the following
disclosures to reduce the misleading aspects of compliance “to the maximum extent possible”:
• The Standard (or Interpretation) requiring the entity to report information concluded to be misleading
and:
• The nature of the requirement;
• The reason why management has concluded that complying with that requirement is so misleading in
the circumstances that it conflicts with the objective of financial statements; and,
• For each period presented, the adjustments to each item in the financial statements that management
has concluded would be necessary to achieve a fair presentation.

Going concern [para 25]

Financial statements must be prepared on a going concern basis unless management either;
• Intends to liquidate the entity; or,
• To cease trading; or
• Has no realistic alternative but to do so.

Management must assess an entity’s ability to continue as a going concern when preparing financial
statements.
In making this assessment management must take into account all available information about the future.
(This is for at least twelve months from the reporting date).

Disclosures
If management is aware, in making its assessment, of material uncertainties related to events or conditions
that may cast significant doubt upon the entity’s ability to continue as a going concern, those uncertainties
must be disclosed.

If the financial statements are not prepared on a going concern basis, that fact must be disclosed, together
with:
• The basis on which the financial statements are prepared; and,
• The reason why the entity is not regarded as a going concern.

Example:

Healthy Oil Limited (HOL) was experiencing cash flow problems and had accumulated losses. It was ready to
declare bankruptcy and close operations all over Pakistan. The Federal government stepped in and gave HOL
a bailout as well as a guarantee. In normal circumstances, HOL would not be considered a going concern, but
since the Federal government stepped in, there is no reason to believe that HOL will cease to operate.

Results of management’s assessment of whether the entity is a going concern (GC):

If the entity is a going concern: If the entity is not a GC: If the entity is a GC but there is
significant doubt that it will be
continue operating as a GC:
The financial statements: The financial statements: The financial statements:
• are prepared on the GC • are not prepared on the GC basis: • are prepared on the GC
basis. • must include disclosure of the: basis;
o the fact that it is not a GC; • must include disclosure of
o the reason why the entity is not the;
considered to be a GC; o the material
o the basis used to prepare the uncertainties causing
financial statements (e.g. the this doubt.
use of liquidation values).

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 O Muslims, Obey Allah and Fear Allah and don’t backbite.

Accrual basis of accounting [para 27]

Financial statements (except for cash flow information) must be prepared under the accrual basis of
accounting.

Materiality and aggregation [para 29]

Each material class of similar items must be presented separately in the financial statements.

Items of a dissimilar nature or function must be presented separately unless they are immaterial.
Information is material if its non-disclosure could influence the economic decisions of users taken on the basis
of the financial statements.

Materiality depends on the size and nature of the item or aggregation of items judged in the particular
circumstances of its omission.

Offsetting [para 32]

Assets and liabilities must not be offset except when offsetting is required or permitted by an IFRS.

The following table summarises examples on offsetting:

Offsetting of: IFRSs Example

Income and Required IFRS 15 requires revenue (income) to be reflected net of the discount
expenses or rebate (expense).
Permitted Gain or loss on disposal of non-current assets may be presented on
net basis reflecting the substance of transaction.
Not permitted Revenue from sale of inventory and related cost of sales must be
presented separately.

Offsetting of: IFRSs Example

Assets and Permitted A receivable and payable balance relating to same counterparty may
liabilities be offset when amounts are to be settled on net basis or
simultaneously .
Not permitted Income tax payable to FBR and sales tax refundable from FBR
cannot be offset as tax legislation does not allow payment of these
on net basis and presentation on net basis would not reflect the
substance of the transactions.

Frequency of reporting [para 36]

Financial statements must be presented at least annually.
When an entity’s reporting date changes its financial statements are presented for a period longer or shorter
than one year. In such cases an entity must disclose, in addition to the period covered by the financial
statements:
• The reason for using a period other than one year; and,
• The fact that amounts presented in the financial statements are not comparable.

Comparative information [IAS 1: 10, 38, 38A & 40A]

Comparative information in respect of the preceding period is also required. An entity shall include
comparative information for narrative and descriptive information if it is relevant to understanding the current
period’s financial statements.

An entity shall present, as a minimum, two statements of financial position, two statements of profit or loss
and other comprehensive income, two separate statements of profit or loss (if presented), two statements of
cash flows and two statements of changes in equity, and related notes.

An additional (third) statement of financial position as at the beginning of the preceding period is also
required when an entity:
a) applies an accounting policy retrospectively (IAS 8); or
AT A GLANCE

b) makes a retrospective restatement of items in its financial statements (IAS 8); or

c) reclassifies items in its financial statements (IAS 1).

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STRUCTURE AND CONTENT OF THE STATEMENT OF FINANCIAL POSITION
Current and non-current assets and liabilities

Current and non-current items should normally be presented separately in the statement of financial
position, so that:
• current and non-current assets are divided into separate classifications; and
• current and non-current liabilities are also classified separately.
Deferred tax balances must not be classified as current assets or current liabilities.

Current assets
IAS 1 states that an asset should be classified as a current asset if it satisfies any of the following criteria:
• The entity expects to realise the asset, or sell or consume it, its normal operating cycle.
• The asset is held for trading purposes.
• The entity expects to realise the asset within 12 months after the reporting period.
• It is cash or a cash equivalent. (Note: An example of ‘cash’ is money in a current bank account. An example
of a ‘cash equivalent’ is money held in a term deposit account with a bank.)

Examples of current assets include accounts receivable, inventories, cash etc. All other assets should be
classified as non-current assets.

Operating cycle
The operating cycle is the time between the acquisition of assets for processing and their realisation in cash
or cash equivalents. When the entity's normal operating cycle is not clearly identifiable, it is assumed to be
twelve months.

Current assets include assets (such as inventories and trade receivables) that are sold, consumed or realised
as part of the normal operating cycle even when they are not expected to be realised within twelve months
after the reporting period.

Illustration:
X Limited uses small amounts of platinum in its production process.
Platinum price has fallen recently so just before its year-end X Limited bought an amount of platinum sufficient
to cover its production needs for the next two years.

This would be a current asset. The amount expected to be used after more than 12 months should be
disclosed.

Current assets also include assets held primarily for the purpose of trading and the current portion of non-
current financial assets.

Non-current assets
These are tangible, intangible and financial assets of a long-term nature.
Examples of non-current assets include property, plant and equipment, intangibles etc.

Current liabilities
IAS 1 also states that a liability should be classified as a current liability if it satisfies any of the following
criteria:
• The entity expects to settle the liability in its normal operating cycle.
• The liability is held primarily for the purpose of trading. This means that all trade payables are current
liabilities, even if settlement is not due for over 12 months after the end of the reporting period.
• It is due to be settled within 12 months after the end of the reporting period.
• The entity does not have the unconditional right to defer settlement of the liability for at least 12 months
after the end of the reporting period.

All other liabilities should be classified as non-current liabilities.

Examples of current liabilities include accounts payable, accruals etc.
Examples of non-current liabilities include deferred tax liability, employment benefits etc.

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Changing from non-current liability to current liability
Liabilities that were originally non-current may become current in a subsequent year, when they become
repayable within 12 months.

Example:
A company has a financial year end of 31 December. On 31 October Year 1, it took out a bank loan of Rs.
50,000. The loan principal is repayable as follows:
• Rs. 20,000 on 31 October Year 3
• Rs. 30,000 on 31 October Year 4

As at 31 December Year 1
The full bank loan of Rs. 50,000 will be a non-current liability

As at 31 December Year 2
A current liability of Rs. 20,000 repayable on 31 October Year 3 and a non-current liability of Rs.
30,000 repayable on 31 October Year 4.

As at 31 December Year 3
Current liability of Rs. 30,000
There is an exception to this rule. A liability can continue to be shown as a long-term liability, even if it is
repayable within 12 months, if the entity has the ‘discretion’ or right to refinance (or ‘roll over’) the loan at
maturity.

An entity classifies its financial liabilities as current when they are due to be settled within twelve months
after the reporting period, even if:
a) the original term was for a period longer than twelve months, and
b) an agreement to refinance, or to reschedule payments, on a long‑ term basis is completed after the
reporting period and before the financial statements are authorised for issue.

In respect of loans classified as current liabilities, if the following events occur between the end of the
reporting period and the date the financial statements are authorised for issue, those events are disclosed
as non‑ adjusting events in accordance with IAS 10:
a) refinancing on a long‑ term basis;
b) rectification of a breach of a long‑ term loan arrangement; and
c) the granting by the lender of a period of grace to rectify a breach of a long‑ term loan arrangement
ending at least twelve months after the reporting period.

STRUCTURE AND CONTENT OF THE STATEMENT OF COMPREHENSIVE INCOME

A single statement or two statements
Total comprehensive income during a period is the sum of:
• The profit or loss for the period; and
• Other comprehensive income.

IAS 1 requires an entity to present all items of income and expense during a period in a statement of
comprehensive income. (now known as a statement of profit or loss and other comprehensive income).

This may be presented as a single statement with two parts:

• A statement of profit or loss which shows the components of profit or loss (beginning with Revenue and
ending with Profit (or Loss) for the year; and
• A statement of other comprehensive income.

Alternatively these two parts can be presented as two separate statements.

Whichever approach is used the following must be shown:
• Profit or loss;
• Total other comprehensive income;
• Comprehensive income for the period (the total of profit or loss and other comprehensive income).

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NOTES

Definitions & structure [IAS 1: 7, 112 &113]

“Notes” contain information in addition to that presented in the statement of financial position, statement(s)
of profit or loss and other comprehensive income, statement of changes in equity and statement of cash
flows. Notes provide narrative descriptions or disaggregation of items presented in those statements and
information about items that do not qualify for recognition in those statements.

The notes shall:

a) present information about the basis of preparation of the financial statements and the specific
accounting policies used;
b) disclose the information required by IFRSs that is not presented elsewhere in the financial statements;
and
c) provide information that is not presented elsewhere in the financial statements, but is relevant to an
understanding of any of them.

An entity shall, as far as practicable, present notes in a systematic manner. In determining a systematic
manner, the entity shall consider the effect on the understandability and comparability of its financial
statements. An entity shall cross‑ reference each item in the statements of financial position and in the
statement(s) of profit or loss and other comprehensive income, and in the statements of changes in equity and
of cash flows to any related information in the notes.

Disclosure of accounting policies [IAS 1: 117]

An entity shall disclose its significant accounting policies comprising:
a) the measurement basis (or bases) used in preparing the financial statements; and
b) the other accounting policies used that are relevant to an understanding of the financial statements.

1.3 Sources of estimation uncertainty [IAS 1: 125]

An entity shall disclose information about the assumptions it makes about the future, and other major
sources of estimation uncertainty at the end of the reporting period, that have a significant risk of resulting in
a material adjustment to the carrying amounts of assets and liabilities within the next financial year. In
respect of those assets and liabilities, the notes shall include details of:
a) their nature, and
b) their carrying amount as at the end of the reporting period.

Other disclosures [IAS 1: 137 & 138]

An entity shall disclose in the notes:
a) the amount of dividends proposed or declared before the financial statements were authorised for issue
but not recognised as a distribution to owners during the period, and the related amount per share; and
b) the amount of any cumulative preference dividends not recognised.

An entity shall disclose the following, if not disclosed elsewhere in information published with the financial
statements:
a) the domicile and legal form of the entity, its country of incorporation and the address of its registered
office (or principal place of business, if different from the registered office);
b) a description of the nature of the entity’s operations and its principal activities;
c) the name of the parent and the ultimate parent of the group; and
d) if it is a limited life entity, information regarding the length of its life.

Regulatory framework for accounting in Pakistan

In Pakistan, companies are required to follow the requirements of Companies Act, 2017 (specifically, fourth
and fifth schedule), when preparing and presenting their financial statements.

In case of conflict between requirements of law and requirements of IFRSs, the requirements of law shall
prevail.

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 “May Allah guide us to right path and forgive our sins and shortcomings.”

IFRS-8 [Operating Segments]:

This standard shall be applied after preparing the financial statements correctly under the
requirements of other IFRS.

[Para 1]
Core Principle: An entity shall disclose information to enable users of its financial statements to evaluate the
nature and financial effects of business activities in which it engages and economic environments in which
it operates.

[Para 2]
Scope:
This IFRS shall apply to:
a) The separate financial statements of an entity:
i) Whose debt or equity instruments(means shares or debentures) are traded in a public
market(means e.g stock exchange) ; or
ii) That files, or is in the process of filing its financial statements with a securities commission(e.g
SECP) for the purpose of issuing shares or debentures in a public market; and

b) The Consolidated financial statements of group with a parent:

• Whose debt or equity instruments(means shares or debentures) are traded in a public market(means
e.g stock exchange) ; or
• That files, or is in the process of filing its financial statements with a securities commission(e.g SECP)
for the purpose of issuing shares or debentures in a public market;
[Para 4]
If a financial report contains both the consolidated financial statements of a parent as well as separate financial
statements’ segment information is required only in consolidated financial statements.

Definition of an Operating Segment [Para 5]

An operating segment is a component of an entity:
a) That engages in business activities from which it may earn revenues and incur expenses (e.g. Paints,
Chemicals and Garments department)(including revenues and expenses relating to transactions with
other components of the same entity);
b) Whose operating results are regularly reviewed by the entity’s chief operating decision marker(e.g:
Chief executive officer or Chief Operating Officer) to make decisions about resources to be allocated to
the segment and assess its performance ; and
c) For which discrete financial information is available.

[Para 6]
Not every part of an entity is necessarily an operating segment, For example, head office or research and
development department may not earn revenue and therefore would not be operating segments.
Chief operating decision maker is a function, not necessarily a person, this function may be performed by a
group of managers.

[Para 13]
Reportable Segments : An entity shall report separately information about an operating segment that meets
any of the following quantitative thresholds (means all operating segments are not reportable segment):
a) Its reported revenue, including both sales to external customers and intersegment sales or transfers, is
10% or more of the combined revenue, internal and external, of all operating segments.
b) The absolute amount of its reported profit or loss is 10% or more of the Greater of:
(i) The combined reported profit of all operating segments that did not report a loss; and
(ii) The combined reported loss of all operating segments that reported a loss; or

[Means the above threshold shall be 10% of profit or loss whichever is higher]

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 If you have Islam then you have everything.”

Question. The following information relates to a quoted company with five divisions of operation:
Operating Profit Loss
Segments Rs. M Rs. m
Division 1 10
Division 2 25
Division 3 40
Division 4 35
Division 5 40
Total 110 40

Required: Which of the business divisions are reportable segments under IFRS 8 Operating segments?

Answer.
Profit Loss Reportable segment
Rs. M Rs. m
Division 1 10 No
Division 2 25 Yes
Division 3 40 Yes
Division 4 35 Yes
Division 5 40 Yes
Total 110 40
Greater of the above 110
Materiality threshold (10%) 11

c) Its assets are 10% or more of the combined assets of all operating segments.

[Para 15][75% RULE]

If the total external revenue reported by reportable segment constitutes less than 75% of the entity’s external
revenue, additional operating segments shall be identified as reportable segments(even if they do not meet
the above quantitative thresholds) until at least 75% of the entity’s external revenue is included in reportable
segments.

Example: Reportable Segments

A listed entity reports six different types of business to its chief executive. In the most recent financial year,
the revenue of these six operations (including those to internal customers), were as follows:

Rs in millions
Business type Internal revenue External revenue Total revenue
A 0 40 40
B 0 20 20
C 12 6 18
D 5 5 10
E 0 7 7
F 0 5 5
17 83 100

Required: Which of the above business types are reportable segments under IFRS 8 operating segments?

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Answer.

Business Internal External Total Notes

Type revenue revenue revenue
A 0 40 40 Reportable segment because 40% of total > 10%
threshold test
B 0 20 20 Reportable segment because 20% of total > 10%
threshold test
C 12 6 18 Reportable segment because 18% of total > 10%
threshold test
D 5 5 10 Reportable segment because 10% of total = 10%
threshold test
E 0 7 7 Not reportable(7% of total < 10% threshold)
F 0 5 5 Not reportable (5% of total < 10% threshold)
17 83 100

Note that the external revenue of segments reportable under the 10% test represents 71M (40 + 20 + 6 + 5)
out of the 83 M. They therefore represent 85.5% (71M/83M x 100) of external revenue and no additional
segments needed to be reported under the “75% rule”.

Discretion of management:
Operating segments that do not meet any of the quantitative thresholds may be considered reportable, and
separately disclosed, if management believes that information about the segment would be useful to users of
the financial statements.

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 If you have Islam then you have everything.”

Practice Questions
Q-1
A listed company has different operating segments, which are listed as under along with other information.
Operating Revenue Profit /(Loss) Assets
Segments Internal External
Rs. (m) Rs. (m) Rs. (m) Rs. (m)
A 110 120 22 1,500
B 65 130 (15) 750
C - 70 42 425
D - 430 16 2,500
E - 55 (7) 630
F - 85 13 1,400
Total 175 890 93/(22) 7,205

Required: - Determine the reportable segments under IFRS 8.

Q-2
A listed company has different product lines (Operating segments). The detail of which along with their relevant
information is given as under:-
Operating segment Revenue Profit/(loss) Assets
Internal External
Rs. (m) Rs. (m) Rs. (m) Rs. (m)
A 210 150 25 70
B 12 200 (14) 85
C 70 150 18 78
D 125 170 42 102
E 80 52 23 78
F 47 153 10 12
G 45 155 7 105
Total 589 1,030 125/(14) 530

Required:- Identify the reportable segment under IFRS 8?

Q.3 Diamond Limited, a listed company, has six operating segments. These segments do not have similar
economic characteristics. Following segment wise information is available:

Revenue

External Inter-segment Total Profit/(loss) Total assets

Segments ---------------------------------Rs. in ‘000---------------------------------
A - 24,000 24,000 (1,800) 5,400
B 184,000 8,000 192,000 (12,000) 48,000
C 22,000 4,500 26,500 19,000 4,500
D 24,000 - 24,000 (23,200) 6,000
E 23,000 - 23,000 2,300 6,500
F 25,000 3,000 28,000 2,900 18,000
278,000 39,500 317,500 (12,800) 88,400

Required:
Identify the reportable segments under IFRSs along with brief justification. (07)

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 Forgive and forget people and keep having sabr

Solution:
A.3 Quantitative thresholds for reportable segments:

Total 10%
Revenue 317,500 31,750
Absolute loss *37,000 3,700
Assets 88,400 8,840

*Higher of total profit i.e. 24,200 or total loss i.e. 37,000

Segment Reportable Explanation

A No Because it fails to meet any of the criteria specified in IFRS-8
B Yes Because it meets all of the criteria specified in IFRS-8
C Yes Because its profit of Rs. 19,000 is greater than Rs. 3,700
D Yes Because its loss of Rs. 23,200 is greater than Rs. 3,700
E No Because it fails to meet any of the criteria specified in IFRS-8
F Yes Because its assets of Rs. 18,000 are greater than Rs. 8,840

Check that 75% test is satisfied: (184,000+22,000+24,000+25000)÷278,000=91%

[Para 21]
An entity shall disclose the following for each period for which statement of comprehensive income is
presented (means comparatives as well):
a) General information: [Para 22]
(i) Factors used to identify the entity’s reportable segments, (& whether management has chosen to
organize the entity around differences in products and services, or geographical areas etc)
(ii) Types of products and services from which each reportable segment derives its revenues.
b) Information about reported segment profit or loss, including revenues and expenses included in reported
segment profit or loss, segment assets and segment liabilities. [Para 23 – 27]

Example of Disclosures:
[Para 23]
Information about profit or loss, assets and liabilities
Segment Segment B Segment C
A
Revenue – external customers X X X
Revenue – inter segment X X X
Total revenue X X X
Interest revenue X X X
Interest expense (X) (X) (X)
Depreciation and amortisation (X) (X) (X)
Other material non-cash items X/(X) X/(X) X/(X)
Material income/expense X/(X) X/(X) X/(X)
Share of profit of associate X X X
Segment profit before tax X X X
Income tax expense (X) (X) (X)
[Para 24]
Segment assets X X X
Investments in associate X X X
Unallocated assets
Entity’s total assets
Capital Expenditures X X X
Segment liabilities X X X
Unallocated liabilities
Entity’s total liabilities
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 “Biggest richness is the richness of imaan so strengthen your imaan.”

Entity wide Disclosures:

The following applies to all listed entities or which are in the process of listing including those entities that have
a single reportable segment.

[Para 32]
1. Information of revenue from external customers for each Product and Service:
An entity shall report the revenues from external customers for each product and services unless the
necessary information is not available and the cost to develop it would be excessive, in which case that fact
shall be disclosed.
[Para 33]

2. Information about Geographical Areas:

An entity shall report the following geographical information unless the necessary information is not available
and the cost to develop it would be excessive:
a) Revenue from external customers:
(i) Attributed to the entity’s country of domicile; and
(ii) Attributed to all foreign countries in total from which the entity derives revenue.

If revenues from external customers attributed to an individual foreign country are material, those revenues
shall be disclosed separately.

b) Non Current Assets:

(i) Located in the entity’s country of domicile; and
(ii) Located in all foreign countries in total in which the entity holds assets.

If assets in an individual foreign country are material, those assets shall be disclose separately.
Example of (a) and (b) above
Information about geographical areas
Country of domicile Foreign countries Total
Revenue – external customers X X X
Non – current assets X X X

[Para 34]
Information about Major Customer:
An entity shall provide information about the extent of its reliance on its major customers (IPPs and Wapda;
PSO and Railways). If revenues from transactions with a single external customer amount to 10% or more of
an entity’s revenues, the entity shall
(i) Disclose that fact;
(ii) The total amount of revenues from each such customer; and
(iii) The identity of the segment or segments reporting those revenues.

The entity need not disclose the identity of a major customer

C) Four Reconciliation are required:.

1. Reconciliation of totals of segment revenues to the corresponding combined entity’s revenue.
2. Reconciliation of the total of segment profit or loss to corresponding combined entity’s profit or loss
before tax.
3. Reconciliation of the total of segment assets to corresponding combined entity’s assets.
4. Reconciliation of the totals of segment liabilities to corresponding combined entity’s liabilities..

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[Para 28]

[Para 16]
Information about other business activities and Operating segments that are not reportable shall be combined
and disclosed in an “all other segments” category.

[Para 5]
Start-up Operations: An operating segment may engage in business activities for which it has yet to earn
revenues. (It can even then be reportable segment based on Assets criteria or loss criteria). Therefore, startup
operations may be operating segments before earning revenues.

[Para 14]Aggregation of segments [Combining operating segments below the quantitative threshold
to make a reportable segment]
An entity may combine information about operating segments that do not meet the quantitative threshold with
information about other operating segments that do not meet the quantitative thresholds to produce a
reportable segment only if the operating segments have similar economic characteristics.

Similar characteristics means

[Para 12]:
a) Nature of the products and services;
b) Nature of the production process;
c) Type or class of customers for their products and services,
d) The methods used to distribute their products or provide their services; and
e) If applicable, the nature of the regulatory environment, for example, banking, insurance or public utilities.

[Para 17]
If management judges that an operating segment identified as a reportable segment in the immediately
preceding period is of continued significance, information about the segment shall continue to be reported
separately in the current period even if it no longer meets the cretira of reportable segment (i.e Quantitative
thresholds).

[Para 18]
If an operating segment is identified as a reportable segment in the current period in accordance with
the quantitative thresholds, segment data for a prior period presented for comparative purposes shall be
restated to reflect the newly reportable segment as a separate segment, even if that segment did not satisfy
the criteria in the prior period unless the necessary information is not available and the cost to develop it
would be excessive.

[Para 19]
IFRS-8 does not set an upper limit as to the number of operating segments that should be separately reported.
However the standard sets out that if the number of separately reported segments exceeds 10 then it is
likely that information may become too detailed and consequently lose its usefulness.

[Para 29]
If an entity changes the structure of its internal organization in a manner(e.g Internal decision making is
changed from products and services to geographical areas) that causes the composition of its reportable
segments to change, the corresponding information for earlier periods, shall be restated unless information is
not available and the cost to develop it is excessive.
Roshni limited

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 Verify news/message before you spread

Self test questions:

Q-1
Gohar Limited (GL) a listed company, is engaged in chemicals, soda ash, polyester, paints and pharma
businesses. Results of each business segment for the year ended 31 March 2015 are as follows:
Business Total Sales Gross profit Operating Assets Liabilities
segments expenses
--------------------------------------------Rs. In million---------------------------------------
Chemical 1,790 1,101 63 637 442
Soda Ash 216 117 57 444 355
Polyester 227 48 23 115 94
Paints 247 26 16 127 108
Pharma 252 31 12 132 98

Included in total sales, inter-segment sale by Chemicals to Polyester and Soda Ash is Rs. 28 million and Rs.
10 million respectively at a margin of 30%.

Total Operating expenses of the business include GL’s head office expenses amounting to Rs. 75 million
which have not been allocated to any segment. Furthermore, assets and liabilities amounting to Rs. 150 million
and Rs. 27 million have not been allocated in the assets and liabilities of any segment.

Required:
In accordance with the requirements of International Financial Reporting Standards:
(a) Determine the reportable segments of Gohar Limited; and (07)
(b) Show how these reportable segments and the necessary reconciliation would be disclosed in GL’s
financial statements for the year ended 31 March 2015. (08)

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 “May Allah give us sabr and let us to die as Muslim.”

IFRS-8 QB
Q.1 SHAZAD INDUSTRIES LIMITED
Shazad Industries Ltd has recently acquired four large subsidiaries. These subsidiaries manufacture products
which are of different lines from those of the parent company. The parent company manufactures plastics and
related products whereas the subsidiaries manufacture the following:
Product Location

Subsidiary 1 Textiles Karachi

Subsidiary 2 Car products Lahore

Subsidiary 3 Fashion garments Peshawar

Subsidiary 4 Furniture items Multan

The directors have purchased these subsidiaries in order to diversify their product base but do not have any
knowledge of the information required in the financial statements regarding these subsidiaries.

Required
(a) Explain to the directors the purpose of segmental reporting of financial information.
(b) Critically evaluate IFRS 8, Operating segments, setting out any problems with the standard.

Solution:
(a) The purposes of segmental information are:
• to provide users of financial statements with sufficient details for them to be able to appreciate the
different rates of profitability, different opportunities for growth and different degrees of risk that apply
to an entity’s classes of business and various geographical locations.
• to appreciate more thoroughly the results and financial position of the entity by permitting a better
understanding of the entity’s past performance and thus a better assessment of its future prospects.
• to create awareness of the impact that changes in significant components of a business may have on
the business as a whole.

(b) IFRS 8 lays down some very broad and inclusive criteria for reporting segments. Unlike earlier attempts
to define segments in more quantitative terms, segments are defined largely in terms of the breakdown
and analysis used by management. This is, potentially, a very powerful method of ensuring that preparers
provide useful segmental information.

There will still be problems in deciding which segments to report, if only because management may still
attempt to reduce the amount of commercially sensitive information that they produce.

The growing use of executive information systems and data management within businesses makes it
easier to generate reports. It would be relatively easy to provide management with a very basic set of

internal reports and analyses and leave the individual managers to prepare their own more detailed information
using the interrogation software provided by the system.

If such analyses become routine then they would be reportable under IFRS 8, but that would be very difficult
to check and audit.

There are problems in the measurement of segmental performance if the segments trade with each
other. Disclosure of details of inter-segment pricing policy is often considered to be detrimental to the good of
a company. There is little guidance on the policy for transfer pricing.

Different internal reporting structures could lead to inconsistent and incompatible segmental reports, even
from companies in the same industry (some companies can disclose on the basis of products and others on
the basis of region).

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Q.2 AZ
For enterprises that are engaged in different businesses with differing risks and opportunities, the usefulness
of financial information concerning these enterprises is greatly enhanced if it is supplemented by information
on individual business segments.

Required
(a) Explain why the information content of financial statements is improved by the inclusion of segmental data
on individual business segments.
(b) Discuss how IFRS 8 requires that segments be analysed.

Solution:
(a) Usefulness of segmental data
Many entities carry out several classes of business and operate in a number of countries across the world.
Each of these businesses and geographical segments carries with it different opportunities for growth,
different rates of profit and varying degrees of risk. Some business segments may be strongly influenced
by the health of the economy whereas other segments may be unaffected by recession. One country may
be experiencing growth; another country may be less stable because of political events. Awareness of
these cultural and environmental differences is important to investors in order to allow them to fully
understand the performance and position of the entity over the past, its prospects for the future and the
risks that it faces.

IFRS 8 requires that segmental information should be provided to enable investors to understand the
impact that the different segments of a business may have on the business as a whole. If the user of
financial statements is only provided with figures for the entity as a whole, this might hide the risks and
problems or profits and opportunities of the underlying business segments. The disaggregated financial
information provided by segmental reporting allows for analytical review on a segment by segment basis
which will provide greater understanding of the entity’s position and performance and allow a better
assessment of its future.

(b) Analysing segments

IFRS 8 defines an operating segment as a component of an entity that engages in business activities from
which it may earn revenues and incur expenses, whose operating results are reviewed regularly by the
chief operating decision maker in the entity and for which discrete financial information is available.

Not every part of a business is necessarily an operating segment or part of an operating segment. Head
office is an example, since head office does not usually earn revenues. Generally an operating segment has
a segment manager who is directly accountable to and maintains regular contact with the chief operating
decision-maker, to discuss the performance of the segment.

IFRS 8 requires that entities should report information about each operating segment that is identified
and that exceeds certain quantitative thresholds for size of revenue, operating profit or loss or assets.
Financial information about operating segments with similar characteristics can be aggregated.

IFRS 8 sets out the information about each reportable operating segment that should be disclosed, including
total assets, profit or loss, revenue from external customers, revenue from sales to other segments, interest
income and expense, depreciation, material items of income or expense and tax.

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IFRS 8 OPERATING SEGMENTS
Existence of segment managers [para 8 to 10 & 12]

Generally, an operating segment has a segment manager who is directly accountable to and maintains regular
contact with the CODM to discuss operating activities, financial results, forecasts, or plans for the segment.

The term ‘segment manager’ identifies a function, not necessarily a manager with a specific title. The CODM
also may be the segment manager for some operating segments and a single manager may be the segment
manager for more than one operating segment.

If the characteristics (of definition of operating segment) apply to more than one set of components of an
organisation but there is only one set for which segment managers are held responsible, that set of
components constitutes the operating segments.

Matrix Structures

The characteristics (of definition of operating segment) may apply to two or more overlapping sets of
components for which managers are held responsible. That structure is sometimes referred to as a
matrix form of organisation. For example, in some entities, some managers are responsible for
different product and service lines worldwide, whereas other managers are responsible for specific
geographical areas. It is likely that the CODM regularly reviews the operating results of both sets of
components, and financial information is available for both. In that situation, the entity shall determine which
set of components constitutes the operating segments by reference to the core principle i.e. to enable users
of its financial statements to evaluate the nature and financial effects of the business activities in which it
engages and the economic environments in which it operates.

Comparative information [IFRS 8: 18]

Segment data for a prior period presented for comparative purposes shall be restated to reflect the newly
reportable segment as a separate segment, even if that segment did not satisfy the criteria for reportability in
the prior period, unless the necessary information is not available and the cost to develop it would be
excessive.

All Other Segments [IFRS 8: 16]

Information about other business activities and operating segments that are not reportable shall be combined
and disclosed in an ‘all other segments’ category separately from other reconciling items in the reconciliations
required by disclosure under IFRS 8.

The sources of the revenue included in the ‘all other segments’ category shall be described.

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 “Islam teaches us truth and helps us in promoting peace and humanity.”

IFRS 8 Test Questions

Q.1 Fashion & Style Textile (FST) Limited is public listed company and renowned in the textile industry. The
company has five segments, each having its own revenues, expenses, assets and liabilities. The details of
each business segment for the year ending December 31, 2016 are as follows:

Rs. In “million”
Business Segment Revenues Gross Profit Operating expenses Assets Liabilities
Spinning 1,969 1,211 69 701 486
Weaving 238 129 63 488 391
Dyeing 250 53 25 127 103
Home Textile 272 29 18 140 119
Garments 277 34 13 145 108

Additional Information:
➢ The weaving and dyeing segment revenues include external customers as well as inter segment revenues.
Intersegments revenues of both the segments are as follows:
▪ Revenues of weaving segment include inter segment revenue of Rs. 30 million. It supplies fabrics to
Dyeing segment at margin of 25%.
▪ Revenues of Dyeing segment includes inter segment revenue of Rs. 12 million as it provides dyeing
services to Garments segment at margin of 20%.
➢ The operating expenses of the Company’s head office amounting to Rs. 80 million have not been allocated
to any segment.
➢ Assets and liabilities of Rs. 160 million and Rs. 35 million respectively have not been reported in the asset
and liabilities of any segment.

Required:
In accordance with the IFRS
i. Identify which of the above will be classified as reportable segments of FST Limited.
ii. Show how the reportable segments and the necessary reconciliation would be disclosed in FST Limited
financial statement for the year ended December 31, 2016?

Q.2 Zeshan limited,(ZL ) a listed company, is engaged in ‘spinning’, ‘weaving’, ‘knitting’, ‘dyeing’ and ’home
textile’ businesses. Result of each business segment for the year ended June 30, 2018 is as follows:
Rs. In billion
Business Segments Sales Gross Profit Operating Assets Liabilities
Expenses
Spinning 20.000 1.800 0.800 15.000 0.750
Weaving 5.500 0.825 0.275 4.000 0.250
Knitting 3.000 0.420 0.220 1.200 0.075
Dyeing 3.200 0.384 0.175 4.500 0.125
Home textile 2.500 0.200 0.100 2.500 0.150
34.200 3.629 1.570 27.200 1.350

Inter- Segment sales by ‘spinning’ to ‘weaving and ‘knitting’ is Rs. 2 billion and 0.70 billion respectively and by
‘weaving’ to ‘dyeing’ is Rs. 1.5 billion. Spinning inter-segment sales have been sold at 9% margin and that of
‘weaving’ at 15% margin.

Operating expenses, assets and liabilities amounting to Rs. 0.5 billion, Rs. 0.25 billion and Rs. 0.1 billion
respectively, have not been allocated to any segment.

Required:
In accordance with the requirement of IFRS 8- Operating Segments:
i. Determine the reportable segments of ZL
ii. Show how these segments would be disclosed in ZL’s financial statements for the year ended June
30, 2018.
iii. Also prepare the reconciliation of revenues, profit or loss, Assets and Liabilities.

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 “Show mercy and kindness on the people.
Allah will show mercy and kindness on you”
Solutions:
A.1 (i)
Rs. In million
Segments Total External Internal Profit (gross profit Assets Reportable
Revenue sales sales – operating Criteria met or
expenses) not
Spinning 1,969 1,969 1,142 701 Yes (revenue,
(1,211-69) profit, assets)
Weaving 238 208 30 66 (129-63) 488 Yes(assets)
Dyeing 250 238 12 28 (53-25) 127 No
Home 272 272 11 (29-18) 140 No
Textile
Garments 277 277 21 (34-13) 145 No
Total 3,006 2,964 42 1,268 1,601

Only pinning and Weaving Segments meet the reportable segment criteria. However total sale of the two
segments to external customers is:
Spinning external sales 1,969
Weaving external sales 208
Total spinning and weaving external sales 2,177
% of total external sale (2,177/2,964) 73.45% which means further segments
need to be identified
e.g. Garment segment (highest among remaining segments in External sale is 277
terms of sales and assets)
Grand total(2,177+277/2,964 x100) 82.79%
So garments segment should also be included as reportable segments.
Point to remember:
Note that while applying 10% rule, both external and internal sales are combined but in applying 75% rule,
only external sales are considered.
(ii)Discloure in Financial Statements of Fashion and Style Textile
Operating Segments results. Rs. in million
Segment Spinning Weaving Garments Others Total
Revenue from external customers 1,969 208 277 510 2,964
(238+272)
Intersegment revenue 30 12 42
Total revenue 1,969 238 277 522 3,006
Other material information
Operating expense 69 63 13 43 (25+18) 188
Segment profits 1,142 66 21 39 (28+11) 1,268
Segment assets 701 488 145 267 (127+140) 1,601
Segment liabilities 486 391 108 222 1,207
(103+119)

Reconciliation of reportable segments revenue, profit or loss, Assets and liabilities:

Reportable Other than Elimination of Other Fashion &
segment Total reportable Intersegment Adjustments Style Textile
segment Total Total
Revenue 2,484 522 (42) - 2,964
(1,969+238+277) (30+12)
Operating 145 43 - 80 268
expenses (69+63+13) (188+80)
Segment 1,229 39 (10)* (80)** 1,178
profit (1,142+66+21) (1,268-10-80)
Segment 1,334 267 - 160 1,761
Assets (701+488+145) (1,601+160)
Segment 985 222 - 35 1,242
Liabilities (486+391+108) (1,207+35)
*[30/100 x 25 + 12/100 x 20] =10
** (Unallocated head office operating expenses will result into reduction in total profit of business).
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 Fear Allah because of his punishment. Love Allah because he is full of mercy.

A.2
i. Determine the reportable segments:
Rs. In billion
Spinning Weaving Knitting Dyeing Home Total
textile
Sales 20.000 5.500 3.000 3.200 2.500 34.200
Less: Inter segment sales
(2.70) (1.5) ------ ----- ------ (4.20)
(2+0.7)
Sales to external 17.300 4.000 3.000 3.200 2.500 30.000
customers
Gross Profit 1.800 0.825 0.420 0.384 0.200 3.629
Operating expenses (0.800) (0.275) (0.220) (0.175) (0.100) (1.570)
Profit 1.000 0.550 0.200 0.209 0.100 2.059
Assets 15.000 4.000 1.200 4.500 2.500 27.200

Criteria for reportable segment identification Reportable segment identified

10% of Sales i.e. Rs. 3.42 billion Spinning, Weaving
10% of Profit i.e. Rs. 0.206 billion Spinning, Weaving, Dyeing
10% of asset i.e. Rs. 2.72 billion Spinning, Weaving, Dyeing

Means reportable segments are Spinning, Weaving & Dyeing. In additional total external revenue is
82% (17.3+4+3.2/30 x 100) which is more than 75% threshold therefore no need to identify any extra
segment for disclosure.

ii. Disclosure of reportable segments in the financial statements of Zeeshan Limited:

Rs. In billion
Spinning Weaving Dyeing Others Total
Revenue from External customers 17.300 4.000 3.200 5.500 30.000
(3+2.5)
Inter segment revenue 2.700 1.500 ----- ------ 4.200
Total revenue 20.000 5.500 3.200 5.500 34.200
Other material information:
Operating expenses 0.800 0.275 0.175 0.320 1.570
(0.22+0.1)
Segment profit 1.000 0.550 0.209 0.300 2.059
(0.2+0.1)
Segment assets 15.000 4.000 4.500 3.700 27.200
(1.2+2.5)
Segment Liabilities ( Given) 0.750 0.250 0.125 0.225 1.350
(0.075+0.15)

Reconciliation of reportable segments revenue, profit or loss, Assets and liabilities:

Reportable Other than Elimination of Other Totals
segment Total reportable Intersegment Adjustments
segment Total
Revenue 28.7 5.5 (4.2) - 30
(20+5.5+3.2)
Operating 1.25 0.32 - 0.5 2.07
expenses (0.8+0.275+0.175) (1.57+0.5)
Segment 1.759 0.3 (0.468)* (0.5) 1.091
profit (1.00+0.55+0.209) (2.059-
0.468-0.5)
Segment 23.5 3.7 - 0.25 27.45
Asset (15+4+4.5) (27.2+0.25)
Segment 1.125 0.225 - 0.1 1.45
Liabilities (0.75+0.25+0.125) (1.35+0.1)

[*(2.7/100 x9 + 1.5/100 x 15) = 0.468]

**Unallocated head office Admin expense will result into decrease in total Profit.

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 “Spread message of Quran and Sunnah and earn reward from Allah.”

Lease Part 2
Exception to the Previous discussion of lease [Para 6]:
A lessee may elect (it is an option not a compulsion) not to apply the above requirements to a lease contract
if:
(a) A lease is a short term lease*; or
*Short term lease; means a lease that at the commencement date, has a lease term of 12 months or less
(including extension period if any). A lease that contains a purchase option is not a short term lease. (even
if it is for 12 months or less).
(b) A lease of low value assets*.
Low value asset lease does not only means price is low but also includes that asset is not significant for
business operation (means main business activities are not dependent on it)
An asset can be of low value if:
(a) The lessee can obtain benefit from use of asset with own resources available to the lessee (means can
be purchased by lessee itself); and
(b) The underlying asset is not highly dependent on, or highly interrelated with, other asset.

Examples of low-value assets can include tablets, personal computers, small items of office furniture, and
telephones.
IFRS -16 however specifically prescribes that lease of vehicles is not a lease low value assets.
The lessee shall assess the value of the asset based on the value of the asset when it is new, regardless of
the age of asset being leased.

Accounting Treatment [Para 6]:

No recording of right of use asset and lease liability.
No segregation of rental into principal and interest by preparing the finance charge allocation table.
If there is a short term lease or lease for which the asset is of low value, the lessee shall recognise the lease
payments as an expense on a straight line basis in statement of profit or loss; unless there is any other method
available in question.

Example:
A lease is entered into on January 1, 2001 for a period of 12 months. There is no purchase option. Therefore,
it is a short term lease. Payments are structured as follows:
o The first 6 instalments will be Rs 2,000 per month and the next 6 instalments will be Rs 3,000 per month.
o Fair value of asset is Rs 500,000.
o Lease payments are made at the end of each month.
Required:
Prepare journal entries in the books of lessee for the year ended 30-06-2001 and 30-06-2002

Solution
Journal entries: (In the books of Lessee)

30-06-2001 Rental Expense (2,500 x 6) 15,000

Cash 12,000
Rentals Payable 3,000
(this entry is the sum of six month, however in practice monthly entries will be made)

30-06-2002 Rental Expense 15,000

Rental Payable 3,000
Cash 18,000
(this entry is the sum of six month, however in practice monthly entries will be made)

Working 1 Rental Expense

2,000 x 6 = 12,000
3,000 x 6 = 18,000
Lease payments 30,000 ÷12

Per month expense = 2,500

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Further examples:
Example -1
Short term lease (Less than 1 year)
Lessee acquired a car for 9 months on a lease at a monthly rental of Rs. 10,000. There is no purchase
option.

Pass the journal entry.

Solution:
Journal entries: Dr. Cr.
Rent expense 10,000
Cash 10,000
This entry will be pass every month

Example -2
Low value assets (computers and furniture and laptops)
Lessee acquired a laptop on a lease for 3 years on 1st January 2012.
Rent payments to be made on 31 December each year as follows:
2012 10,000
2013 12,000
2014 15,000

Solution:
Lessee will record expense on straight line basis or another reasonable basis
Lease payments
31-12-2012 10,000
31-12-2013 12,000
31-12-2014 15,000
37,000
Expense (37,000 / 3) 12,333

Journal entries: Dr. Cr.

Date Particulars
Rent expense 12,333
31-12-2012 Cash 10,000
Rent payable 2,333
Rent expense 12,333
31-12-2013 Cash 12,000
Rent payable 333
Rent expense 12,333
31-12-2014 Rent payable 2666
Cash 15,000

Example -3
Entity A leases office equipment for 5 years. The total value of the equipment when new is Rs. 5,000
(determined by Entity A to be low value). Entity A elects to apply the low-value asset exemption.
Lease payments are payable as follows:
Year 1 Rs. Nil (rent-free period)
Year 2 and 3 Rs. 1,750 per year at the end of year
Year 4 and 5 Rs. 1,500 per year at the end of year

Required:
1. Calculate rent expense per year
2. prepare the journal entries for first three years of lease

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 Solution:
Total payments = 0+ (1,750 x 2 ) + (1,500 x 2) = Rs. 6,500
Lease term : 5 years
Rental expense per year : Rs. 1,300 (6,500 / 5)

Journal entries: Dr. Cr.

Date Particulars
Lease rent expense 1,300
31-12 year1 Lease rent payable 1,300
(recording of rent expense for first year)
Lease rent expense 1,300
Lease rent payable 450
31-12 year2
Cash 1,750
(recording of payment and rent expense)

Lease rent expense 1,300

31-12 year3 Lease rent payable 450
Cash 1,750
(recording of payment and rent expense)
In the case of a short term lease, the choice of applying the simplified approach must be made by class of
asset.(means for all vehicles or machinery etc)
In the case of a low value asset lease, the choice of applying the simplified approach must be made on lease
by lease basis rather than by class of asset.
Disclosure:
(1) A lessee that accounts for short term leases or leases of low value assets applying the above accounting
treatment shall disclose this fact in notes to financial statements [Para 60].
(2) A lessee shall disclose the amount of its lease commitments for short term leases (and for lease of low
value asset). (A disclosure in notes related to maturity analysis of future lease payments)
(3) In statement of cash flow; short term lease payments and payment for leases of low-value assets should
be classified within operating activities.

Treatment of lease in the books of Lessor:

A lessor shall classify each of its leases as either an operating lease or a finance lease. [Para 61]

Finance Lease:
A lease that transfers substantially all risks and rewards incidental to ownership of an asset. [Para 62].
Operating Lease:
A lease that does not transfers substantially all risks and rewards incidental to ownership of an asset [Para
62]. [means a lease which is not a finance lease].
Examples of situations that individually or in combination lead to a lease being classified as a finance lease
are [Para 63]:
(a) The lease transfers ownership of the asset to the lessee by the end of the lease term.
(b) The lessee has an option to purchase the asset at a price that is expected to be sufficiently lower than the
fair value of the asset at the end of lease term and it is reasonably certain at the inception of lease that
lessee will exercise the option to purchase the asset.
(c) The lease term is for the major part of the economic life of the asset (major part means lease term covers
at least 75% or more of economic life).

Economic Life; means total period over which asset is expected to be used (means total life of asset)
Useful life; Period over which asset is expected to be used by the entity to obtain benefits (means lessee in
case of lease)
The above lives can be same or different depending upon the circumstances.
Assuming no other condition is met we are only checking (c) condition.
Lease Lease Term Economic Life Classification
A 4 10 Not a finance lease
B 3 5 Not a finance lease
C 8 10 finance lease
D 5 5 finance lease

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 “Remember Allah. Allah will remember you.”

(d) At the inception of lease, present value of lease payments is substantially equal to fair value of asset
(substantially equal means at least PV of lease payments is 90% or more of fair value of asset).
(e) The asset is of such a specialized nature that only lessee can use it without major modification.

There are three more indicators of finance lease as given in para 64 of IFRS 16.[at the end of
Chapter]

Residual Value:
The value of an asset at the end of the lease term.
There is a concept of residual value if ownership of asset is not expected to be transferred to lessee at the
end of lease term.

Residual value can be of two types:

Guaranteed Residual Value (GRV): A residual value (may or may not be equal to full residual value)
guaranteed to a lessor by a party (may be lessee or an independent third party unrelated to lessor) that asset
will be at least a specific amount at the end of the lease term.

Unguaranteed Residual Value (URV): A portion of residual value of asset, the realisation of which by lessor
is not assured (means not guaranteed) or guaranteed by a party related to lessor.

e.g
a) RV= Rs 10,000 (nothing is assured) → it became URV
b) RV= Rs 10,000
Rs 8,000 is guaranteed by lessee
Remaining Rs 2,000 is URV

Finance Lease (in the books of lessor)

Calculation of lease payment:
(A) Calculation of lease payment to be received by lessor (if ownership is expected to be transferred to
lessee at the end of lease term)
(a) Ownership will be transferred without any additional amount at the end of lease term.
Lease payments (LP) = Down payment + Rentals + zero.

(b) Ownership will be transferred by paying an additional lump sum amount at the end of lease term:
(means a purchase option which is reasonable certain at the inception).
Lease payments (LP) = Down payment + Rentals + Amount to obtain ownership
In these cases lessee will also calculate its lease payments as mentioned above.

(B) Calculation of lease payments to be received by lessor: (if ownership is not expected to be
transferred to lessee at the end of lease term).
(a) If lessee or a party related to lessee [Para 70 (c)] has provided a guarantee of residual value
to lessor:
Lease payments (LP) = Down payment + Rentals + GRV
(b) If an independent third party has provided a guarantee of residual value to lessor:
Lease payments (LP) = Down payment + Rentals + GRV

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 Calculations of lease payments :
If ownership of asset is expected to be If ownership of asset is not expected to be
transferred to lessee at the end lease term transferred to lessee at the end lease term
Lessee : i) If there is GRV (lessee) and lessee
i) If ownership of asset is expected to be expects that amount will be paid.
transferred without paying any extra amount LP = down payment + rentals + GRV (lessee)
at the end lease term
LP = down payment + rentals + 0 ii) If there is GRV but guarantee is provided
by independent third party amount will be
ii) If ownership of asset is expected to be paid.
transferred by paying an amount of purchase LP = down payment + rentals + 0
option (P.O) at the end lease term
LP = down payment + rentals + P.O

Residual value : Amount expected to be obtained at the end of lease term.

There are two types of residual values:

Guaranteed Residual value (GRV) Un-Guaranteed Residual value (URV)

GRV ( lessee) GRV ( lessor)

RV guaranteed by lesse or party RV guaranteed by lessee or party
related to lessee related to lessee or by any
independent third party
URV : Residual value which is not assured or assured by a party related to lessor.

Point to remember: URV is not included in calculation of lease payments by lessor. It is included in
calculation of Gross Investment by lessor.

Terminologies Used by lessor:

Gross Investment = Lease payments + URV
Net Investment = PV of lease payments + PV of URV
Unearned Finance Income = Gross Investment – Net Investment

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Q.7 Following information is available for you.
Fair Value 68,000
Down Payment 10,000
Interest rate implicit in lease 10.65% p.a.
Annual installment Rs 20,000 payable in arrears
Lease term 3 Years
Residual value 12,000
GRV( Lessee) 10,000

Calculate the following

a) Gross investment
b) Net investment
c) Unearned finance Income

[Para 67] At the commencement date; A lessor shall recognise a receivable at an amount equal to net
investment in lease.

Subsequent Measurement:
A lessor shall recognise finance income over the lease term using a constant period rate of return.

Q.8 M Corporation is a company involved in the manufacturing industry. It recently decided to import a
range of new equipment costing Rs 400,000. Once the equipment had arrived at their premises (1
January 2006), it became evident that M Corporation did not have the expertise necessary to operate
the sophisticated equipment.

The CEO then made a few calls and found a company (D Manufacturing) that wanted to acquire the
equipment'. Unfortunately, however, D Manufacturing did not have adequate funds to purchase the equipment
immediately. The CEO was reluctant to leave the equipment lying around, and therefore came up with the
following agreement:
1) He would lease the equipment to D Manufacturing, immediately (1 January 2006).
2) The equipment would be leased to D Manufacturing for a period of 3 years.
3) At the end of 3 years D Manufacturing would have to pay an amount of Rs 20,000 and ownership would
then transfer.
4) The lease rentals are Rs 150,000 paid annually in advance.

Other information includes:

A fair market interest rate for agreements of the above nature is 17.082%.

Required:
a) Provide the journal entries required to account for the above information in the records of M Corporation
from the start of the lease up to 31-12-2008.
b) Prepare extracts from statement of Financial Position of M Corporation as on 31-12-2006.

Q.9 Shoaib Leasing Limited (the lessor) has entered into a three year agreement with Sarfaraz Limited
(the lessee) to lease a machine with an expected useful life of 4 years. The cost of machine is Rs.
2,100,000.
The following information relating to lease transaction is available:
1) Date of commencement of lease is July 1, 2007.
2) The lease contains a reasonable certain purchase option at Rs. 100,000. At the end of the lease term, the
value of the machine will be Rs. 300,000.
3) Lease installments of Rs. 860,000 are payable annually, in arrears, on June 30.
4) The implicit interest rate is 12.9972%.

Required:
a) Prepare the journal entries for the years ending June 30, 2008, 2009 and 2010 in the books of lessor.
b) Produce extracts from the statement of financial position including relevant notes as at June 30, 2008 to
show how the transactions carried out in 2008 would be reflected in the financial statements of the lessor.

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 Note:
1. If a note / disclosure is required in case of finance lease (lessor) then prepare a maturity analysis of
undiscounted contractual future lease payments receivable for a minimum of each of the first five
years plus a total amount for the remaining years. In addition a lessor shall reconcile the undiscounted
lease payments to net investment in lease. In addition immediately after the disclosure a narrative
information about lease is also to be prepared.
2. If there is a purchase option in question, then always assume that it is reasonably certain unless
otherwise specified.

Q.9a Galaxy Leasing Limited (GLL) has leased certain equipment to Dairy Products Limited on
1 July 2013. In this respect, the following information is available:
Rs. in million
Cost of equipment 28.69
Amount received on 1 July 2013 3.00
Four annual installments payable in arrears on 30 June, each year 7.80
Guaranteed residual value on expiry of the lease 5.00

Useful life of the equipment is estimated at 5 years. Rate of interest implicit in the lease is 14%.

Required:
(a) Prepare accounting entries for the year ended 30 June 2014 in the books of GLL to record the
transactions related to the above lease arrangement in accordance with the requirements of International
Financial Reporting Standards. (07)
(b) Prepare a note for inclusion in GLL's financial statements for the year ended
30 June 2014, in accordance with the requirements of International Financial Reporting Standards.
(10)
Types of Lessor (in case of finance lease):
Lessor

Simple Lessor Manufacturer lessor/

E.g Dealer Lessor
Banks
Leasing Companies Manufacturer lessor
E .g Honda Limited Starts
leasing business

Dealer Lessor
E.g Car Dealer starts
leasing business.
For example:
Simple Lessor:
Purchase cost 2,500,000
Interest 300,000
Total Amount of which installments are to be made 2,800,000

Dealer Lessor:
Cost of Purchase 800,000
Profit 200,000
Selling Price 1,000,000
Interest 150,000
Total Amount of which installments are to be made 1,150,000

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 O Muslims, Obey and Fear Allah wherever you are
Manufacturer Lessor:
Cost of manufacturing 1,400,000
Profit 300,000
Selling Price 1,700,000
Interest 200,000
Total Amount of which installments are to be made 1,900,000

Nature of
Income

Simple Lessor Manufacturer/ Dealer Lessor


Interest Income Normal Profit Interest Income
 (Sale – Cost of sales) 
Recognized on  Recognized on time
time basis Recognized when the basis
asset is sold (means when
the control is transferrred)

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Q.10 Applebee Limited is a manufacturer of harvesting equipment. Applebee Limited sells the equipment
to farmers all around the country. Some customers purchase the equipment for cash and others purchase
under Applebee Limited's finance lease arrangement.

Mr. Hatfield purchased a harvester from Applebee Limited and made use of their finance lease agreement.
The details of the lease are as follows:
1) The lease period is 5 years (signed on 1 January 2015)
2) Lease installments of Rs 200,000 are payable annually in arrears on 31 December.

A fair market interest rate for this type of lease is 16.9911%.

The cost to Applebee Limited to manufacture this harvester was Rs 500,000. Applebee Limited implements a
mark-up of cost plus 28% on their cash sales.

Required:
Journalize the entries required to account for the abovementioned transaction for each of the years ended 31
December 2015 to 2019 in the books of Applebee Limited.

Initial Entries of Manufacturer / Dealer Lessor [In case of finance lease]

Lease receivable (Net Investment) xxx
Sales xxx
(Lower of FV & PV of LP at market rate of interest)

Cost of sales (Cost- PV of URV) xxx

Stock (cost) xxx
This lower of is an application of prudence concept, means revenue is not overstated.

Q.11 Following information is available for you.

Lease payment(LP) 100,000
Present value of LP 70,000
Cost of Purchase 60,000
URV 2,000
Present value of URV 1,200
Sale price 71,200

-Required:
a) Cost of sales
b) Gross profit
c) Unearned Finance Income
d) Initial accounting entry in the book of dealer lessor
Important points to remember:
1. If there is a difference between cost and sale price it means there is profit which should be recognized at
the time of sale.
2. For simple lessor → cost is Fair value
3. For Manufacturer/Dealer Lessor → Sale price is Fair value

Q.12 Quartz Auto Limited (QAL) is engaged in the business of manufacturing of trucks. Since a number of
the prospective customers do not have adequate funds to purchase the vehicles against full payment,
QAL provides lease financing facility to its customers. It expects to receive a return at the rate of 15%
per annum on the amount of lease finance.

On 1 July 2010, QAL sold seven trucks to Emerald Goods Transport Company (EGTC) on lease. The terms
of the lease and related information is as follows:
1) The lease period is 4 years, extendable up to the expected useful life of the trucks i.e. 5 years.
2) EGTC has guaranteed a residual value of Rs. 360,000 for each truck, till the end of the fourth year.
However, the guarantee would lapse if the lease term is extended to the fifth year. EGTC will return the
truck at the end of the lease term.
3) Lease rentals amount to Rs. 2,715,224 per annum and are payable in arrears i.e. on 30 June.
4) The cost of each truck is Rs. 900,000. Price in case of outright sale is Rs. 1,350,000 per truck.
5) The expected residual value of each truck at the end of the 4th and 5th year is Rs. 150,000 and Rs.
100,000 respectively.
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 “Love for your fellow Muslims what you love for yourselves.”

Required:
Assuming that QAL and EGTC intend to extend the lease for a period of five years, prepare in the books of
QAL:
a) Journal entries to record the transactions for the year ended 30 June 2011.
b) A note for inclusion in the financial statements, for the year ended 30 June 2011, in accordance with the
requirements of IFRS 16 ‘Leases’.

Q.12a D products deal in large office machine. It also offers such machines on lease. One such machine
was leased to a customer on 1-7-2004. The details of this machine are as follows
a) D product purchased the machine for Rs 150,000.
b) Outright sale price of machine is 188,535.
c) Useful life = 6 years.
d) Lease Term = 6 years.
e) Unguaranteed Residual value = 10,000.
f) Annual rental payable at the beginning of each year = 36,500.
g) Interest rate implicit in lease = 8% p.a.
Required:
a) Compute the following for D products as on 1-7-2004
i. Gross Investment
ii. Unearned Finance Income
b) Prepare journal entries for the year ended 30-6-2005.
c) Prepare extracts from Statement of comprehensive income, Statement of financial position as well as a
disclosure as at June 30, 2005 as per IFRS 16.
Summary of Finance Lease (lessor)
Simple Lessor Dealer/Manufacturer Lessor
Initial Entry
Leased Receivable (NI) Leased Receivable (at NI)
Asset (Cost) Sale(at lower of FV &
(FV is cost) PV of LP)
Cost of sale (cost – PV of URV)
Stock (cost)
(FV is sale price)
Depreciation is charged
 

Finance Charge Allocation Table:

✓ ✓

Treatment of Interest
Interest is recognized as Interest is recognized as
income on time basis income on time basis

Operating lease in the books of lessor: [Para 81 to 85]

• The asset subjected to an operating lease shall continue to be in the books of lessor.
• Lessor shall depreciate the asset over its useful life as per IAS-16 and 38.
• For impairment testing of asset subjected to lease, consider requirements of IAS-36.
• No receivable is recorded.
• No finance charge allocation table is prepared.
• A lessor shall recognise the lease payments from operating leases as income on a straight line basis.
(unless question requires another basis)
Disclosures:
A disclosure of future lease instalments receivable is prepared in notes.[maturity analysis]
Schedule of PPE.
Note:
1. There is no difference in accounting treatment of simple lessor and dealer/manufacturer lessor in case of
an operating lease.
2. Before solving the question of lessor in examination, make a conclusion that whether the lease is a finance
lease or operating lease; and then start solving the question.

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Q.13
Cost of asset Rs 15,000,000
Date of commencement of lease is 1-1-2009
Useful life is 6 years
Lease term is 3 years
Annual Rentals payable in advance Rs 4,000,000 (to be reduce by 5% annually)
Year end is 31 December

Required:
a) Prepare journal entries in the books of lessor for 31-12-2009 and 31-12-2010.
b) Prepare a disclosure in notes to the financial statements of lessor for the year ended 31-12-2009 and 31-
12-2010.

Note: if asset is already purchased or manufactured by dealer or manufacturer lessor then first prepare
the entry to transfer the assets from the inventory to PPE (in case of operating lease)

Q.14
Cost of asset Rs 40,000,000
Date of commencement of lease is 1-7-2009
Useful life is 10 years
Lease term is 3 years
Semi annual Rentals payable in advance Rs 5,000,000 (to increase by 5% annually)

Required:
a) Prepare journal entries in the books of lessor for 31-12-2009 and 31-12-2010.
b) Prepare a disclosure in notes to the financial statements of lessor for the year ended 31-12-2009 and 31-
12-2010.

Initial Direct Cost:

Incremental costs of obtaining a lease that would not have been incurred if the lease contract is not made.

Initial direct costs includes;

– Commissions
– Legal fees
– Costs of negotiating lease terms and conditions (legal advisors fee)
– Costs of arranging collateral
– Payments made to existing tenants to obtain the lease

Treatment of Initial Direct Cost (IDC)

→ Lessee → IDC is added to the amount recognized as an asset.

Illustration IDC:
ABC Limited paid Rs.30,000 to a legal advisor to review and advise on lease agreement of a plant leased by
SRT Limited. Procurement Manager of ABC remained involved for a month for negotiating the lease whose
monthly salary paid at Rs.150,000.

Debit Credit
Right-of-use 30,000
Bank 30,000

→ Lessor→Operating Lease: Initial direct cost shall be added to the amount of the asset and recognized as
an expense over the leased term. [because IDC is for this lease only]

Example:
The company at which you are employed as a finance manager entered into the following operating lease
agreement (as a lessor) to lease an item of property, plant & equipment.

Commencement Date 1-1-2006

Cost of Machine 1,000,000
Useful life 10 years
Machine purchased on 1-1-2006

----------( 254 )----------

 Lease installments in arrears:
31-12-2006 54,270
31-12-2007 67,260
31-12-2008 29,640

Initial direct cost of lessor was Rs 3,000 paid in cash.

Required:
a) Calculate rental income for each year.
b) Journal entries for the year ended 31-12-2006.

Solution:
a) Rental Income
31-12-2006 54,270
31-12-2007 67,260
31-12-2008 29,640
151,170/3 = 50,390 per annum
Operating Rental Income in each of the three years will be Rs 50,390.
b) Journal Entries
For the year ended 31-12-2006
1-1-2006 Machine 1,000,000
Cash 1,000,000
1-1-2006 Machine 3,000
Cash 3,000
31-12-2006 Depreciation 101,000
Acc Depreciation 101,000
(1,000,000÷10 + 3,000/3)
31-12-2006 Bank 54,270
Lease Rental Income 50,390
Unearned rental Income 3,880

→ Lessee → IDC is recognized as an expense in case of short term or low value asset lease.

→ Simple Lessor → Finance Lease

Initial direct Costs paid by the Lessor are included in the initial measurement of the finance lease receivable
and reduce the amount of income recognized over the lease term.

The result will be that net Investment In lease will Include amount of initial direct cost (Instead of having
recognized the expense in the current period, It will result in reduced Income over the lease term). [as in the
debt instruments of IFRS 9]

The above discussion can be understood by the following question.

Calculation of interest rate implicit in lease:

As per IFRS 16 calculation of rate is responsibility of Lessor. Rate is calculated by solving the following
equation.
FV+ Initial Direct Cost of Lessor = PV of LP + PV of URV

Q.18 Following information is available for you.

Fair Value of asset 50,000
UGRV 2,000
Annual installment Rs 15,000 Payable in arrears
lease term 3 Years
initial direct cost of lessor 3,000
Down payment 10,000
Commencement of lease 01.01.2010

Requirement:
Calculate the interest rate implicit in the lease.

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A.18 Solution
50,000+3,000 = 10,000 + 15,000 [1-(1+i)-3] + 2000(1+i)-3
i
Interest rate implicit will be that rate, which will equate this equation. The method used for this purpose is
called as Hit & Trial Method.
Hit & Trial Method
Let assume rate = 8%
53,000 = 10,000 + 15,000 [1-(0.08)-3] + 2000(1.08)-3
0.08
=10,000 + 38,656 + 1,588
53,000  50,244
It means rate is not 8%.
Increase in rate will result into decrease in PV and vice versa. Therefore we should not use rate above 8%
because we need higher present value.
Let assume rate =7%
=10,000 + 15,000 [1-(1.07)-3] + 2000(1.07)-3
0.07
=10,000+39,365+1,633
53,000  50,998
Let assume rate =5%
=10,000 + 15,000 [1-(1.05)-3] + 2000(1.05)-3
0.05
=10,000+ 40,849 + 1,729
53,000  52,577

Let assume rate =4%

=10,000 + 15,000 [1-(1.04)-3] + 2000(1.04)-3
0.04
=10,000+41,626+1,778
53,000  53,404
Let assume rate =4.5%
=10,000 + 15,000 [1-(1.045)-3] + 2000(1.045)-3
0.045
=10,000+41,234+1,753
= 52,987
It is therefore approximately equal to 4.5%

Note: in case of simple lessor finance lease, IDC is already included in net investment therefore simply
ignore in workings. (unless any missing figure to be calculated from equation)

Dealer/Manufacturer lessor → Finance Lease

IDC should be recognized as an expense when incurred in the period of delivery of asset.
Therefore in case of dealer/manufacturer lessor equation to calculate implicit rate of return is
FV = PV of LP + PV of URV
Point to remember: URV means an amount which is not assured or guaranteed by party related to lessor
Calculation of Lease Rental

Fair value = 1,200,000

Lease term = 5years
URV=100,000
Rate = 8%
There are five annual rental in advance.
We can use the same previous equation to calculate rental as well if required.

FV+ Initial Direct Cost of Lessor = PV of LP + PV of URV

1,200,000+0=R+R [1-(1.08)-4] + 100,000(1.08)-5

0.08
1,200,000 = R + R [3.31212684] + 68,058

R=262,502
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 “Control your tongue and speak good.”

Extra practice questions

Question No. 1
FV = 491,000
Lease term = 8 years
Annual rental of Rs. 82,487.75 payable in advance
URV = 10,000
Calculate Interest date implicit.

Answer No. 1
FV = PV of LP + PV of URV
[1 − (1 + i) −7 ]
491,000 = 82487.75 + 82487.75 + 10,000 (1 + i)–8
i
Interest rate implicit will be that rate, which will equate this equation. The method used for this purpose is
called as Hit and Trial Method.
Lets assume rate = 12% per annum
[1 − (1 + 0.12 ) −7 ]
= 82,487.75 + 82487.75 + 10,000(1+0.12) –8
0.12
= 82,487.75 + 376,454 + 4,523
= 463,465
Lets assume rate = 10% per annum
[1 − (1 + 0.10 ) −7 ]
= 82,487.75 + 82487.75 + 10,000(1+0.10) –8
0.10
= 82,487.75 + 401,585 + 5,132
= 489,205

It is therefore approximately equal to 10%

Calculate rental with respect to simple lessor.
Question No. 2
FV = 45,556
IDC = 10,000
i = 10.65%
Lease term = 3 years
Annual rentals are in arrears
URV = 10,000

Answer No. 2
FV + IDC = PV of LP + PV of URV
[1 − (1 + 0.1065 ) −3 ]
45,556 + 10,000 =R 10,000 (1 + 0.1065)–3
0.1065
55,556 = R (2.45866) + 7,382
Rentals = (55,556 – 7,382) / 2.45866
= 19,594
Question No. 3
FV = 112,080
i = 8% p.a
Lease term = 2 years
Quarterly rentals are in advance
Calculate rental
Answer No. 3
FV = PV of LP
Interest rate will be adjusted due to quarterly rentals
[1 − (1 + 0.02 ) −7 ]
112,080 =R+R
0.02
112,080 = R + 6.4 R
Rentals = 112,080/7.47
= 15,000 per quarter
Summary of rates:
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 Speak truth and avoid bad company.”

• Calculation of the interest rate implicit in lease is the responsibility of the lessor. Lessor will always use
this rate in his calculations.
• If this rate is known to lessee then he will also use that rate.
• If implicit rate is not known to lessee then he can use its incremental borrowing rate (means assume as if
lessee has borrowed the funds instead of taken the asset on lease).
• Sometimes manufacturer or dealer lessor might quote artificially low rate of interest to attract the
customers. The use of such a rate would result into lessor recognizing excessive amount of total income
at the commencement of lease (which is against the prudence concept) [lower rate would result into higher
PV and vice versa]. In such cases, the selling profit is restricted to that which would apply if a market rate
of interest is charged (means if both the lower implicit rate and market rate of interest are given then use
market rate for the calculation of present value).

Defined periods
A lease may be split into a primary period followed by an option to extend the lease for a further period (a
secondary period).
In some cases, the lessee might be able to exercise such an option with a small rental or even for no rental
at all. If such an option exists and it is reasonably certain that the lessee will exercise the option, the second
period is part of the lease term.

Question in practice questions.

Lease accounting (Lessee) [summary]

At the commencement date, a lessee should recognise a right-of-use asset and a lease liability. It is the date
on which a lessor makes an underlying asset available for use by a lessee.
At the commencement date, a lessee should measure the right-of-use asset at cost. The cost of the right-of-
use asset should comprise:
(a) the present value of lease payments;
(b) less any lease incentives received;
(c) Add any initial direct costs incurred by the lessee;
(d) an estimate of costs to be incurred by the lessee in dismantling and removing the asset, restoring the
site on which it is located or restoring the underlying asset to the condition required by the terms and
conditions of the lease.

The lease payments shall be discounted using the interest rate implicit in the lease, if that rate can be readily
determined. If that rate cannot be readily determined, the lessee shall use the lessee’s incremental borrowing
rate.

Property companies: Many companies own properties which they lease out to others. These companies will
apply IAS 40 to their assets.

SOLUTIONS

----------( 258 )----------

A.9
Solution
Shoaib Leasing LTD

a) Journal Entries

1-7-2007 Lease Receivable 2,100,000

Machine 2,100,000
Net Investment
860,000 [1 – (1 + 0.129972 )-3 ]+ 100,000 ( 1 + 0.129972 )-3 = 2,100,000
0.129972

30-6-2008 Bank 860,000

Lease Receivable 587,059
Finance Income 272,941

30-6-2009 Bank 860,000

Lease Receivable 663,360
Finance Income 196,640

30-6-2010 Bank 960,000

Lease Receivable 849,581
Finance Income 110,419

b) Shoaib Leasing Company

(i) Statement of Financial Position (Extracts)
As on 30-6-2008
Non-Current Assets 2008
Lease Receivable 849,581
Current Assets
Current Portion of Lease Receivable 663,360

(i) Note to the financial statements

Disclosure for the year ended 30-6-2008
Maturity Analysis – contractual undiscounted lease payments
Less than one year 860,000
One to two years (860,000 + 100,000) 960,000
Total undiscounted lease receivable 1,820,000

Reconciliation:
Total lease receivable (860,000 x 2 + 100,000) 1,820,000
Add: unguaranteed residual value -
Gross investment in lease 1,820,000
Less: unearned finance income (196,640 + 110,419) (307,062)
Net investment in lease 1,512,938
Current portion 663,360
Non current portion of net investment 849,581

The company has entered into a lease agreement with Sarfaraz Limited. The lease bears
interest @ 12.9972%. Rentals are payable annually in arrears.
Working
Finance Charge Allocation Table
Rental Principal Interest Balance
1-7-2007 2,100,000
30-6-2008 860,000 587,059 272,941 1,512,991
30-6-2009 860,000 663,360 196,640 849,581
30-6-2010 960,000 849,581 110,419 -
(860,000+100,000)

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 “Allah is sufficient for believers.”

A.12a Solution
a) Gross Investment 36500 x 6 + 10,000
=
=219000 + 10,000
=229,000

Net Investment = 36500 + 36500 [ 1- (1+0.08)-5] + 10,000 (1.08)-6

0.08
= 182,234 + 6302
= 188,536

Unearned Finance Income = 229,000 – 188,536

= 40,464

b)Accounting Entries
For the year ended 30-6-2005
1-7-2004 Lease Receivable (N.I) 188,536
Sales* 182,234
Cost of Sales** 143,698
Inventory stock 150,000
* FV=188,535;PV of LP=182,234;Lower=182,234
**150,000 – 6,302=143,698

1-7-2004 Bank 36,500

Lease Receivable 36,500

30-6-2005 Interest Receivable 12,163

Interest Income 12,163

c) i)
D Products
Statement of Financial Position (Extracts)
As at 30-6-2005
Non-current asset
Lease receivable 127,699

Non-current asset
Current Portion of lease receivable 24,337
Interest receivable 12,163

ii)
D Products
Income Statement Extracts
For the year ended 30-6-05

Sales 182,234
Cost of Sales (143,698)
Gross Profit 38,536
Interest Income 12,163

----------( 260 )----------

 ii) D Products
Notes to the Financial Statements
For the year ended 30-6-2005

Maturity Analysis – contractual undiscounted lease payments

Less than one year 36,500
One to two years 36,500
Two to three years 36,500
Three to four years 36,500
Four to five year 36,500
Total undiscounted lease receivable 182,500

Reconciliation:
Total lease receivable (36,500 x 5) 182,500
Add: unguaranteed residual value 10,000
Gross investment in lease 192,500
Less: unearned finance income (10,216 + 8,113 + 5,842 + 3,390 + 28,301
740 )
Net investment in lease (principal 152,036; interest 12,163) 164,199

The company has entered into a finance lease agreement as a lessor. The lease bears interest at the rate of
8% per annum. Rentals are receivable annually in advance.

Working
Finance charge allocation Table
Date Rental Principal Interest Balance
1-7-04 188,536
1-7-04 36,500 36,500 - 152,036
1-7-05 36,500 24,337 12,163 127,699
1-7-06 36,500 36,284 10,216 101,415
1-7-07 36,500 28,387 8,113 73,028
1-7-08 36,500 30,658 5,842 42,370
1-7-09 36,500 33,110 3,390 9,260
30-6-10 10,000 9260 740 -

----------( 261 )----------

 “May Allah forgive us and guide us all to right path.”
Additional Practice Questions
1 SHER KHAN LIMITED

Consider the following independent scenarios:

Sher Khan Limited (lessee) enters in to lease over a plant

Scenario 1.
The lease is non-cancellable for a period of 3 years from commencement date after which Sher Khan
Limited then has the option to extend the lease for a further 2 years. Sher Khan Limited is reasonably
certain that it will exercise the renewal option.

Scenario 2.
The lease is non-cancellable for a period of 3 years from commencement date after which Sher Khan
Limited then has the option to extend the lease for a further 2 years. Sher Khan Limited is reasonably
certain that it will not exercise the renewal option.

Scenario 3.
The lease is for a 10-year period during which the first 7 years is non-cancellable. At the end of the 7-
year period, Sher Khan Limited has the option to terminate the lease. Sher Khan Limited is reasonably
certain that it will exercise the termination option.

Scenario 4.
The lease is for a 10-year period during which the first 7 years is non-cancellable. At the end of the 7-
year period, Sher Khan Limited has the option to terminate the lease. Sher Khan Limited is reasonably
certain that it will not exercise the termination option.

Scenario 5.
The lease is for a 10-year period during which the first 7 years is non-cancellable. At the end of the 7-
year period, both Sher Khan Limited and the lessor have the option to terminate the lease. Sher Khan
Limited is reasonably certain that it will not exercise the termination option.

Required
Calculate lease term for each of the scenarios above along with explanation.

2 T LIMITED

T limited leased a plant from P limited on 1st January 2018.

Following are the details pertaining to plant leased by T Limited:
1. Asset was originally purchased at a cost of Rs. 700,000 on 1st January 2013 with a useful life
of 10 years by P limited.
2. Lease term is 3 years.
3. Residual Value was Rs. 50,000 which was unguaranteed.
4. T Limited has an option to purchase the asset at the end of lease term at a Price of Rs.
30,000
5. Fair value of asset at the time of commencement of lease was Rs. 290,000
6. T limited was reimbursed 50% of the initial direct cost paid by him, by P limited.
7. T Limited Immediately paid Rs. 50,000 on 1st January 2018.

Other relevant information of lease agreement is as follows:

1. Initial direct cost paid by T limited 100,000
2. Dismantling cost of plant at the end of lease term Rs.50,000

Required
a. Calculate Rental which should be charged by P Limited to achieve a return of 10%. Rentals are
payable annually in arrears.
b. Prepare journal entries in the books of P limited and T Limited for the year ended 31.12.2018..
c. Prepare relevant financial position extracts of both companies as on 31.12.2018..
d. Disclose the lease related information in both companies in notes to financial statements for the year
ended 31.12.2018.

----------( 262 )----------

Q.3 Qaseem Ahmed & Company and Ebad Company signed a lease agreement dated January 1,
2001that calls for Qaseem Ahmad & Company to lease equipment to Ebad and company beginning
January1, 2001. The terms and provisions of the lease agreement and other pertinent data are as
follows:
a) The term of the lease is 5 years, and the lease agreement is non-cancelable, requiring equal
rental payments of Rs 47,963 at the beginning of each year (annuity due basis).
b) The equipment has a fair value at the inception of the lease of Rs. 200,000, an estimated
economic life of 5 years, and no residual value.
c) The lease contains no renewal options, and the equipment reverts to Lessor Company at the
termination of the lease.
d) Ebad Company s incremental borrowing rate is 11% per year.
e) Ebad Company depreciates on a straight line basis similar equipment that it owns.
f) Qaseem Ahmad & Company sets the annual rental to earn a rate of return on its investment of
10% per year; this fact is known to Ebad & Company.

Required:
In light of IFRS 16, state with the reasons:
(I) Which interest rate would be used for capitalization of lease, in the books of Ebad & Company in
accordance with IFRS 16?
(II) Calculate the amount to be capitalized in the books of lessee.
(III) Prepare a Lease Amortization Schedule in the Books of Ebad & Company, showing amount of profit
and reduction in principal. (Round-off the figures in nearest Rupees)

Q.4 Munir Niazi Corporation, a lessor, purchased a new machine for Rs. 1,200,000 on December 31,
2001. This was delivered the same day to Ahmad Nadeem & Company (the lessee).

Following information relating to lease transaction is available:

(I) The Lease Asset has an estimated useful life of 5 years which coincides with the Lease term.
(II) At the end of lease term, machine will revert to Munir Niazi Corporation, at which time it is expected
to have a residual value of Rs. 100,000. (None of which is guaranteed by Ahmad Nadeem &
Company).
(III) Munir Niazi Corporation’s implicit interest rate is 8% which is known to Ahmad Nadeem & Company.
(IV) Ahmad Nadeem & Company's incremental borrowing rate is 10% at December 31, 2001.
(V) Lease rentals consist of five equal annual payments, the first of which was paid on December 31,
2001.
(VI) Both the lessor and the lessee use calendar year as their accounts period and depreciate all fixed
assets on straight line basis.

Required:
a) Compute the annual rental under the lease.
b) Compute the amounts of Gross investment and unearned finance income that Munir Niazi Corporation
should disclose at the inception of the lease i.e 31-12-2001.
c) What expense should Ahmad Nadeem & Company record for the year ended 31, 2002?

----------( 263 )----------

 Your Interview with ALLAH is Coming

ANSWERS

1 SHER KHAN LIMITED

Scenario 1: Lease term = 5 years

Explanation: The optional extension period is included because Sher Khan limited (lessee) is
reasonably certain that it will exercise the option to extend the lease.

Scenario 2: Lease term = 3 years

Explanation: The optional extension period is excluded because Sher Khan limited (lessee) is not
reasonably certain that it will exercise the option to extend the lease.

Scenario 3: Lease term = 7 years

Explanation: The optional cancellable period is excluded since it is only included if there is reasonable
certainty that the option to cancel (terminate) the lease would not be exercised. However, in this case,
Sher Khan limited (lessee) is reasonably certain that it will exercise its option to cancel.

Scenario 4: Lease term = 10 years

Explanation: The optional cancellable period is included because we include it if we are reasonably
certain that we would not exercise our option to cancel (terminate) the lease. In this case, Sher Khan
limited (lessee) is reasonably certain that it will not wish to cancel the lease.

Scenario 5: Lease term = 7 years

Explanation: The optional cancellable period is excluded. Although we normally include the cancellable
periods if we are reasonably certain that the option to cancel (terminate) will not be exercised, and in
this case, Sher Khan limited (lessee) is reasonably certain that it will not wish to cancel the lease, the
cancellable period is excluded because the lessor also has the option to cancel the lease during this
period.

2.
(i) Calculation of rentals

Fair value + IDC = PV of LP + PV of URV

290,000 + 50,000** = 50,000 + R [1- (1+0.1)-3 + 30,000* (1+0.1)-

3

0.1
*as there is a purchase option, therefore URV will not be applicable as ownership is expected to be transferred
at the end of the lease term because of purchase option.
** 100,000 x 50% = 50,000
R= 107,550 (approx) Rupees

Cost 700,000 Purchase on 1st Jan 2013

Life 10 Years
Accumulated depreciation as on 31.12.2018
(700,000/10 x 5)
350,000
Carrying amount 350,000

----------( 264 )----------

 When we repair our relationship with Allah, He repairs everything else for us
(b)
Journal Entries in the books of P limited for the year ended 31-12-2018
1-1-2018 Lease Receivable (net 340,000
investment) 350,000
Acc. depreciation 60,000
Loss (WDV 350,000; FV
290,000)
Plant 700,000
Cash (IDC) 50,000
1-1-2018 Bank 50,000
Lease Receivable 50,000
31-12-2018 Bank 107,550
Lease Receivable 78,550
Finance income 29,000
(To record receipt of 1st installment of the lease)

Payment Rentals Principal Interest @ 15% Closing

Date Repayment Principal
01-01-18 340,000
01-01-18 50,000 50,000 - 290,000
31-12-18 107,550 78,550 29,000 211,450
31-12-19 107,550 86,405 21,145 125,045
31-12-20 137,550 125,045 12,505 -
(107,550+30,000)

P limited
Statement of Financial Position (Extracts)
As at 31-12-2018
Non-current Asset
Lease Receivable 125,045

Current Asset
Lease Receivable (current portion) 86,405

Notes to the financial statements for the year ended 31-12-2018

Maturity Analysis – contractual undiscounted lease payments
Less than one year 107,750
One to two years (107,750 + 30,000) 137,550
Total undiscounted lease receivable 245,100
Reconciliation:
Total lease receivable (107,550+137,550) 245,100
Add: unguaranteed residual value -
Gross investment in lease 245,100
Less: unearned finance income (21,145+12,506) (33,650)
Net investment in lease 211,450

Journal Entries in the books of T limited:

1-1-2018 Right to use Asset 340,000
Leased Liability 340,000

PV of LP = 50,000 + 107,550[ 1-
(1+0.1)-3
+30,000 (1+0.15)-3 0.1

1-1-2018 Right to use Asset 50.000

Cash 50,000

[IDC (100,000 x 50%)]

----------( 265 )----------
 1-1-2019 Right to use Asset 37,566
Provision for dismantling 37,566
50,000 (1+0.1)-3

1-1-2018 Lease Liability 50,000

Cash 50,000
31-12-2018 Lease Liability 78,550
Interest Expense 29,000
Cash 107,550
31-12-2018 Depreciation 85,513
Acc Depreciation 85,513
(340,000+50,000+37,566)/5
10-5 (already passed up to the
date of lease)=5 (take useful life
as base as there is purchase
option)
31-12-2018
Interest Expense 3,757
Provision 3,757

[unwinding of discount]
(37,566 x 10%)

T limited
Statement of financial position (Extracts)
As at 31.12. 2018
ASSETS Rupees
Non-current assets
Property, plant and equipment (Right of use) 341,053
[340,000+50,000+37,566=427,566-85,513]
LIABILITIES
Non-current liabilities
Lease liability 125,045
Provision for dismantling (37,566+3,757) 41,323
Current liabilities
Current portion of obligation under lease 86,405

Notes to the financial statements (Extracts)

As at 31 Dec 2019
Property, plant and equipment 2019
Right of use Rupees
Cost
Opening balance -
Addition during the year 427,566
Closing balance 427,566
Accumulated depreciation
Opening balance -
Depreciation for the year 85,513
Closing balance 85,5132
Carrying Amount 341,053

----------( 266 )----------

 “If you want that Allah love you then obey Allah.”

Maturity analysis – contractual undiscounted lease payments

Less than one year 107,550

One to two year (107,750 + 30,000) 137,550
Total undiscounted lease payments 245,100

The Company has entered into a lease agreement in respect of a plant. The lease liability bears interest at
the rate of 10% per annum. There is a purchase option at 30,000. The lease rentals are payable in arrears.
There are no financial restriction in the lease agreement.

A.3 Solution:
Qaseem Ahmad

Rate to be used
Ebid Company should use 10% as implicit rate. This rate is being charged by lessor and is known to the
lessee.

Incremental borrowing rate is used by lessee when implicit rate is not available.
Amount to be capitalized

Present value of LP = Rental x Annuity Factor

=47,963 x 4.16986
= 200,000 approximately

Lease Amortization Schedule

Date Rental Principal Finance Charge Balance
Jan 0 ,2001 - - - 200,000
Jan 1,2001 47,963 47,963 - 152,037
Jan 1,2002 47,963 32,759 15,204 119,278
Jan 1,2003 47,963 36,035 11,928 83,243
Jan 1,2004 47,963 39,639 8,324 43,604
Jan 1,2005 47,963 43,604 4,359 Nil
239,815 200,000 39,815

A.4 Solution:
Munir Niazi
a) Computation of Annual Rental
According to IFRS 16, by using interest rate implicit in the lease
FV of Asset + IDC = PV of LP + PV of URV
1,200,000 + 0 = R + R[1-(1+i)-n] + URV (1+n)-n
i

=R+ R [1-(1+0.08)-4] + 100,000 (1 + 0.08)-5

0.08
R = 262,502
b) Computation of Gross Investment
Gross investment = 262,502 x 5 + 100,000
= 1,412,510
Unearned Finance Income
UFI = GI – NI
= 1,412,510 – 1,200,000
= 212,510
Net Investment = 262,502 + 262,502 [1- (1+ 0.08)-4] + 100,000 (1+0.08)-5
0.08
= 1,131,942 + 6,8058
= 1,200,000

----------( 267 )----------

c) Books of Ahmad Nadeem & Co
Income Statement (Extracts)
For the year ended Dec 31, 2002

*Depreciation [ 1,131,940] 226,388

5
**Finance Charge 69,555

*Lessee records the asset at PV of LP. In this case PV of LP is 1,131,940

and FV = 1,200,000
W-1 PV of LP = 262,502 + 262,502 [ 1- (1 + 0.08)-4]
0.08
= 1,131,940
**Finance Charge (1,131,941 – 262,502) x 8% 69,555
= =

----------( 268 )----------

Extra Practice Question
Q1.
Coal Limited (cl) is preparing its financial statements for the year ended 30 June 2019.
Following information is available:

On 1 January 2019, CL acquired a machine on lease from a bank. Fair value of machine on acquisition was
Rs. 70 million. CL incurred initial direct cost of Rs. 5 million and received lease incentives of Rs. 2 million.

The terms agreed with the bank are as follows:

▪ The lease term and useful life are 4 years and 10 years respectively.
▪ Instalment of Rs. 17 million is to be paid annually in advance on 1 January.
▪ The rate implicit in the lease is 15.096% per annum.
▪ At the end of the lease term, CL has an option to purchase the machine at its estimated fair value of
Rs. 25 million. It is not reasonably certain that CL will exercise this option.
Required:
Prepare extracts from CL’s statement of financial position and related notes to the financial statements for the
year ended 30 June 2019. (Note on Property, plant and equipment is not required) (07)

Q.2
Guava Limited (GL), had acquired a machinery from Honeyberry Limited (HL) on 1 July 2017 on the following
terms:
The non-cancellable lease period is 3.5 years. Each semi-annual lease instalment of Rs. 48 million is payable
in arrears.
The lease contains an option to extend the lease term by 1.5 years. Each semi annual lease installment in the
extended period will be of Rs. 15 million, payable in arrears. It is reasonably certain that GL will exercise this
option.
The rate implicit in the lease is 10% per annum.
The useful life of machinery is 6 years.
The un guaranteed residual value at the end of lease term is estimated at Rs. 20 millions.
Required:
Prepare extracts from GL’s statement of financial position and related notes to the financial statements for the
year ended 30 June 2018. (Note on Property, plant and equipment is not required)

A.2
Guava Limited
Statement of finsncial position
For the year ended 30 June 2018
Rs. in million
Non Current Assets
Right of use asset (w-3) 245.424

Non current liabilities

Lease liabilities (w-1) 166.01
Current liabilities
Current portion of lease liabilities 73.82
(36.0+37.81)

Guava Limited
Notes to the financial statements
For the year ended 30 June 2018
Rs. in million
Maturity analysis - contractual undiscounted cash flows
Less than one year (48×2) 96.00
One to two years (48×2) 96.00
Two to three years (48+15) 63.00
Three to four years [(15×2)] 30.00
285.00
----------( 269 )----------
 And whoever fears ALLAH, he will make for him a way out. [65:2]

The Company has entered into a lease agreement. The lease liability bears interest at the rate of 10% per
annum. Ownership is not expected to be transferred at the end of lease term. The lease rentals are payable
in semi annually in arrears. There are no financial restriction in the lease agreement.
W-1: Lease schedule
Instalment Principal Interest @ Balance
Date 10%per annum
--------------------------------- Rs. in million ----------------------
1-Jul-17 306.78
31-Dec-17 48.00 32.66 15.34 274.12
30-Jun-18 48.00 34.29 13.71 239.83
31-Dec-18 48.00 36.01 11.99 203.82
30-Jun-19 48.00 37.81 10.19 166.01

W-2: present value of lease payments

Rs. in million

PV of Rs. 48 million over 7 installment [48×{(1–1.05–7)÷0.05}] 277.75

PV of Rs. 15 million over 3 installment [15×{(1+.05 )+ 15×{(1+.05–9)+
–8

15×{(1+.05–10)] 29.03
306.78
W-3: Right of use asset Rs. in million
Present value of lease rental 306.78
Depreciation (306.78÷5) (61.356)
245.424

Lease (Lessor)
Q. GUAVA LEASING LIMITED (GLL)

Guava Leasing Limited (GLL), had leased a machinery to Honeyberry Limited (HL) on 1 July 2017 on the
following terms:

The non-cancellable lease period is 3.5 years. Each semi-annual lease instalment of Rs. 48 million is
receivable in arrears.

The lease contains an option to extend the lease term by 1.5 years. Each semi annual lease instalment in
the extended period will be of Rs. 15 million, receivable in arrears. It is reasonably certain that HL will
exercise this option.

The rate implicit in the lease is 10% per annum.

The useful life of machinery is 6 years.

The unguaranteed residual value at the end of lease term is estimated at Rs. 20 million. GLL incurred a
direct cost of 10 million and general overheads of 0.5 million to complete the transaction.

Required:
Prepare note(s) for inclusion in GLL’s financial statements, for the year ended 30 June 2018.

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A.
Guava Limited
Notes to the financial statements
For the year ended 30 June 2018

Rs. in million

Reconciliation:
Lease payments [(48×5)+(15×3)] 285.00
Unguaranteed residual value of machinery 20.00
Gross investment in lease 305.00
Unearned lease income (Bal.) (51.65)
Net investment in lease (W-1) 253.36
Current portion of net investment in lease (Bal.) (72.43)
(W-1) 180.92
Maturity analysis - contractual undiscounted lease payments:
Less than one year (48×2) 96.00
One to two years (48×2) 96.00
Two to three years (48+15) 63.00
Three to four years [(15×2)] 30.00
285.00
Note: URV is not a part of lease payments.

W-1: Amortization Schedule

Installment Interest Closing

Date
--------------------- Rs. in million ---------------------

1-Jul-17 319.06
31-Dec-17 48.00 (15.95) (287.01)
30-Jun-18 48.00 (14.35) (253.36)
31-Dec-18 48.00 (12.67) (218.03)
30-Jun-19 48.00 (10.90) (180.92)

W-2: Net investment in lease on 1 July 2017

Rs. in million
PV of Rs. 48 million over 7 installment [48×{(1–1.05–7)÷0.05}] 277.75
PV of Rs. 15 million over 3 installment [15×{(1+.05 –8)+ 15×{(1+.05–9)+
15×{(1+.05–10)] 29.03
PV of Rs. 20 million of UGRV [20×1.05–10] 12.28
319.06

DEFINITIONS AND CONCEPTS

Recognition requirement for lessee [IFRS 16: 22]
A lessee is required to recognise a right-of-use asset representing its right to use the underlying leased asset
and a lease liability representing its obligation to make lease payments.

Recognition Exemptions [IFRS 16: 5, 6 & 8]

A lessee may avail exemption from above recognition requirements in following cases:
a) Short term leases: A lease that, at commencement date, has a lease term of 12 months or less
(including extension option etc.). A lease that contains a purchase option is not a short-term lease.
This exemption is available to lessee by class of assets.
b) Leases of low value items (whether or not material to lessee): The leases for which the underlying
asset is of low value (e.g. telephones, laptop computers, and office furniture). A lease of an underlying
asset does not qualify as a lease of a low-value asset if the nature of the asset is such that, when
new, the asset is typically not of low value. This exemption is available to lessee on lease by lease
basis.

----------( 271 )----------

The lease payments associated with short term and low value item leases are charged as an expense on
either a straight-line basis over the lease term or another systematic basis (only if more representative).

Inception date & commencement date [IFRS 16: Appendix A]

Inception date of the lease

The earlier of the date of a lease agreement and the date of commitment by the parties to the principal terms
and conditions of the lease. The type of lease is identified on this date.

Commencement date of the lease

The date on which a lessor makes an underlying asset available for use by a lessee. The accounting treatment
is applied from this date.

Example:
J Limited enters into a contract for the lease of a car with K Leasing Limited on January 18th. K Leasing
Limited agrees to transfer the car in the name of J Limited on February 3rd. However, J Limited would have
the right to use the car as at February 22nd.
Required: Identify the inception date and commencement date of lease.

ANSWER:
Inception date: January 18th
Commencement date of lease: February 22nd

Lease Term [IFRS 16: 18]

Lease term is the non-cancellable period for which a lessee has the right to use an underlying asset,
together with both:
• periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that
option; and
• periods covered by an option to terminate the lease if the lessee is reasonably certain not to exercise
that option.

Example:
S Limited acquired a plant on lease for a non-cancellable period of 6 years. S Limited has right to extend the
period of lease further 4 years at the end of first 6 years.
Required:
Determine the lease term assuming that:
(a) It is reasonably certain that S Limited will not exercise extension option.
(b) It is reasonably certain that S Limited will exercise extension option.

ANSWER:
(a) 6 years
(b) 10 years

Economic life and useful life [IFRS 16: Appendix A]

Economic life is either:
• The period over which an asset is expected to be economically usable by one or more users; or
• The number of production or similar units expected to be obtained from the asset by one or more
users.
Useful life is either:
• The period over which an asset is expected to be available for use by an entity; or
• The number of production or similar units expected to be obtained from an asset by an entity.
Notice that useful life is entity specific concept and economic life is not. Useful life is relevant to calculation
of depreciation while economic life is one of the factors considered while classifying the lease contract.

Example B Limited acquired a second hand plant. The total maximum use of such plant is expected to be
12 years by one or more users. The plant has already been used for 4 years by previous owners. B Limited
intends to use the plant for 5 years and then wants to sell it to someone else.
Required: Determine economic life and useful life.

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ANSWER:
Total economic life is 12 years (remaining 8 years).
Total useful life for B Limited is 5 years.
Lease payments (including residual value guarantee) [IFRS 16: Appendix A]
Lease payments are payments made by a lessee to a lessor relating to the right to use an underlying asset
during the lease term, comprising the following:
• Fixed payments less any lease incentives;
• Variable lease payments that depend on an index or a rate;[e.g. if certain profit level is achieved]
• The exercise price of a purchase option if the lessee is reasonably certain to exercise that option;
and
• Payments of penalties for terminating the lease, if the lease term reflects the lessee exercising an
option to terminate the lease.

Lease payments also include:

• For the lessee, amounts expected to be payable by the lessee under residual value guarantees.
• For the lessor, any residual value guarantees provided to the lessor by the lessee, a party related
to the lessee or a third party unrelated to the lessor that is financially capable of discharging the
obligations under the guarantee.

“Residual value guarantee” is a guarantee made to a lessor by a party unrelated to the lessor that the
value (or part of the value) of an underlying asset at the end of a lease will be at least a specified amount.

Example
Adeel Limited (AL) acquired a machine on lease from Kashif Limited (KL) on following terms:
Down Payment Rs. 5 million
Annual Payments (in arrears) Rs. 8 million
Lease Term 5 years
In addition to above information consider the following three independent scenarios:

Scenario 1: AL has guaranteed residual value of Rs. 10 million, although it expects to pay Rs. Nil as
machine has expected residual value of Rs. 15 million.

Scenario 2: AL has guaranteed residual value of Rs. 10 million, although it expects to pay only Rs. 3 million
as machine has expected to have market value of Rs. 7 million at end of lease term.

Scenario 3: AL has not guaranteed any residual value, however, M Limited (manufacturer of machine) has
guaranteed KL to purchase the machine at the end of lease term at Rs. 13 million if KL so desire.

Required: Calculate total lease payments for AL and KL for each of the above scenarios.

ANSWER:
Scenario 1:
For AL (Lessee): [5m + (8m x 5 years) + Nil] = Rs. 45 m
For KL (Lessor): [5m + (8m x 5 years) + 10m] = Rs. 55m
Scenario 2:
For AL (Lessee): [5m + (8m x 5 years) + 3m] = Rs. 48 m
For KL (Lessor): [5m + (8m x 5 years) + 10m] = Rs. 55m
Scenario 3:
For AL (Lessee): [5m + (8m x 5 years) + Nil] = Rs. 45 m
For KL (Lessor): [5m + (8m x 5 years) + 13m] = Rs. 58m

Definitions relating to finance lease calculation [IFRS 16: Appendix A]

Example:
M Leasing Limited (MLL) leased an asset (fair value Rs. 285,000) to XYZ Limited for use at annual rental (in
arrears) of Rs. 80,000 for five years. MLL incurred initial direct costs of Rs. 5,227 on inception of lease. MLL
estimated the residual value of Rs. 30,000 at the end of lease term, however, only Rs. 20,000 is guaranteed
by XYZ Limited. Interest rate implicit in lease is 14%.

Required: Calculate amounts relevant to finance lease from the above information for MLL.

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ANSWER:
Residual value guarantee = Rs. 20,000
Lease payments [(80,000 x 5) + 20,000] = Rs. 420,000
Unguaranteed residual value [30,000 – 20,000] = Rs. 10,000
Gross investment in lease [420,000 + 10,000] = Rs. 430,000

PV of rentals [80,000 x (1-1.14-5) / 0.14] = Rs. 274,646

PV of RV guarantee [20,000 x 1.14-5] = Rs. 10,387
PV of URV [10,000 x 1.14-5] = Rs. 5,194
Net investment in lease [274,646 + 10,387 + 5,194] = Rs. 290,227
Unearned finance income
[430,000 – 290,227] = Rs. 139,773

Example [To calculate lease rental]

Sani Limited (SL) leased an asset having fair value of Rs. 3,500,000 from Khan Limited (KL) for a lease term
of 5 years. SL incurred initial direct costs of Rs. 60,000 and KL incurred initial direct costs of Rs. 40,000
separately.

KL estimates the residual value of the asset at the end of lease term to be Rs. 500,000 out of which 200,000
is guaranteed by SL.
KL incorporates interest rate implicit in the lease of 15% while incremental borrowing rate of SL is 14%.

Required: Calculate annual rentals (equal) to be paid in arrears in the above lease arrangement.

Answer
Using the equations (from lessor’s perspective):
1−(1+0.015)−5
3500000 + 40000 = [𝑅 [ ] + 200,000(1.15)−5 ] + 300,000(1.15)−5
0.15
981,879

AT GLANCE
ACCOUNTING BY LESSEE
Example
On 1 January 2020, Multan Limited (ML) acquired a machine on lease from Vehari Leasing Limited (VLL) for
3 years. The first annual instalment amounting to Rs. 35 million was paid on 1 January 2020 and two more
subsequent annual instalments of Rs. 35 million are payable on 1 January each year.

ML incurred initial direct cost of Rs. 5 million. ML uses similar owned machines for 7 years and depreciates
them on straight line basis.

Interest rate implicit in the lease is not known to ML. However, ML’s incremental borrowing rate is 12%.
The machine shall be returned to VLL at the end of lease term. The estimated residual value of the machine
at the end of 3 years is estimated at Rs. 30 million, out of which ML has guaranteed Rs. 20 million.

ML is also obliged to incur decommissioning cost of Rs. 4 million at the end of the lease term. The pre‑ tax
rate that reflects current market assessments of the time value of money and the risks specific to such
obligation is 10%.

Required: Prepare the journal entry at commencement date of lease in the books of ML.

Answer:
Date Particulars Debit Rs. m Credit
Rs. m
1 Jan 2020 Right of use asset 102.16
Bank (first instalment) 35
Bank (initial direct cost) 5
Lease liability (35 x (1-1.12-2)/0.12 59.15
Provision for decommissioning (Rs. 4m x 3.01
1.10-3)
Note: Nothing is expected to be paid for residual value guarantee as expected residual
value is more than the amount guaranteed.
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Example:
Use the data from previous example on Multan Limited (ML).
Required: Prepare journal entries reflecting subsequent measurement of right of use asset and provision for
decommissioning (assuming that provision was settled as estimated).

Date Particulars Debit Rs. m Credit Rs.

m
31 Dec 2020 Depreciation (Rs. 102.16m / 3 years) 34.05
Accumulated depreciation (ROU) 34.05
31 Dec 2020 Finance cost (Rs. 3.01m x 10%) 0.30
Provision for decommissioning 0.30
31 Dec 2021 Depreciation (Rs. 102.16m / 3 years) 34.05
Accumulated depreciation (ROU) 34.05
31 Dec 2021 Finance cost (Rs. 3.31m x 10%) 0.33
Provision for decommissioning 0.33
31 Dec 2022 Depreciation (Rs. 102.16m / 3 years) 34.06
Accumulated depreciation (ROU) 34.06
31 Dec 2022 Finance cost (Rs. 3.64m x 10%) 0.36
Provision for decommissioning 0.36
31 Dec 2022 Accumulated depreciation (ROU) 102.16
Right of use asset 102.16
31 Dec 2022 Provision for decommissioning 4
Bank 4

Subsequent measurement – lease liability [IFRS 16: 36 to 38]

After the commencement date, a lessee re-measures the lease liability by:
Increasing the carrying amount to reflect interest on the lease Dr. Interest expense
liability. Cr. Lease liability
Reducing the carrying amount to reflect the lease payments Dr. Lease liability
made. Cr. Bank
Variable lease payments that have not been included in the Dr. Expense (PL)
initial measurement of the lease liability are recognised in the Cr. Bank / Accrual
period in which the event or condition that triggers the
payments occurs.

Example
Use the data from previous examples on Multan Limited (ML).

Required: Prepare journal entries reflecting subsequent measurement of lease liability (assuming that no
payment was required to be paid at the end of lease term for residual value guarantee as expected earlier).

ANSWER:
Date Particulars Debit Rs. m Credit
Rs. m
31 Dec 2020 Interest expense 7.10
Lease liability 7.10
1 Jan 2021 Lease liability 35
Bank 35
31 Dec 2021 Interest expense 3.75
Lease liability 3.75
1 Jan 2022 Lease liability 35
Bank 35
W1 - Lease schedule (Payment in advance)
Opening balance Payment Net Balance Interest @ 12% Closing
Payment Date Balance
Rs. m
01-Jan-20 94.15 (35) 59.15 7.10 66.25
01-Jan-21 66.25 (35) 31.25 3.75 35
01-Jan-22 35 (35) 0 0 0
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Accounting for short term and low value item leases [IFRS 16: 6]
The lease payments associated with short term and low value item leases are charged as an expense on
either a straight-line basis over the lease term or another systematic basis (only if more representative).

Example
An entity leased a car under a ten months lease at Rs. 40,000 per month for first five months and Rs. 30,000
for next five months. The asset had fair value of Rs. 3,000,000. The ownership will not transfer to the lessee.
Required: Briefly explain the accounting treatment assuming that the entity wants to apply recognition
exemption under IFRS 16.

ANSWER:
The above lease meets short term lease definition as lease term is less than 12 months and ownership will
not be transferred at the end of lease term. The monthly expense on straight line basis would be:
[(Rs. 40,000 x 5 months) + (Rs. 30,000 x 5 months )] / 10 months = Rs. 35,000 per month

Date Particulars Debit Rs. Credit Rs.

For each of firstLease rental expense 35,000
five months Prepayment 5,000
Cash/Bank 40,000
For each of next Lease rental expense 35,000
five months Cash/Bank 30,000
Prepayment 5,000

Example
S Limited (SL) leased a laptop computer under a 24 months lease at Rs. 2,500 per month. A sum of Rs.
4,800 was also deposited as non-refundable down payment. The fair value of the laptop computer is Rs.
95,000. SL determines that it is low value asset.

Required: Briefly discuss the accounting treatment assuming that SL want to apply recognition exemption
under IFRS 16.

ANSWER:
When the lessee makes payments to lessor over 24 months, the lessee shall account for the payments in
equal instalments (straight line basis). The monthly expense on straight line basis would be:
[Rs. 4,800 + (Rs. 2,500 x 24 months )] / 24 months = Rs. 2,700 per month

Date Particulars Debit Rs. Credit Rs.

On down Prepaid lease rental 4,800
payment Cash/Bank 4,800
For each monthly Lease rental expense 2,700
payment and Cash/Bank 2,500
expense Prepaid lease rental 200

Disclosure [IFRS 16: 52 to 58 & 60]

Requirement
A lessee shall disclose information about its leases for which it is a lessee in a single note or separate
section in its financial statements. However, a lessee need not duplicate information that is already
presented elsewhere in the financial statements, provided that the information is incorporated by cross-
reference in the single note or separate section about leases.

Specific amounts to be disclosed

A lessee shall disclose the following amounts for the reporting period:
a) depreciation charge for right-of-use assets by class of underlying asset;
b) interest expense on lease liabilities;
c) the expense relating to short-term leases;
d) the expense relating to leases of low-value assets;
e) the expense relating to variable lease payments not included in the measurement of lease liabilities;
f) total cash outflow for leases;
g) additions to right-of-use assets; and
h) the carrying amount of right-of-use assets at the end of the reporting period by class of underlying
asset
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Requirements of other Standards
If right-of-use assets meet the definition of investment property, a lessee shall apply the disclosure
requirements in IAS 40.
If a lessee measures right-of-use assets at revalued amounts applying IAS 16, the lessee shall disclose the
information specified in relevant disclosure of IAS 16 for those right of use assets.

Example:
On 1 April 2015 Acacia Ltd entered into the following lease agreement.
I. Plant with a fair value of Rs. 275,000 was leased under an agreement which requires Acacia Ltd to
make annual payments of Rs. 78,250 on 1 April each year, commencing on 1 April 2015, for four years.
After the four years Acacia Ltd has the option to continue to lease the plant at a nominal rent for a further
three years and is likely to do so as the asset has an estimated useful life of seven years. The present
value of the lease payments is Rs. 272,850. Acacia Ltd is responsible for insuring and maintaining the
plant during the period of the lease.
II. Office equipment with a fair value of Rs. 24,000 was leased under a non-cancellable agreement which
requires Acacia Ltd to make annual payments of Rs. 6,000 on 1 April each year, commencing on 1 April
2015, for three years. The lessor remains responsible for insuring and maintaining the equipment during
the period of the lease. The equipment has an estimated useful life of ten years. The present value of
the lease payments is Rs. 16,415. This lease is considered low value item lease by Acacia Ltd.

Acacia Ltd allocates finance charges on an actuarial basis. The interest rate implicit in the lease is 10%.

Required: Prepare all relevant extracts from Acacia Ltd.’s financial statements for the year ended 31 March
2016.

ACACIA Limited
Statement of Comprehensive Income
For the year ended 31 March 2016 Rs.
Depreciation [272,850 / 7 years] 38,979
Interest expense W1 19,460
Lease rental expense (low value item lease) 6,000

ACACIA Limited
Statement of financial position
As at 31 March 2016 Rs.
Non-current assets
Right of use [272,850 – 38,979] 233,871
Non-current liabilities
Lease liability W1 135,810
Current liabilities
Lease liability W1 78,250

Notes to the financial statements

Maturity Analysis Rs.
Less than one year 78,250
One to two year 78,250
Two to three years 78,250
234,750

W1 - Lease schedule (Payment in advance)

Opening balance Payment Net Balance Interest @ 10% Closing Balance
Payment Date Rs.
01-Apr-15 272,850 (78,250) 194,600 19,460 214,060
01-Apr-16 214,060 (78,250) 135,810

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Example
Progress Limited acquired a machine from Fine Rentals Limited on January 3, 2016 under a lease agreement
extending over three years.

The agreement required them to make an initial deposit of Rs. 1,280,000 to be followed by three annual
payments of Rs.800,000 on 31 December each year starting from 2016.

The cash price of the machinery was Rs. 3,200,000 and Fine Rentals Limited added 12% interest which was
duly communicated to Progress Limited.

Required:
a) Compute the interest element and the capital portion of the annual repayments; and
b) Show the journal entries that will record the transaction resulting from the lease agreement (excluding
depreciation entries).

ANSWER
1−(1+0.12) −3
PV of lease payments = 1,280,000+800,000 = 3,201,465
0.12
Part (a)
Lease schedule (Payment in arrears)
Payment Date Opening Interest @ Rental payment Closing Capital
balance 12% Balance repayment
Rs. Rs.
03-Jan-16 3,201,465 (1,280,000) 1,921,465 1,280,000
31-Dec-16 1,921,465 230,576 (800,000) 1,352,041 569,424
31-Dec-17 1,352,041 162,245 (800,000) 714,286 637,755
31-Dec-18 714,286 85,714 (800,000) 0 714,286
478,535 (3,680,000) 3,201,465

Part (b) Journal entries

Date Particulars Dr. Rs. Cr. Rs.
03-Jan-16 Right of use (Plant & Machinery) 3,201,465
Bank 1,280,000
Lease liability 1,921,465
31-Dec-16 Interest expense 230,576
Lease liability 230,576
31-Dec-16 Lease liability 800,000
Bank 800,000
31-Dec-17 Interest expense 162,245
Lease liability 162,245
Date Particulars Dr. Rs. Cr. Rs.
31-Dec-17 Lease liability 800,000
Bank 800,000
31-Dec-18 Interest expense 85,714
Lease liability 85,714
31-Dec-18 Lease liability 800,000
Bank 800,000

Indicators of situations that individually or in combination could also lead to a lease being classified as a
finance lease (not always conclusive) are:
• Lessor’s losses associated with the cancellation of lease are borne by the lessee;
• Gain or losses from the fluctuation in fair value accrue to the lessee (as discussed above that risks
and rewards are of lessee); and/or
• The lessee has the ability to continue the lease for secondary period at a rent that is substantially
lower than market rent.
Classification is not changed due to:
• change in estimates (economic life, residual value etc.); and/or
• change in circumstances (e.g. default by lessee).

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Example
Consider the following independent scenarios:
I. E Limited acquired a special customized engine on lease. The engine can only be used by E Limited
unless substantial modifications are made to the engine.
II. P Limited acquired an asset on lease with fair value of Rs. 10 million and present value of lease
payments is Rs. 9.7 million.
III. M Limited acquired an asset on lease economic life of 20 years while M Limited wants to use the asset
only for 17 years. The company has no intention to purchase the asset at the end of its lease term.
IV. T Limited acquired an asset on lease with an option to buy the asset at the end of lease term for Rs.
12 million. The fair value of the asset at the end of lease term is expected to be at least Rs. 55 million.
Required: Identify the above leases as either finance or operating leases from the perspective of lessor.

ANSWER:
All of the above leases are likely to be classified as finance lease because:
i. The underlying assets is of such specialised nature that only lessee can use it without major
modifications.
ii. The present value of lease payments amounts to substantially all of the fair value of underlying asset.
iii. The lease term is for the major part of the economic life of the underlying asset.
iv. As purchase options is sufficiently lower than the fair value at the date of option, it is reasonably certain
that this option will be exercised by the lessee.

Example
Jhang Construction has leased a cement lorry. The cash price of the lorry would be Rs.3,000,000. The lease
is for 6 years at an annual rental (in arrears) of Rs.600,000. The asset is believed to have an economic life of
7 years. The interest rate implicit in the lease is 7%.

Jhang Construction is responsible for maintaining and insuring the asset.

Required: Identify the type of lease from lessor’s perspective and state the reasons.

ANSWER:
The lease is a finance lease. The reasons are:
• The lease is for a major part of the life of the asset (6 out of 7 years).
• Jhang Construction must insure the asset. It is exposed to one of the major risks of ownership of the
asset (its loss).
• The present value of the lease payments is 95.3% [(600,000 x (1-1.07-6/0.07))/3,000,000] of the fair
value of the asset at the inception of the lease.

Accounting for finance lease (manufacturer or dealer lessor) [IFRS 16: 71 to 75]
A manufacturer or dealer lessor shall account for the finance lease as follows:

Initial recognition – Dr. Net Investment in lease

at commencement Dr. Cost of Sales [Cost – PV of URV] (Note 1)
date of lease. Cr. Sales [Lower of fair value & PV of lease payments] (Note 2)
Cr. Inventory [at Cost]

Note 1: Selling profit or loss [Revenue – Cost of Sales] is recognised in PL regardless of whether the
lessor transfers the underlying asset as described in IFRS 15

Note 2: Manufacturer or dealer lessors sometimes quote artificially low rates of interest in order to attract
customers. The use of such a rate would result in a lessor recognising an excessive portion of the total
income from the transaction at the commencement date(which is against the prudence concept)(the use
of lower rate results into higher present value and vice versa) If artificially low rates of interest are
quoted, a manufacturer or dealer lessor shall restrict selling profit to that which would apply if a market
rate of interest were charged.

----------( 279 )----------

Example:
Multan Motors (MM) is a car dealer. It sells cars on cash and also offers a certain model for sale by lease.
MM sold a car on lease on 1 January 2022. The following information is relevant:

Price of the car in a cash sale Rs. 2,000,000

Cost of the car to MM Rs. 1,500,000
Lease option:
Annual rental in arrears Rs. 764,018
Lease term 3 years
Interest rate implicit in the lease 10%
Estimated residual value (unguaranteed) Rs. 133,100
Costs incurred by MM in setting up the lease (IDC) Rs.20,000

The market rate of interest is also 10%.

Required: Prepare journal entries at commencement date of lease term for MM.

ANSWER:
Date Particulars Dr. Cr.
Rs. Rs.
1 Jan 2022 Net investment in lease 2,000,000
Cost of sales [1,500,000 – 100,000] 1,400,000
Revenue 1,900,000
Inventory 1,500,000
1 Jan 2022 Selling expenses 20,000
Bank 20,000

Workings Rs.
Present value of lease payments [Rs. 764,018 x (1-1.10-3)/0.10] 1,900,000
Revenue shall be recognised at lower of fair value (Rs. 2,000,000) and PV of lease payments (Rs.
1,900,000).
Present value of unguaranteed residual value [Rs. 133,100 x 1.10-3] 100,000
Net investment in lease (Rs. 1,900,000 + 100,000) 2,000,000
Note: The lease schedule shall be made using 10% rate.

Example:
Karachi Motors (KM) is a car dealer. It sells cars on cash and also offers a certain model for sale by lease.
KM sold a car on lease on 1 January 2022. The following information is relevant:

Price of the car in a cash sale Rs. 2,000,000

Cost of the car to KM Rs. 1,500,000
Lease option:
Annual rental Rs. 764,018
Lease term 3 years
Interest rate implicit in the lease 10%
Estimated residual value (unguaranteed) Rs. 133,100
Costs incurred by KM in setting up the lease (IDC) Rs.20,000
Market interest rate is 15%. KM has quoted artificially low rate to attract customers.
ANSWER:
Date Particulars Dr. Cr.
Rs. Rs.
1 Jan 2022 Net investment in lease 1,831,940
Cost of sales [1,500,000 – 87,515] 1,412,485
Revenue 1,744,425
Inventory 1,500,000
1 Jan 2022 Selling expenses 20,000
Bank 20,000
----------( 280 )----------
Disclosure – Additional Information
This additional information (qualitative & quantitative) includes, but is not limited to, information that helps
users of financial statements to assess:
• the nature of the lessor’s leasing activities; and
• how the lessor manages the risk associated with any rights it retains in underlying assets, in
particular, its risk management strategy for its rights in underlying assets.
The above additional disclosure are applicable to both, finance lease and operating lease.
Accounting for operating lease [IFRS 16: 81 to 86 & 88]
Lease income Lease income from operating lease shall be recognized on a straight-line basis
over the lease term unless another systematic basis is more representative of
benefit derived from the leased asset.
Related costs A lessor shall recognise costs, including depreciation, incurred in earning the
lease income as an expense.
Depreciation and The deprecation is to be charged as per normal depreciation policy as per IAS 16
impairment or IAS 38. Similarly, IAS 36 shall be applied for impairment.
Initial direct costs A lessor shall add initial direct costs incurred in obtaining an operating lease to the
carrying amount of the underlying asset and recognise those costs as an expense
over the lease term on the same basis as the lease income.
Presentation in SFP A lessor shall present underlying assets subject to operating leases in its
statement of financial position according to the nature of the underlying asset.
Manufacturer or A manufacturer or dealer lessor does not recognise any selling profit on entering
dealer lessor into an operating lease because it is not the equivalent of a sale.
Example
Jay Limited entered into an operating lease agreement with Mojo Limited on 1 January 2021 incurring the
initial direct cost of Rs. 30,000.
The lease was over a plant (which Jay Limited had bought on 1 January 2020 for Rs. 1,600,000). The terms
of the lease are as follows:
Commencement date: 1 January 2021
Lease term 3 years
Fixed lease instalments, payable as follows:
- 31 December 2021 Rs. 200,000
- 31 December 2022 Rs. 220,000
- 31 December 2023 Rs. 300,000

Plant has total useful life of 8 years and is being depreciated using straight line method.
Required: Prepare the journal entries in the books of Jay Limited from the start to end of lease term. Jay
Limited year-end is 31 December.
ANSWER:
Date Particulars Dr. Rs. Cr. Rs.
01-Jan-21 Plant 30,000
Bank (initial direct costs) 30,000
31-Dec-21 Depreciation W2 210,000
Accumulated depreciation 210,000
31-Dec-21 Bank 200,000
Lease rental receivable 40,000
Lease rental income (PL) W1 240,000
31-Dec-22 Depreciation W2 210,000
Accumulated depreciation 210,000
31-Dec-22 Bank 220,000
Lease rental receivable 20,000
Lease rental income (PL) W1 240,000
31-Dec-23 Depreciation W2 210,000
Accumulated depreciation 210,000
31-Dec-23 Bank 300,000
Lease rental receivable 60,000
Lease rental income (PL) W1 240,000

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W1 - Annual lease income (straight line basis) Rs.
First rental 200,000
Second rental 220,000
Third rental 300,000
720,000
Lease term 3 years
240,000

W2 - Depreciation Rs.
On initial direct costs capitalised [Rs. 30,000 / 3 years] 10,000
On cost of plant [Rs. 1,600,000 / 8 years] 200,000
210,000

Example
Square Limited (SL) is a dealer of electronic items. SL acquires refrigerators of a particular model from a
manufacturer at a discount of 15% on the retail price of Rs. 300,000 per unit.

On 1 January 2018, SL sold 12 refrigerators to Cube Hotel at retail price on lease.

The rate of interest implicit in the lease was 10% per annum. The payment is to be made in three equal
annual instalments payable in advance. Residual value at the end of 3 years is nil.

The market rate of interest is 14% per annum.

Required:
Prepare journal entries in the books of SL in respect of above transaction for the year ended 31 December
2018.

Note: Rentals will be calculated by 10% implicit rate . However lease calculation will be by using rate of
14%.

ANSWER:
JOURNAL ENTRIES
Date Particulars Dr. Rs. Cr. Rs.
01-Jan-18 Lease receiveable 3,483,079
Cost of sales [300,000 x 85% x 12 units] 3,060,000
Sales revenue 3,483,079
Inventory 3,060,000
01-Jan-18 Bank 1,316,028
lease receiveable 1,316,028
31-Dec-18 Interest receivable 303,387
Finance income (PL) 303,387

FV = PV of LP + PV of URV
1−(1+0.1)−2
3,600,000 = 𝑥 + 𝑥 [ ]
0.1
X= 1,316,028

Net investment in lease [ 1,316,028 + Rs. 1,316,028 x (1 – 1.14-2) /0.14)] Rs. 3,483,079

Revenue shall be measured at lower of fair value Rs. 3,600,000 (i.e. Rs. 300,000 x 12 units) and present
value of lease payments Rs. 3,483,079.

Since market rate of interest is 14% and SL has quoted lower interest rate. The present value shall be
calculated using market rate of interest.

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W2: Lease schedule (Payment in advance)
Opening Payment Net Balance Interest @ Closing Balance
Payment Date balance 14%
Rs.
01-Jan-18 3,483,079 (1,316,028) 2,167,051 303,387 2,470,439
01-Jan-19 2,470,439 (1,316,028) 1,154,411 161,617 1,316,028
01-Jan-20 1,316,028 (1,316,028) (0)

Disclosure [IFRS 16: 89 to 97]

Disclosure – Finance Lease

• The following amounts are to be disclosed (preferably in tabular format):
selling profit or loss;
• finance income on the net investment in the lease; and
• income relating to variable lease payments not included in the measurement of the net investment in
the lease.

Changes in net investment in lease

A lessor shall provide a qualitative (means whether an amount is still considered good) and quantitative
explanation (any change in rental because of e.g modification option) of the significant changes in the
carrying amount of the net investment in finance leases.

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 “Help others and don’t cause the problem.”

Lease Part 3:

Lease Classification

Identifying whether entity has a lease

At inception of a contract, an entity shall assess whether the contract is, or contains, a lease.

Definition of lease contract:

A contract is, or contains, a lease if the contract conveys the right to control the use of an identified asset
for a period of time in exchange for consideration.

Is the asset identified?

a. Identification can be explicit or implicit: the contract might name a specific asset (e.g specific serial
numbers of asset (explicit identification) or a specific asset could simply be implied through it being made
available to the entity (implicit identification) e.g supplier has only one asset [Link] or generator which can
be given away) that is capable of being used to meet the contract terms.

b. Portions of asset can be identified: An identified asset could be just a portion of an asset if the portion is
physically distinct (eg floor of a plaza).

c. Assets are not considered as ‘identified’ if supplier has substantive right of substitution:
A supplier’s right to substitute assets is considered substantive if the supplier has both :
• Practical ability to substitute (for example, asset with specialized nature cannot be substituted) ; and
• Would benefit economically if it substituted the asset (i.e. benefits of substitution exceeds cost of
substitution)

Example 1:
A plaza has 8 floors. First 2 floors are given on rent. However, owner (supplier) has right to substitute these
two floors if a new customer provides higher rent and then transfer first customer to other floors of the plaza
(or supplier has more than one vehicles and he can substitute them if he gets higher rent from another
customer)

Example 2:
If an asset is located at customer premises then it is very difficult and costly to substitute the asset by the
supplier (it could be an example that substitution rights are not substantive)

If the right of supplier is considered to be substantive based on above criteria, the asset is not identified
and thus there is no lease.

Does the customer (potential lessee) has the right to “control the use’ of the asset?

The customer (lessee) shall be deemed to have the right to “control the use of asset” if:
i. He has a right to obtain substantially all the benefits from the use of the asset; and
ii. He has a right to direct the use of asset (explanation below)

The right to substantially all of the benefits

When assessing whether the customer (lessee) has the right to obtain substantially all the economic benefits,
it does not matter whether it can obtain these benefits directly or indirectly. This means that the entity could
obtain the benefits from using the leased asset (direct usage) or, for example, sub-leasing the asset (indirect
usage). The phrase ‘all of economic benefits’ refers to the benefits from both the primary output and also any
secondary output (i.e. it includes the inflows expected from, for example, the sale of by-products).

If the customer has the right to control the use of an identified asset for only a portion of the term of the contract,
the contract contains a lease for that portion of the term.

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 “Prayer purifies our hearts and brings mercy of Allah to us.”

Lease identification criteria [IFRS 16: B31]

The contract contains a lease if all of the following criteria are met:
(a) The underlying asset is identified.
(b) The customer (i.e. potential lessee) have the right to obtain substantially all of the economic
benefits from use of the asset throughout the period of use.
(c) The customer (and not the supplier) has the right to direct how and for what purpose the
asset is used throughout the period of use. (if supplier has the right to direct how and for
what purpose asset is used then it is not leased)
If neither party has such right then:
• If the customer has the right to operate the asset throughout the period of use, without the supplier
having the right to change those operating instructions then it is a lease contract; or
• If the customer has design the asset in a way that predetermines how and for what purpose the
asset will be used throughout the period of use then it is a lease contract.

Example: Substantive substitution right

ABC Ltd enters into a 5 year contract with a freight carrier (XYZ Ltd.) to transport a specified quantity of
goods. XYZ Ltd. uses rail cars of a particular specification, and has a large pool of similar rail cars that can
be used to fulfil the requirements of the contract. The rail cars and engines are stored at XYZ Ltd. premises
when they are not being used to transport goods. Costs associated with substituting the rail cars are minimal
for XYZ Ltd.

Required: whether the contract contains a lease.

Answer: In this case, because the rail cars are stored at XYZ Ltd. premises, it has a large pool of similar rail
cars and substitution costs are minimal, the benefits to XYZ Ltd. of substituting the rail cars would exceed
the costs of substituting the cars.

Therefore, XYZ Ltd. substitution rights are substantive and the arrangement does not contain a lease.

Low Value asset:

The underlying asset is not highly dependent on, or highly interrelated with other assets.
(Means we cannot break the aero plane into seats, engines etc. and say these are individually low value
assets.)

Example 1:
Lease commencement date 01-01-2018.
There are following lease payments in the contract:
60,000 in first year in arrears.
72,000 in second year in arrears.
84,000 in fourth year in arrears.
Rate = 10%

Lease is not for an asset considered as low value.

Required:
Prepare amortization table with respect to lessee.

Answer 1:

PV of lease payment = 60,000 (1+0.1)-1 + 72,000 (1+0.1)-2 +84,000 (1+0.1)-4

=171,422

Date Rentals Principle Interest Balance

1.1.2018 171,422
31.12.2018 60,000 42,858 17,142 128,564
31.12.2019 72,000 59,144 12,856 69,420
76,362
31.12.2020 - - 6,942 (69,420+6,942)
31.12.2021 84,000 76,364 7,636 2

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Entries of last two years:
31-12-2020
Interest expense 6,942
Interest payable 6,942
31-12-2021
Interest expense 7,636
Interest payable 6,942
Lease liability (76,364- 69,420
6.942)
Cash 84,000
Example 2:
Lease commencement date 01-01-2019.
There are seven annual lease rentals of Rs. 60,000 in arrears to be payable under the lease contract.

However no rentals are payable in fourth and fifth year of lease.

Rate = 10%

Required:
Prepare amortization table with respect to lessee.

Answer 2:
PV of lease payments: = 60,000 [1-(1+0.1)-3]+ 60,000 [1-(1+0.1)-4] x (1+0.1)-5
0.1 0.1
=267,305

Date Rentals Principle Interest Balance

1.1.2019 - - - 267,305
31.12.2019 60,000 33,269 26,731 234,036
31.12.2020 60,000 36,596 23,404 197,440
31.12.2021 60,000 40,256 19,744 157,184
31.12.2022 172,902
- - 15,718 (157,184+15,718)
31.12.2023 190,192
- - 17,290 (172,902+17,290)
31.12.2024 60,000 40,981 19,019 149,211
31.12.2025 60,000 45,079 14,921 104,132
31.12.2026 60,000 49,587 10,413 54,545
31.12.2027 60,000 54,545 5,455 -

Entry on 31.12.2024:
Interest expense 19,019
Interest payable (15,718+17,290) 33,008
Lease liability (40,981-33,008) 7,973
Cash 60,000

Example 3
On 1 Feb 2019, CCL entered into a lease agreement for non-cancelable period of 2.5 year with effect from
01-03-2019. Under the agreement 8 installments of 12 million are to be paid quarterly in arrears commencing
from end of 3rd quarter i.e 30-11-2019.

Interest rate implicit is 15% p.a which is not known to lessee (CCL). Incremental borrowing rate of CCL is 16%
p.a. On 1 April 2019, CCL completed installation of machine at a cost of 4 million and put it into use.

Required:
Prepare amortization table with respect to lessee.

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Answer 3:
PV of lease payment = 12 [1-(1+0.04)-8]
0.04
= 80.79 (1 + 0.04)-2
= 74.70
Date Rentals Principle Interest Balance
Rs. In million
1-3-2019 - - - 74.70
31-5-2019 - - 2.99 77.69
31-8-2019 - - 3.11 80.80
30-11-2019 12 8.77 3.23 72.03
28-2-2020 12 9.12 2.88 62.91
31-5-2020 12 9.48 2.52 53.43
31-8-2020 12 9.86 2.14 43.57
30-11-2020 12 10.26 1.74 33.31
28-2-2021 12 10.67 1.33 22.64
31-5-2021 12 11.09 0.91 11.55
31-8-2021 12 11.54 0.46 -

Example 4 ;
Lease commencement date =1-1-2018

Lease term =3 years

10 quarterly instalments of Rs. 10,000 each in advance starting from 1-7-2018.

Rate = 12%

Required:
Prepare amortization table with respect to lessee.

Answer 4:
PV of lease payment = 10,000+10,000 [1-(1+0.03)-9]
0.03
= 87,861 (1 + 0.03)-2
= 82,818

Date Rentals Principle Interest Balance

1-1-2018 82,818
1-1-2018 - - - 82,818
1-4-2018 - - 2,485 85,303 (82,818 + 2,485)
1-7-2018 10,000 7,441 2,559 77,862
1-10-2018 10,000 7,664 2,336 70,198
1-1-2019 10,000 7,894 2,106 62,304
1-4-2019 10,000 8,131 1,869 54,173
1-7-2019 10,000 8,375 1,625 45,798
1-10-2019 10,000 8,626 1,374 37,172
1-1-2020 10,000 8,885 1,115 28,287
1-4-2020 10,000 9,151 848 19,136
1-7-2020 10,000 9,426 574 9,710
1-10-2020 10,000 9,709 291 -

Example 5:
Lease commencement date =1-4-2019

Lease term =4 years

7 semiannual instalments of Rs. 8,000 each in advance starting from 1-10-2019.

Lessee’s incremental borrowing rate = 13.731%

Required:
Prepare amortization table with respect to lessee.
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Answer 5:
PV of lease payment = 8,000+8,000 [1-(1+0.068655)-6] [13.731 / 2 = 6.8655]
0.068655
= 46,291 (1 + 0.068655)-1
= 43,317

Date Rentals Principle Interest Balance

1-4-2019 43,317
1-10-2019 8,000 5,026 2,974 38,291
1-4-2020 8,000 5,371 2,692 32,920
1-10-2020 8,000 5,740 2,260 27,180
1-4-2021 8,000 6,134 1,866 21,046
1-10-2021 8,000 6,555 1,445 14,491
1-4-2022 8,000 7,005 995 7,486
1-10-2022 8,000 7,486 514 -

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 “Spread message of Quran and Sunnah and earn reward from Allah.”

Summary of lease[IFRS 16]

Treatment of Lease in the Books of Lessee:
At the commencement date*, a lessee shall recognise a right of use asset and a lease liability.
Subsequent Measurement of Right to use Asset:
After the commencement date, a lessee shall measure the right of use asset applying the cost model or
revaluation model. If right of use asset relates to property, plant and equipment (IAS 16) and revaluation model
is applied then lessee shall apply the revaluation model to all of the right to use assets that relate to that class
of property, plant & equipment. If right of use asset relates to Investment Property (IAS 40) the lessee can use
fair value model of IAs 40.
Cost Model: [Para 30]
If asset is measured at cost model, then lessee shall measure the right of use the asset at cost less
accumulated depreciation and accumulated impairment losses (as in IAS 16).
Depreciation Policy: [Para 32]
If the lease transfers ownership of the asset to lessee by the end of the lease term or if it is reasonably certain
that lessee will exercise the purchase option available in the lease contract, lessee shall depreciate the asset
over useful life. If this is not the case, the lessee shall depreciate the asset over the shorter of lease term and
useful life e.g. lets consider the following examples by assuming no transfer of ownership or purchase option
in lease contract.
Presentation: [Para 47]
A lessee shall present in statement of Financial Position [Para 47]:
(a) Right to use assets separately from other assets in non current assets.
(b) Lease liabilities separately from other liabilities by segregating the amounts into current and non current
liabilities.
In the statement of profit or loss, a lessee shall present interest expense on lease liability and depreciation
charge for the right to use asset. Interest expense is a component of financial charges in statement of profit
or loss. [Para 49]
Disclosures
• A schedule of right to use asset as like in IAS-16 [Para 53]
• If the lessee measures the right to use asset at revalued amounts as per IAS-16 or IAS 40, the lessee
shall disclose the revaluation related disclosures for that right to use asset (as discussed in IAS 16 or
IAS 40) [Para 57]
• A lessee shall disclose the maturity analysis of lease liability for the remaining contractual future lease
payments (without discounting) of each of the first five years plus a total amount for the remaining years.
• A narrative disclosure about leasing activities of lessee [Para 59] e.g:
(a) Nature of lessee’s leasing activities
(b) Information about purchase options or guaranteed residual values (if any)
(c) Interest rate
(d) amount of instalments
(e) Restrictions imposed by lessors in lease agreements.

Exception to the Previous discussion of lease for lessee [Para 6]:

A lessee may elect (it is an option not a compulsion) not to apply the above requirements to a lease contract
if:
(a) A lease is a short term lease*; or
*Short term lease; means a lease that at the commencement date, has a lease term of 12 months or less
(including extension period if any). A lease that contains a purchase option is not a short term lease. (even
if it is for 12 months or less).
(b) A lease of low value assets*.
Low value asset lease does not only means price is low but also includes that asset is not significant for
business operation (means main business activities are not dependent on it)

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An asset can be of low value if:
(a) The lessee can obtain benefit from use of asset with own resources available to the lessee (means can
be purchased by lessee itself); and
(b) The underlying asset is not highly dependent on, or highly interrelated with, other asset.
Examples of low-value assets can include tablets, personal computers, small items of office furniture, and
telephones.
IFRS -16 however specifically prescribes that lease of vehicles is not a lease low value assets.
The lessee shall assess the value of the asset based on the value of the asset when it is new, regardless of
the age of asset being leased.
Accounting Treatment [Para 6]:
No recording of right of use asset and lease liability.
No segregation of rental into principal and interest by preparing the finance charge allocation table.
If there is a short term lease or lease for which the asset is of low value, the lessee shall recognise the lease
payments as an expense on a straight line basis in statement of profit or loss; unless there is any other method
available in question.
Disclosure:
(1) A lessee that accounts for short term leases or leases of low value assets applying the above accounting
treatment shall disclose this fact in notes to financial statements [Para 60].
(2) A lessee shall disclose the amount of its lease commitments for short term leases (and for lease of low
value asset). (A disclosure in notes related to maturity analysis of future lease payments)
(3) In statement of cash flow; short term lease payments and payment for leases of low-value assets should
be classified within operating activities.

Treatment of lease in the books of Lessor:

A lessor shall classify each of its leases as either an operating lease or a finance lease. [Para 61]
Finance Lease:
A lease that transfers substantially all risks and rewards incidental to ownership of an asset. [Para 62].
Operating Lease:
A lease that does not transfers substantially all risks and rewards incidental to ownership of an asset [Para
62]. [means a lease which is not a finance lease].
Examples of situations that individually or in combination lead to a lease being classified as a finance lease
are [Para 63]:
(a) The lease transfers ownership of the asset to the lessee by the end of the lease term.
(b) The lessee has an option to purchase the asset at a price that is expected to be sufficiently lower than the
fair value of the asset at the end of lease term and it is reasonably certain at the inception of lease that
lessee will exercise the option to purchase the asset.
(c) The lease term is for the major part of the economic life of the asset (major part means lease term covers
at least 75% or more of economic life).
(d) At the inception of lease, present value of lease payments is substantially equal to fair value of asset
(substantially equal means at least PV of lease payments is 90% or more of fair value of asset).
(e) The asset is of such a specialized nature that only lessee can use it without major modification.

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Terminologies Used by lessor:
Gross Investment = Lease payments + URV
Net Investment = PV of lease payments + PV of URV
Unearned Finance Income = Gross Investment – Net Investment
Note:
1. If a note / disclosure is required in case of finance lease (lessor) then prepare a maturity analysis of
undiscounted contractual future lease payments receivable for a minimum of each of the first five
years plus a total amount for the remaining years. In addition a lessor shall reconcile the undiscounted
lease payments to net investment in lease. In addition immediately after the disclosure a narrative
information about lease is also to be prepared.
2. If there is a purchase option in question, then always assume that it is reasonably certain unless
otherwise specified.

Types of Lessor (in case of finance lease):

Lessor

Simple Lessor Manufacturer lessor/

E.g Dealer Lessor
Banks
Leasing Companies
Manufacturer lessor
E .g Honda Limited Starts
leasing business

Dealer Lessor
E.g Car Dealer starts leasing
business.

Nature of Income

Simple Lessor Manufacturer/ Dealer Lessor


Interest Income Normal Profit Interest Income
 (Sale – Cost of sales) 
Recognized on  Recognized on time
time basis Recognized when the asset is basis
sold

Initial Entries of Manufacturer / Dealer Lessor [In case of finance lease]

Lease receivable (Net Investment) xxx

Sales (Lower of FV & PV of LP) xxx

Cost of sales (Cost- PV of URV) xxx

Stock (cost) xxx
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Important points to remember:
1. If there is a difference between cost and sale price it means there is profit which should be recognized at
the time of sale.
2. For simple lessor → cost is Fair value
3. For Manufacturer/Dealer Lessor → Sale price is Fair value

Summary of Finance Lease (lessor)

Simple Lessor Dealer/Manufacturer Lessor
Initial Entry
Leased Receivable (NI) Leased Receivable (at NI)
Asset (Cost) Sale(at lower of FV & PV
(FV is cost) of LP)
Cost of sale (cost – PV of URV)
Stock (cost)
(FV is sale price)
Depreciation is charged
 

Finance Charge Allocation Table:

✓ ✓

Treatment of Interest
Interest is recognized as Interest is recognized as income
income

Operating lease in the books of lessor: [Para 81 to 85]

• The asset subjected to an operating lease shall continue to be in the books of lessor.
• Lessor shall depreciate the asset over its useful life as per IAS-16 and 38.
• For impairment testing of asset subjected to lease, consider requirements of IAS-36.
• No receivable is recorded.
• No finance charge allocation table is prepared.
• A lessor shall recognise the lease payments from operating leases as income on a straight line basis.
(unless question requires another basis)

Disclosures:
A disclosure of future lease instalments receivable is prepared in notes.[maturity analysis]

Schedule of PPE.
Note:
1. There is no difference in accounting treatment of simple lessor and dealer/manufacturer lessor in case of
an operating lease.
2. Before solving the question of lessor in examination, make a conclusion that whether the lease is a finance
lease or operating lease; and then start solving the question.

Initial Direct Cost:

Incremental costs of obtaining a lease that would not have been incurred if the lease contract is not made.

Initial direct costs includes;

– Commissions
– Legal fees
– Costs of negotiating lease terms and conditions (legal advisors fee)
– Costs of arranging collateral
– Payments made to existing tenants to obtain the lease

Treatment of Initial Direct Cost (IDC)

→ Lessee → IDC is added to the amount recognized as an asset.

→ Lessor→Operating Lease: Initial direct cost shall be added to the amount of the asset and recognized as
an expense over the leased term. [because IDC is for this lease only]

→ Lessee → IDC is recognized as an expense in case of short term or low value asset lease.
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→ Simple Lessor → Finance Lease
Initial direct Costs paid by the Lessor are included in the initial measurement of the finance lease receivable
and reduce the amount of income recognized over the lease term.

The result will be that net Investment In lease will Include amount of initial direct cost (Instead of having
recognized the expense in the current period, It will result in reduced Income over the lease term). [as in the
debt instruments of IFRS 9]

The above discussion can be understood by the following question.

Calculation of interest rate implicit in lease:

As per IFRS 16 calculation of rate is responsibility of Lessor. Rate is calculated by solving the following
equation.
FV+ Initial Direct Cost of Lessor = PV of LP + PV of URV

Dealer/Manufacturer lessor → Finance Lease

IDC should be recognized as an expense when incurred in the period of delivery of asset.
Therefore in case of dealer/manufacturer lessor equation to calculate implicit rate of return is
FV = PV of LP + PV of URV
Point to remember: URV means an amount which is not assured or guaranteed by party related to lessor

Summary of rates:
• Calculation of the interest rate implicit in lease is the responsibility of the lessor. Lessor will always use
this rate in his calculations.
• If this rate is known to lessee then he will also use that rate.
• If implicit rate is not known to lessee then he can use its incremental borrowing rate (means assume as if
lessee has borrowed the funds instead of taken the asset on lease).
• Sometimes manufacturer or dealer lessor might quote artificially low rate of interest to attract the
customers. The use of such a rate would result into lessor recognizing excessive amount of total income
at the commencement of lease (which is against the prudence concept) [lower rate would result into higher
PV and vice versa]. In such cases, the selling profit is restricted to that which would apply if a market rate
of interest is charged (means if both the lower implicit rate and market rate of interest are given then use
market rate for the calculation of present value).[page 545 Q.6 and 393]

Defined periods
A lease may be split into a primary period followed by an option to extend the lease for a further period (a
secondary period).
In some cases, the lessee might be able to exercise such an option with a small rental or even for no rental
at all. If such an option exists and it is reasonably certain that the lessee will exercise the option, the second
period is part of the lease term.

Lease accounting (Lessee) [summary]

At the commencement date, a lessee should recognise a right-of-use asset and a lease liability. It is the date
on which a lessor makes an underlying asset available for use by a lessee.
At the commencement date, a lessee should measure the right-of-use asset at cost. The cost of the right-of-
use asset should comprise:
(a) the present value of lease payments;
(b) less any lease incentives received;
(c) Add any initial direct costs incurred by the lessee;
(d) an estimate of costs to be incurred by the lessee in dismantling and removing the asset, restoring the
site on which it is located or restoring the underlying asset to the condition required by the terms and
conditions of the lease.

The lease payments shall be discounted using the interest rate implicit in the lease, if that rate can be readily
determined. If that rate cannot be readily determined, the lessee shall use the lessee’s incremental borrowing
rate.

Property companies: Many companies own properties which they lease out to others. These companies will
apply IAS 40 to their assets.

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Ethical Issues in Financial Reporting
Example:

Ibrahim is member of ICAP working as a unit accountant.

He is a member of a bonus scheme under which, staff receive a bonus of 10% of their annual salary if profit
for the year exceeds a trigger level.
Ibrahim has been reviewing working papers prepared to support this year’s financial statements.
He has found a logic error in a spreadsheet used as a measurement tool for provisions.
Correction of this error would lead to an increase in provisions. This would decrease profit below the trigger
level for the bonus.

Analysis:
Ibrahim faces a self-interest threat which might distort his objectivity.
Ibrahim has a professional responsibility to ensure that financial information is prepared and presented fairly,
honestly and in accordance with relevant professional standards. He has further obligations to ensure that
financial information is prepared in accordance with applicable accounting standards and that records
maintained represent the facts accurately and completely in all material respects.
Ibrahim must make the necessary adjustment even though it would lead to a loss to himself.

ICAP CODE OF ETHICS

Introduction
Ethics can be difficult to define but it is principally concerned with moral principles, character and conduct.
Ethical behaviour is more than obeying laws, rules and regulations. It is about doing ‘the right thing’. The
accountancy profession is committed to acting ethically and in the public interest.
Professional accountants may find themselves in situations where values are in conflict with one another
due to responsibilities to employers, clients and the public.
ICAP has a code of conduct which members and student members must follow. The code provides guidance
in situations where ethical issues arise.

Comment
Most people are honest and have integrity and will always try to behave in the right way in a given set of
circumstances. However, accountants might face situations where it is not easy to see the most ethical
course of action. One of the main roles of the ICAP code is to provide guidance in these situations.

Impact on members in practice

All members and student members of ICAP are required to comply with the code of ethics and it applies to
both accountants in practice and in business.

ICAP-Code of ethics has been bifurcated into following parts:

Part 1: Complying with the Code, Fundamental Principles and Conceptual Framework (All Chartered
Accountants)
Part 2: Chartered Accountants in Practice Part 3: Chartered Accountants in Business
Part 4A - Independence for Audit and Review Engagements
Part 4B - Independence for Assurance Engagements other than Audit and Review

This chapter explains ethical issues surrounding the preparation of financial statements and other financial
information.

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The fundamental principles
ICAP’s Code of Ethics expresses its guidance in terms of five fundamental principles. . These are:
▪ integrity;
▪ objectivity;
▪ professional competence and due care;
▪ confidentiality; and
▪ professional behaviour

Integrity
Members should be straightforward and honest in all professional and business relationships.
Integrity implies not just honesty but also fair dealing and truthfulness.
A chartered accountant should not be associated with reports, returns, communications or other information
where they believe that the information:
• Contains a materially false or misleading statement;
• Contains statements or information furnished recklessly; or
• Omits or obscures information required to be included where such omission or obscurity would be
misleading.

Objectivity
Members should not allow bias, conflicts of interest or undue influence of others to override their
professional or business judgements.

A chartered accountant may be exposed to situations that may impair objectivity. It is impracticable to define
and prescribe all such situations.
Relationships that bias or unduly influence the professional judgment of the chartered accountant should be
avoided.

Professional competence and due care

Practising as a chartered accountant involves a commitment to learning over one’s entire working life.

Members have a duty to maintain their professional knowledge and skill at such a level that a client or
employer receives a competent service, based on current developments in practice, legislation and
techniques. Members should act diligently and in accordance with applicable technical and professional
standards.

Continuing professional development develops and maintains the capabilities that enable a chartered
accountant to perform competently within the professional environments.

Confidentiality
Members must respect the confidentiality of information acquired as a result of professional and business
relationships and should not disclose such information to third parties without authority or unless there is a
legal or professional right or duty to disclose.

Confidential information acquired as a result of professional and business relationships should not be used
for the personal advantage of members or third parties.

Professional behaviour
Members must comply with relevant laws and regulations and should avoid any action which discredits the
profession. They should behave with courtesy and consideration towards all with whom they come into
contact in a professional capacity.

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Threats to the fundamental principles
Compliance with the fundamental principles may potentially be threatened by a broad range of
circumstances. Many threats fall into the following categories:
▪ Self-interest;
▪ Self-review;
▪ Advocacy;
▪ Familiarity; and
▪ Intimidation.

Members must identify, evaluate and respond to such threats. Unless any threat is clearly insignificant,
members must implement safeguards to eliminate the threats or reduce them to an acceptable level so that
compliance with the fundamental principles is not compromised.

Self- interest threats

Self-interest threats may occur as a result of the financial or other interests of members or their immediate or
close family members.
Such financial interests might cause members to be reluctant to take actions that would be against their own
interests.
Examples of circumstances that may create self-interest threats include, but are not limited to:
▪ Incentive compensation arrangements.
▪ Concern over employment security.
▪ Commercial pressure from outside the employing organization.

Self-review threats
Self-review threats occur when a previous judgement needs to be re-evaluated by members responsible for
that judgement. For example, where a member has been involved in maintaining the accounting records of a
client he may be unwilling to find fault with the financial statements derived from those records. Again, this
would threaten the fundamental principle of objectivity.

Circumstances that may create self-review threats include, but are not limited to, business decisions or data
being subject to review and justification by the same chartered accountant in business responsible for
making those decisions or preparing that data.

Advocacy threats
A chartered accountant in business may often need to promote the organisations position by providing
financial information. As long as information provided is neither false nor misleading such actions would not
create an advocacy threat.

Familiarity threats
Familiarity threats occur when, because of a close relationship, members become too sympathetic to the
interests of others. Examples of circumstances that may create familiarity threats include:
• A chartered accountant in business in a position to influence financial or non-financial reporting or
business decisions having an immediate or close family member who is in a position to benefit from
that influence.
• Long association with business contacts influencing business decisions.
• Acceptance of a gift or preferential treatment, unless the value is clearly insignificant.

Intimidation threats
Intimidation threats occur when a member’s conduct is influenced by fear or threats (for example, when he
encounters an aggressive and dominating individual at a client or at his employer).
Examples of circumstances that may create intimidation threats include:
• Threat of dismissal or replacement over a disagreement about the application of an accounting
principle or the way in which financial information is to be reported.
• A dominant personality attempting to influence decisions of the chartered accountant.

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PREPARATION AND REPORTING OF INFORMATION
Accountants in business
Accountants in business are often responsible for the preparation of accounting information.
Accountants in business need to ensure that they do not prepare financial information in a way that is
misleading or that does not show a true and fair view of the entity’s operations.

Accountants who are responsible for the preparation of financial information must ensure that the
information they prepare is technically correct, reports the substance of the transaction and is adequately
disclosed.

There is a danger of influence from senior managers to present figures that inflate profit or assets or
understate liabilities. This puts the accountant in a difficult position. On one hand, they wish to prepare
proper information and on the other hand, there is a possibility they might lose their job if they do not comply
with their managers wishes.
In this case, ethics starts with the individual preparing the information. They have a difficult decision to make;
whether to keep quiet or take the matter further. If they keep quiet, they will certainly be aware that they are
not complying with the ethics of the accounting body they belong to. If they speak out, they may be bullied at
work into changing the information or sacked.

Section 220 of the ICAP Code of Ethics

Users of information prepared and presented by a Chartered Accountant:
Chartered accountants in business at all levels are often involved in the preparation and presentation of
information that may either be made public or used by others inside or outside the employing organisation
including:
• Management and those charged with governance(i.e board of directors including supervisory board
having non executive directors).
• Investors and lenders or other creditors.
• Regulatory bodies (SECP or SBP).

Types of information prepared and presented by a Chartered Accountant:

Such information may include financial or management information, for example:
• Operating and performance reports.
• Decision support analyses (like trend and ratio analysis in annual reports)
• Forecasts and budgets;
• Information provided to the internal and external auditors.
• Risk analyses.
• General and special purpose financial statements (e.g. forcasted financial statement to be provided
to financial institutions to obtain the financing).
• Tax returns.
• Reports filed with regulatory bodies for legal and compliance purposes.

Basic principals in preparing and presenting information:

When preparing or presenting information, a chartered accountant shall:
a. Prepare or present the information in accordance with a relevant reporting framework (like IFRS
and Companies Act 2017), where applicable (if budgets or ratio analysis is prepared and presented
then there is no such reporting frameworks);
b. Prepare or present the information in a manner that is intended neither to mislead nor to
influence contractual or regulatory outcomes inappropriately;
c. Exercise professional judgment to:
• Represent the facts accurately and completely in all material respects;
• Describe clearly the true nature of business transactions or activities;
• Classify and record information in a timely and proper manner; and
• Not omit anything with the intention of rendering the information misleading or of influencing
contractual or regulatory outcomes inappropriately.

Use of Discretion in Preparing or Presenting Information

(Sometimes IFRS provide options e.g. FIFO or weighted average; cost model or revaluation model etc.)
Preparing or presenting information might require the exercise of discretion in making professional
judgments. The chartered accountant shall not exercise such discretion with the intention of misleading
others or influencing contractual or regulatory outcomes inappropriately.
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Examples of ways in which discretion might be misused to achieve inappropriate outcomes include:
a. Determining estimates, for example, determining fair value estimates (different property dealers
are providing different fair values of property) in order to misrepresent profit or loss.
b. Selecting or changing an accounting policy or method among two or more alternatives permitted
under the applicable financial reporting framework, for example, selecting a policy for accounting for
inventories in order to misrepresent profit or loss.
c. Determining the timing of transactions, for example, timing the sale of an asset near the end of
the accounting year in order to mislead.(e.g. changing the revenue recognition policy from delivery
of goods to dispatch of goods)
d. Determining the structuring of transactions, for example, structuring financing transactions in
order to misrepresent assets and liabilities or classification of cash flows.(e.g classifying the lease
agreements as low value asset leases or vice versa)
e. Selecting disclosures, for example, omitting or obscuring (conceal) information relating to financial
or operating risk in order to mislead.(e.g. non disclosure of possible contingencies and
commitments)
If in certain situations compliance with relevant reporting framework is not required then chartered
accountant should exercise his professional judgment:
When performing professional activities, especially those that do not require compliance with a relevant
reporting framework (e.g. when preparing budgets or forecasts), the chartered accountant shall exercise
professional judgment to identify and consider:
(a) The purpose for which the information is to be used (e.g. planning);
(b) The context within which it is given (e.g. organization as a whole or departments); and
(c) The audience to whom it is addressed(e.g. departmental heads or BOD).
For example, when preparing or presenting budgets or forecasts, the inclusion of relevant estimates,
approximations and assumptions, where appropriate, would enable those who might rely on such
information to form their own judgments.
The chartered accountant might also consider clarifying the intended audience, context and purpose of the
information to be presented.

Relying on the Work of Others (revaluation report of valuers whether internal or external to
comply with IAS 16 or Actuaries in case of employee benefit plans like pension and Gratuities
or lawyers when applying IAS 37)
A chartered accountant who intends to rely on the work of others, either internal or external to the employing
organization, shall exercise professional judgment to determine what steps to take, if any, in order to fulfill
his responsibilities

Factors to consider in determining whether reliance on others is reasonable include:

• The reputation and expertise of, and resources available to, the other individual or organization.
• Whether the other individual is subject to applicable professional and ethics standards.(means
whether his professional body has adopted any professional and ethical standards like ICAP)

From where a Chartered accountant can obtain above information [Actions to be taken in such a
situation]:
Such information might be gained from prior association with, or from consulting others about, the other
individual or organization.

Addressing Information that is or Might be Misleading

When the chartered accountant knows or has reason to believe that the information with which the
accountant is associated is misleading, the accountant shall take appropriate actions to seek to resolve
the matter including:
1. Discussing concerns that the information is misleading with the chartered accountant’s superior
and/or the appropriate level(s) of management within the accountant’s employing organization or
those charged with governance, and requesting such individuals to take appropriate action to
resolve the matter. Such action might include:
• Having the information corrected.
• If the information has already been disclosed to the intended users, informing them of the
correct information.
2. Consulting the policies and procedures of the employing organization (for example, an ethics
or whistle-blowing policy) regarding how to address such matters internally.

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If employing organization has not taken appropriate action:
The chartered accountant might determine that the employing organization has not taken appropriate action.
If the accountant continues to have reason to believe that the information is misleading, the following further
actions might be appropriate provided that the accountant remains alert to the principle of confidentiality:
Consulting with:
a. A relevant professional body (e.g. ICAP).
b. The internal or external auditor of the employing organization.
c. Legal counsel (legal Advisors).
Determining whether any requirements exist to communicate to:
• Third parties, including users of the information.
• Regulatory and oversight authorities (SECP and SBP to disclose fraudulent practices).

After exhausting all options:

If after exhausting all feasible options, the chartered accountant determines that appropriate action has not
been taken and there is reason to believe that the information is still misleading then:
1. The accountant shall refuse to be remain associated with the information.
2. In such circumstances, it might be appropriate for a chartered accountant to resign from the
employing organization.

Documentation (Create an evidence)

The chartered accountant is encouraged to document:
a. The facts.
b. The accounting principles or other relevant professional standards involved.
c. The communications and parties with whom matters were discussed.
d. The courses of action considered.
e. How the accountant attempted to address the matter(s).

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 Practice questions
Q.1 Zia is a Chartered Accountant and works as a financial controller in Unique Engineering Limited (UEL).
UEL is currently considering the acquisition of Top Storage Limited (TSL) and Zia is a member of the team
which is currently negotiating the acquisition with the management of TSL.
After becoming aware of the prospective acquisition, Zia purchased 1,000,000 shares of TSL in the name of
his wife and son.

Required:
Briefly explain how Zia is in breach of the fundamental principles of ICAP’s code of ethics. Also explain the
potential threats that may be involved in the above situation. (06)

Q.2 Baqir, ACA is working as Finance Manager at Kiwi Limited (KL), a listed company, and reports to
Shahid, FCA who is the Chief Financial Officer of the company.
Before the date of authorization for issuance of KL’s financial statements for the year ended 30 June
2018, Zahoor (a mutual friend of Baqir and Shahid) informed Baqir that Shahid has recommended him to
purchase KL’s shares as higher EPS is expected this year. Zahoor also sought Baqir’s advice on this
matter.

Required:
Briefly explain how Shahid may be in breach of the fundamental principles of ICAP’s code of ethics. Also
state the potential threats that Baqir may face in the above circumstances and how he should respond. (08)

Q.3 Umer Sheikh, ACA is Manager Finance at Charming Limited (CL) and reports to Abid, FCA who is the
Chief Financial Officer of CL. Abid is also a close relative of the major shareholder of CL.
CL is negotiating an important financing arrangement with Union Standard Bank (USB) in order to
expand its business in foreign markets. The rate quoted by USB is comparatively higher than existing
rates being paid by CL.
During a meeting with the Executive Vice President (EVP) of USB, where Umer Sheikh was also
present, Abid revealed that his son has applied for a house financing in USB last month but has not
received any response from USB so far. Abid requested EVP to consider his application. EVP agreed to
look into the matter. On conclusion of the meeting, Abid asked Umer Sheikh to prepare a note for the
board of directors proposing the acceptance of the rate offered by USB.

Required:
Briefly explain how Abid may be in breach of the fundamental principles of ICAP’s code of
ethics. Also state the potential threats that Umer Sheikh may face in the above circumstances
and how he should respond. (08)

Q.4
Ali and Bashir are chartered accountants and have been working as Managing Director (MD) and Chief
Financial Officer (CFO) in a listed company. In a recent meeting of the Board, the directors have decided to
expand the business within six months by opening 20 retail outlets. This expansion would require financing of
Rs. 300 million which may be arranged through bank loan.

MD has advised the CFO to arrange the loan from MN Bank. He has also informed that the President of the
bank is his good friend and the loan can be arranged on a fast track basis at a mark-up of 15% per annum,
subject to the following conditions:
1. current ratio and quick ratio should be at least 2:1 and 1:1 respectively;
2. gearing ratio should not exceed 40%; and
3. interest cover should be at least 3.

CFO is not comfortable with this deal as the mark-up offered by the bank is much higher than the rate on the
existing loan and it is difficult for the company to meet the gearing requirements of the bank. However, MD
has asked him to make certain changes in the draft financial statements before submission to the bank;
which according to the CFO are not in accordance with the IFRSs.

Required: Briefly explain how the MD may be in breach of fundamental principles of ICAP’s code of Ethics.
Also state the potential threats that CFO may face along with available safeguards.

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Q.5
On receiving the revised financial statements, the CEO called Faraz and briefed him in the following manner:
“Since the position of the CFO is vacant, I intend to promote you as CFO. Company has been through a
rough year and has some disappointing results but a reasonable profit needs to be reported for the mutual
benefit of all stakeholders. Moreover, the financial statements would also be scrutinized by the bank to
ensure that the loan covenants are met which include maintaining total assets at 1.5 times the total
liabilities.
Therefore, I want you to confirm the draft financial statements without making any adjustment for
presentation before the Board and submission to the bank.”

Required: Identify the threats faced by Faraz along with available safeguards

Q.6
Waheed is a chartered accountant, recently employed by AA Public limited Company as deputy to the
finance director, Arif (also a chartered accountant). AA Public limited Company is listed on the Pakistan
stock exchange.
On Waheed’s first day on the job he met with Arif who said ‘Look, keep it to yourself but I’m having a second
interview next week for a new job. The first thing that I need you to do is to review the financial statements
before the auditors arrive. I qualified a few years ago and am not up to date on all of the little technicalities in
IFRS. You should know these better than me and you’ll know more about what the auditors might focus on.
We must do our best to present the financial statements in the most favourable light as the bonus paid to
employees (including me) depends on profit being more than 10% bigger than last year’s and remember that
you qualify for this too. Keep this in mind when you carry out the review as we do not really want to find
anything. Do well at this and I might put in a good word for you when I leave as I’m sure you’ll be a great
replacement for me.”

Required:
Brief explain how Arif may be in breach of the fundamental principles of ICAP’s code of Ethics. Also state the
potential threats that Waheed may face in the above circumstances and how he should respond.

Q.7
Atif is a chartered accountant and has been working as Manager – Accounts in an unlisted public company
MNZ Limited.
While preparing the financial statements for the year ended 31 December 2016, CFO of MNZ who is also a
chartered accountant informed Atif that the directors are considering to have the company listed on Pakistan
Stock Exchange.

Consequently, CFO wants to show higher profit and has asked Atif to identify areas where book adjustments
can be made. He has also informed that if MNZ is able to list the shares at a price of Rs. 35 or more, all
managerial staff would be given an additional bonus this year.

Required:
Briefly explain how the CFO is in breach of the fundamental principles of ICAP’s code of ethics. Also state the
potential threats that Atif may face under the above circumstances and how he should respond.

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 ANSWERS

A.1 Mr. Zia breached the following fundamental principles of ICAP code of ethics:
(i) Confidentiality
Under the Code of Ethics, member must respect the confidentiality of information acquired as a
result of professional and business relationship. Confidential information acquired should not be
used for the personal advantage by a member.
In the above scenario, Mr Zia has breached the principle of confidentiality by using the confidential
information for the personal advantage since the information was not publicly available.

(ii) Professional behaviour

Under the Code of Ethics, member must comply with relevant laws and regulations and should
avoid any action which discredits the profession.
Since it can be a non compliance of laws and regulation, he may be in breach of the principle of
professional behaviour.

Potential threats involved in the circumstances:

Self interest threat
Since Mr. Zia is part of a team which is negotiating the price of the shares and he has purchased
shares in the name of his wife and son, it creates self interest threat and he would be reluctant to take
any decision that would be against his own interest.(i.e. non-acquisiton of TSL).

Ans.2 In the given situation, CFO may be in breach of:

(i) Principle of Professional behavior:
This principle imposes an obligation on all chartered accountants to comply with relevant
laws and regulations and avoid any action that discredits the profession. According to
Zahoor, Shahid revealed inside information to him which is non-compliance of regulations
pertaining to inside information and his act may discredit the profession as well. As a result
Shahid has breached this principle.
(ii) Principle of confidentiality:
This principle imposes an obligation on all chartered accountants to refrain from using
confidential information acquired as a result of professional and business relationships to
their personal advantage or the advantage of third parties.

In given scenario, Shahid misused the confidential information for the advantage of his friend so
Shahid has breached this principle.

Threats faced by Baqir

i. Intimidation threat:
Baqir may face intimidation threat from his superior if he raises objection on non-compliance
of regulations by Shahid.

ii. Familiarity Threat:

Baqir may also face familiarity threat as his interest towards friendship with Zahoor may be at
stake if he refuses to disclose (confirm or deny) the confidential information to him.

Available safeguards for Baqir:

a. He should refrain himself from disclosing any confidential information to his friend.

b. He should discuss the concerned issue with Shahid.

c. He should consider informing appropriate authorities like Audit Committee/CEO.

d. consult the policies and procedures of the company with respect to ethics or whistle blowing policy
to address the matter internally
e. Consider consulting with the relevant professional body, internal or external auditor, legal council or
informing third parties or appropriate authorities in line with the ICAP guidance on confidentiality.
f. should resign.

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Ans.3 In the given situation, CFO may be in breach of :
i. Principle of professional behavior:
This principle imposes an obligation on all chartered accountants to avoid any action that the
chartered accountant knows or should know may discredit the profession. CFO should have
avoided discussing his personal interest in official meeting.
ii. Principle of objectivity:
Chartered Accountant should not compromise their professional or business judgment
because of bias, conflict of interest or the undue influence of others. In this circumstance, he
has compromised his professional and business judgment due to his personal interest as he
requested the EVP to consider application of his son who has applied for house financing in
USB.
iii. Principle of integrity:
Chartered Accountant should be straight forward and honest in all professional and business
relationship. It seems that CFO may be inclined to accept higher mark-up rate as compared
to existing rate being paid by CL, resulting breach of integrity.

Intimidation threat faced by Mr. Umer

Umer may face intimidation threat from his superior if he would raise his objection on acceptance of higher
mark-up rate offered by the Bank specially where his superior i.e. Abid is a relative of principal shareholder
too.

Available safeguards
If this threat is significant Umer should consult with superiors within the organization in order to eliminate or
reduce it to an acceptable level.
Where it is not possible to reduce the threats to an acceptable level, Umer should refuse to associate with
this financing arrangement and take the following appropriate steps:
i. should consider informing appropriate authorities like Audit Committee / CEO;
ii. consult the policies and procedures of the company with respect to ethics or whistle blowing policy to
address the matter internally;
iii. consider consulting with the relevant professional body, internal or external auditor, legal council or
informing third parties or appropriate authorities in line with the ICAP guidance on confidentiality;
iv. should resign.

Answer 4:
In this situation, the existence of threats to fundamental principles will depend on following factors:
• Whether financing from other banks is available at lower mark up;
• Whether it is feasible to borrow @15% for the expansion.
If financing from other banks is available or it may not be feasible to finance the project at the rate of 15%,
and still MD is pressurizing the CFO to obtain financing at higher rate of mark-up the MD may be in breach
of:
Principle of objectivity
It can be a bias decision on part of MD, as he may be favoring his friend who is the president of the bank or
may have any other interest in taking loan from that particular bank.
Principle of integrity
MD may be in breach of principle of integrity because he is asking CFO to manipulate the financial
information.
Potential threat to CFO:
Preparation of financial information as per the instructions of MD, will result in intimidation threat to integrity
and objectivity.
Available safeguards
Identified threat is significant as the CFO is being instructed from the highest level of management. In order to
reduce the threat to an acceptable level, the following safeguards should be applied:
• Consult with superiors such as audit committee or those charged with governance.
• Consult the policies and procedures of the company with respect to ethics or whistle blowing policy
to address the matter internally.
• Consider consulting with the relevant professional body, internal or external auditor, legal council or
informing third parties or appropriate authorities in line with the ICAP guidance on confidentiality.
• Where it is not possible to reduce the threat to an acceptable level, CFO shall refuse to be remain
associated with the financial information and consider resigning from the post of CFO.
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A.5
In the given situation, Faraz may face following threats:
i. Self-interest threat
Self-interest threat occurs as Faraz has been told by the CEO that he would be promoted to CFO.
ii. Intimidation threat
Faraz may have to quit this job if he would not confirm the draft financial statement as per CEO’s
instructions.
Available safeguards:
Where it is not possible to reduce the threats to an acceptable level, Faraz:
(i) should refuse to remain associated with information which is or may be misleading;
(ii) should consider to consult with superiors such as audit committee or those charged with
governance;
(iii) consult the policies and procedures of the company with respect to ethics or whistle blowing policy
to address the matter internally;
(iv) consider consulting with the relevant professional body, internal or external auditor, legal council or
informing third parties or appropriate authorities in line with the ICAP guidance on confidentiality;
(v) may resign.

Ans.6
The range of comments made by Arif raises questions over his ethical behaviour and professional
standards.
A chartered accountant should be unbiased when involved in preparing and reviewing financial information.
A chartered accountant should prepare financial statements fairly, honestly, and in accordance with relevant
professional standards and must not be influenced by considerations of the impact of reported results.

Arif’s breach of fundamental principles:

Principle of Integrity:
Arif appears to be influenced by the need to achieve a specified level of profit. This is not appropriate and calls
his integrity into question.

Principle of Professional competence

In addition, Arif’s professional competence seems to be suspect. His comment on not being up to date on all
of the little technicalities in IFRS s suggests that he has not maintained a level of professional competence
appropriate to his professional role.

ICAP members have a responsibility to engage in continuing professional development in order to ensure
that their technical knowledge and professional skills are kept up to date. Arif should seek continuing
professional development activities and improve his knowledge on ethical standards. Furthermore, it might
be expected that as Waheed’s superior he should set an example to Waheed and guide him in his
responsibilities. Clearly this is not happening.

Principle of Professional behavior:

As a member of ICAP Arif should be aware of the ICAP code of ethics. Arif should know of the danger of self-
interest threats and intimidation threats to himself and to others. His attempt to influence the outcome of a
fellow professional by applying such a threat to that individual is very unprofessional.

Waheed’s Threats:

Self interest threat

Waheed faces a self-interest threat, in that there is the possibility of a bonus provided profit being more than
10% bigger than last year’s. Arif has also suggested that he can influence the Board’s decision over
employing him as a replacement finance director – another self-interest threat to Waheed. Both of these
threats must be ignored.

Available safeguards
Arif’s comments imply that his application of professional responsibility is lacking. This may extend into the
way in which the current financial statements have been prepared. Waheed must be very careful (as always)
to carry out the review with all due care.

Waheed should first discuss his recommendations with Arif and remind him of his professional
responsibilities to ensure that the accounting standards are correctly followed. If the financial statements are
found to contain errors or incorrect accounting treatment, then they must be amended. If Arif refuses to
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amend the draft financial statements, if necessary, Waheed should take appropriate actions to resolve the
matter including:
• should report the matter to the audit committee or the other directors;
• -consult the policies and procedures of the company with respect to ethics or whistle blowing policy
to address the matter internally;
• consider consulting with the relevant professional body, internal or external auditor, legal council or
informing third parties or appropriate authorities in line with the ICAP guidance on confidentiality.
• Should resign.

Ans.7
In given situation, CFO is in breach of:
1. Principle of integrity:
Chartered Accountant should be straight forward and honest in all professional and business
relationship. Since he asked Accounts manager to identify the areas where through adjustments,
profit may be reported on higher side, he has breached the principle of integrity.
2. Principle of professional behaviour:
This principle imposes an obligation on all chartered accountants to avoid any action that the
chartered accountant knows or should know may discredit the profession. Since CFO asked
Accounts Manager for booking the adjustments to increase the current year profit, which have a
negative effect on the reputation of the profession.
3. Principle of objectivity:
Chartered Accountant should not compromise their professional or business judgment because of
bias, conflict of interest or the undue influence of others. In this circumstance, he has compromised
his professional and business judgment due to biasness.

Self-interest threat faced by Mr. Atif

Self-interest threat occurs as a result of financial or other interest of members or their immediate family
member. In this case, he has been told by the CFO that he would be given an additional bonus this year so
he faces self-interest threat.

Available safeguards
If this threat is significant Atif should consult with superiors within the organisation in order to eliminate or
reduce it to an acceptable level.
Where it is not possible to reduce the threats to an acceptable level, Atif:
i. should refuse to remain associated with information which is or may be misleading;
ii. should consider informing directors;
iii. consult the policies and procedures of the company with respect to ethics or whistle blowing policy
to address the matter internally;
iv. consider consulting with the relevant professional body, internal or external auditor, legal council or
informing third parties or appropriate authorities in line with the ICAP guidance on confidentiality;
v. should resign.

ETHICAL ISSUES IN FINANCIAL REPORTING

Serving employers with professional competence requires the exercise of sound judgment in applying
professional knowledge and skill when undertaking professional activities. Maintaining professional
competence requires a continuing awareness and an understanding of relevant technical, professional and
business developments. Continuing professional development enables a chartered accountant to develop
and maintain the capabilities to perform competently within the professional environment.

Diligence encompasses the responsibility to act in accordance with the requirements of an assignment,
carefully, thoroughly and on a timely basis. A chartered accountant shall take reasonable steps to ensure
that those working in a professional capacity under the accountant’s authority have appropriate training and
supervision.

Where appropriate, a chartered accountant shall make employers or other users of the accountant’s
professional services or activities, aware of the limitations inherent in the services or activities.

When a chartered accountant becomes aware of having been associated with misleading or false
information, the accountant shall take steps to be disassociated from that information.

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Confidentiality
The principle of confidentiality requires an accountant to respect the confidentiality of information acquired
as a result of professional and business relationships. Confidentiality serves the public interest because it
facilitates the free flow of information from the chartered accountant’s client or employing organization to the
accountant in the knowledge that the information will not be disclosed to a third party.

A chartered accountant shall continue to comply with the principle of confidentiality even after the end of the
relationship between the accountant and a client or employing organization. An accountant might use his
experience while respecting the confidentiality of information.
An accountant shall:
• Be alert to the possibility of inadvertent disclosure, including in a social environment, and particularly to
a close business associate or an immediate or a close family member;
• Maintain confidentiality of information within the firm or employing organization or disclosed by a
prospective employing organization;
• Not disclose confidential information acquired as a result of professional and business relationships
outside employing organization (even after the relationship has ended).
• Not use confidential information acquired as a result of professional and business relationships for the
personal advantage of the accountant or for the advantage of a third party (even after the relationship
has ended).
• Take reasonable steps to ensure that personnel under the accountant’s control, and individuals from
whom advice and assistance are obtained, respect the accountant’s duty of confidentiality.

The following are circumstances where chartered accountants are or might be required to disclose
confidential information or when such disclosure might be appropriate:
• Disclosure is required by law.
• Disclosure is permitted by law and authorized by the client or employing organisation.
• Disclosure is not prohibited by law and there is professional duty or right to disclose.

Professional behavior
The principle of professional behavior requires an accountant to comply with relevant laws and regulations
and avoid any conduct that the accountant knows or should know might discredit the profession. A chartered
accountant shall not knowingly engage in any business, occupation or activity that impairs or might impair
the integrity, objectivity or good reputation of the profession, and as a result would be incompatible with the
fundamental principles.

Conduct that might discredit the profession includes conduct that a reasonable and informed third party
would be likely to conclude adversely affects the good reputation of the profession.

⯈ Example
Ali is a chartered accountant recruited on a short-term contract to assist the finance director, Bashir (who is
not a chartered accountant) in finalising the draft financial statements.

The decision on whether to employ Ali on a permanent basis rests with Bashir.
Ali has been instructed to prepare information on leases to be included in the financial statements. He has
identified a number of large leases which are being accounted for as rental arrangements even though the
terms of the contract contain clear indicators that the risks and benefits have passed to the company and
applying IFRS 16, right of use asset and lease liability should have been recorded. Changing the accounting
treatment for the leases would have a material impact on asset and liability figures.

Ali has explained this to Bashir. Bashir responded that Ali should ignore this information as the company
need to maintain a certain ratio between the assets and liabilities in the statement of financial position.
Required: Discuss the responsibility of Ali and suggest course of action.

Answer:
Ali faces a self-interest threat which might distort his objectivity. The current accounting treatment is
incorrect.
Ali has a professional responsibility to ensure that financial information is prepared and presented fairly,
honestly and in accordance with relevant professional standards. He has further obligations to ensure that
financial information is prepared in accordance with applicable accounting standards and that records
maintained represent the facts accurately and completely in all material respects.

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Example
Etishad is a chartered accountant who works in a team that reports to Fahad, the finance director of Kohat
Holdings.
Fahad Is also a chartered accountant. He has a domineering personality.

Kohat Holdings revalue commercial properties as allowed by IAS 16. Valuation information received last
year showed that the fair value of the property portfolio was 2% less than the carrying amount of the
properties (with no single property being more than 4% different). A downward revaluation was not
recognised on the grounds that the carrying amount was not materially different from the fair value.

This year’s valuation shows a continued decline in the fair value of the property portfolio. It is now 5% less
than the carrying amount of the properties with some properties now being 15% below the carrying amount.

Etishad submitted workings to Fahad in which he had recognised the downward revaluations in accordance
with IAS 16.

Fahad has sent him an email in response in which he wrote “Stop bothering me with this rubbish. There is
no need to write the properties down. The fair value of the portfolio is only 5% different from its carrying
amount. Restate the numbers immediately”.

Required: Discuss the issue, responsibility and course of action from the perspective of Etishad.

Answer
Etishad faces an intimidation threat which might distort his objectivity.
The current accounting treatment might be incorrect. The value of the properties as a group is irrelevant in
applying IAS 16’s revaluation model. IAS 16 allows the use of a revaluation model but requires that the
carrying amount of a property should not be materially different from its fair value. This applies to individual
properties not the whole class taken together.
(It could be that Fahad is correct because there is insufficient information to judge materiality in this
circumstance. However, a 15% discrepancy does sound significant).

Etishad has a professional responsibility to ensure that financial information is prepared and presented fairly,
honestly and in accordance with relevant professional standards. He has further obligations to ensure that
financial information is prepared in accordance with applicable accounting standards and that records
maintained represent the facts accurately and completely in all material respects.

⯈ Example
Fortune Limited (FL) is quoted on the stock exchange, with revenue of over Rs. 5 billion per annum. During
the year ended 30 June 2015, FL has incurred a loss of Rs. 26 million.

The Chief Executive is of the view that declaration of loss may result in the bankers’ refusal to renew the
credit facility. Therefore, he wants to incorporate certain adjustments in the books of account that will result
in a net profit of Rs. 100 million. However, the Chief Financial Officer (CFO), who is a chartered accountant,
is of the view that all possible adjustments allowable under the applicable accounting regulations have
already been considered and incorporated.

Required: Identify the categories of threats to the fundamental principles of objectivity or professional
competence and due care, that may be created in the above situation and discuss the safeguards available
to the CFO in this respect, under the ICAP’s Code of Ethics.

Answer:
Threats to fundamental principles
The situation may create following threats to the fundamental principles of objectivity or professional
competence and due care:
• Self-interest (employment)
• Intimidation (actual or perceived pressure from CEO)

Safeguards available to the CFO:

In order to reduce the threat to an acceptable level, the following safeguards should be applied:
• Consult with superiors such as audit committee.
• Consult the policies and procedures of the company with respect to ethics or whistle blowing policy to
address the matter internally.
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• Consider consulting with the relevant professional body, internal or external auditor, legal counsel or
informing third parties or appropriate authorities in line with the ICAP guidance on confidentiality.
• Where it is not possible to reduce the threat to an acceptable level, CFO shall refuse to be remain
associated with the financial information and consider resigning from the post of CFO.

⯈ Example
Amir Ali, ACA is CFO at Circle Limited (CL) and reports to Junaid, FCA who is the CEO.
The financial year of CL ends on 30 April and its profit for the nine months ended 31 January 2019 was
below target. In a management meeting held in February 2019, Junaid has proposed the following measures
to improve the results.
(i) Annual maintenance of the manufacturing plant which is due in March 2019 should be deferred to May
2019. Production manager has warned that the deferral may affect the safety of the plant. However,
Junaid is of the view that the maintenance was delayed two years ago as well and nothing adverse
happened at that time.
(ii) Incorporation of the new revaluation report of CL’s buildings should be deferred to the next year as the
resulting increase in valuation is substantial and would result in increase in the deprecation for the year.
Amir had initiated the revaluation during the year since the fair values of the buildings had increased
materially. Junaid is of the view that the buildings were revalued last year and there is no need of such
frequent revaluations.

Due to the dominant nature of Junaid, none of the participants opposed his views. The summary to
implement the above actions has been received by Amir.
Amir has recently applied for an interest free car loan from CL which is expected to be approved in few days.

Required: Briefly explain how Junaid may be in breach of the fundamental principles of Code of Ethics for
Chartered Accountants. Also state the potential threats that Amir may face in the above circumstances and
how he should respond.

Answer:
Breach by CEO Mr. Junaid
In the given situation, Junaid may be in breach of the following fundamental principles of Code of Ethics for
Chartered Accountants:

Professional behaviour: This principle imposes an obligation on all chartered accountants to comply with
relevant laws and regulations and avoid any action that discredits the profession. Junaid has breached this
principle as his proposed suggestion in respect of incorporation of the new revaluation report is not in
accordance with IAS 16. Under IAS 16, carrying amount of property carried at revaluation model should not
be materially different from its fair value so his proposal is against the requirement of IAS 16.

Integrity: Chartered Accountant should be straight forward and honest in all professional and business
relationship. It seems that Junaid’s decision to defer the maintenance of plant despite warning of production
manager in terms of safety of plant and non-incorporation of new annual report in financial statement would
make them misleading.
Objectivity: Chartered Accountant should not compromise his professional or business judgment because
of bias, conflict of interest or the undue influence of others. In this circumstance, he has compromised his
professional and business judgment by proposing unethical/unlawful measures to just improve the falling
profit of the company.

Potential threats faced by Amir:

Amir may face following threats:

Self-interest threat: Amir may face self-interest threat as the disbursement of his car loan may be at stake if
he refuses to obey the instructions.

Intimidation threat: Amir may face intimidation threat from Junaid as refusal to obey instruction may risk his
job.
Identified threats are significant as the CFO is being instructed from the highest level of management.

Response / Actions:
In order to reduce the threat to an acceptable level, Amir should:
• Discuss the matter with CEO and persuade him to follow code of ethics.
• Refuse to implement the given proposals.
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If Junaid does not follow code of ethics and forces him to implement the proposal, Amir should refuse to
associate with these proposals and take the following appropriate steps:
• should consider informing superiors like Audit Committee / directors;
• consult the policies and procedures of the company with respect to ethics or whistle blowing policy to
address the matter internally;
• consider consulting with the relevant professional body, internal or external auditor, legal counsel or
informing third parties or appropriate authorities in line with the ICAP guidance on confidentiality;
• should resign.

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 Prayer is a weapon for believers to overcome the hard situations

Intangible Assets (IAS-38)

An identifiable non-current asset without physical substance. For example
• Software
• Manufacturing Licenses
• Import Licence
• Export Licence/ Export quota
• Airline routes
• Broadcasting Licenses
• Formulas/ Recipes (of medicines)

Asset is a resource controlled by the company as a result of past events and from which future benefits are
expected.

Recognition Criteria: [Para 21]

An intangible asset shall be recognized if and if only:
a) It is probable that future economic benefits will flow to the entity; and
b) Cost of an asset can be measured reliably.

An intangible asset is measured initially at cost.

Elements of cost: [Para 27 to 29](as in IAS 16)

Goodwill:
Internally Generated Goodwill: [Para 48]
It is not recognized as an intangible asset because it is not a separable resource of the business that can be
measured reliably.

Purchased Goodwill: if cost of investment and fair value of NCI is more than the FV of net assets of subsidiary
at the date of acquisition. It is recognized in consolidated statement of financial position as a non-current asset.

It is not amortized; instead it is tested for impairment annually.

The following internally generated items must not be capitalized: [Para 63]
• Good will
• Brands (particular make of product e.g. Bata, Service)
• Mast heads (display title of newspaper e.g. DAWN NEWS etc)
• Publishing titles (profession of publishing books e.g. PBP)
• Customer lists (customer relationships)

If however these items are purchased then these are capitalized.

Internally generated intangible items Other than Goodwill: {Research & Development}

A company may have an intangible item that has been internally generated. There are three distinct phases:
1) Research
2) Development
3) Commercial Production.

Once the research phase is successfully completed, the development phase may begin, the successful
completion of which then leads to the start of the Commercial production phase.
The Research Phase:
It is defined as
• Original and planned investigation
• Undertaken with the prospect of gaining
• New scientific or technical knowledge

Accounting treatment of costs in research phase: [Para 54]

There is no guarantee at this stage that the future economic benefits can be obtained or are probable
(economic benefits are only possible).

Therefore research costs are always expensed out.

Normally they are written as a separate line item after 310
----------( selling & admin expenses in statement of PL (if material).
)----------
 Use patience and prayers to overcome hardships and sufferings we face

Examples of research activities: [Para 56]

The Development Phase:

Development is defined as:
• The application
• Of research finding
• To a plan or design for the production
• Of new or substantially improved products or services
• Prior to the commencement of commercial production or use.

Since development phase is after research phase therefore more advanced stage of creation, it may be
possible that item (formula) is expected to generate future economic benefits and therefore amount can be
capitalized,

if all the following criteria are fulfilled: [Para 57]

a) Technical feasibility of completing the asset;
b) The intention to complete the asset and to either use or sell it;
c) The ability to use or sell the asset;
d) How the asset will generate the future economic benefits;
e) The adequate availability of necessary resources to complete the development and to sell or use the asset
f) The ability to reliably measure the cost of the development of the asset.

If just one of these above mentioned criteria is not met even then the related development costs must
be expensed out.

Examples of development phase [Para 59]

Components of cost of an internally generated asset [Para 66 & 67]
Past Expense not to be capitalized: [Para 71]

Expenditures on an intangible item that are initially recognized as an expense shall not recognize as an asset
at a later date.

The commercial Production in which inventories are produced for sale.

Once development phase is successfully completed, the economic benefits from the use of the development
asset can start to flow into the entity. In order to achieve a better reflection of the diminishing value of the asset
as a result of usage, the development asset should be amortized.

The amortization of the development asset must being as soon as asset is available for use. It therefore does
not matter when we actually start production.

However, research and development project must be continuously tested during the course of completion for
impairment and whenever carrying amount exceeds its recoverable amount an impairment loss should be
recognized immediately.

Q.1.
A company entered into a research and development project, the costs of which are as follows (all costs are
incurred evenly over the year):
2011 120,000
2012 100,000
2013 100,000

On 1 September 2011, the recognition criteria for capitalization of development costs are met.
The recoverable amounts are as follows:
31 December 2011 90,000
31 December 2012 110,000
31 December 2013 200,000

Required:
A. Show all journals related to the costs incurred for each of the years ended 31 December.
B. Disclose the development asset in the statement of financial position for 2011 to 2013.

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Q.2
Zouq Inc. is a multinational company. As part of its vision to expand its business in South Asia, it purchased
a 90% share of a locally incorporated company, Momin Limited. Following are the brief details of the
acquisition:

Date of acquisition January 1, 2014

Total paid up capital of Momin Limited (Rs. 10 each) Rs. 500,000,000
Purchase price per share Rs. 30
Net assets of Momin Limited (as per 2013 audited financial statements) 650,000,000
Fair value of net assets (other than intangible assets) of Momin Limited 1,100,000,000

Momin Limited has an established line of products under the brand name of “Badar”. On behalf of Zouq Inc.,
a firm of specialists has valued the brand name at Rs. 100 million with an estimated useful life of 10 years at
January 1, 2014. It is expected that the benefits will be spread equally over the brand’s useful life.
An impairment test of goodwill and brand was carried out on December 31, 2014 which indicated an
impairment of Rs. 50 million in the value of goodwill.

An impairment test carried out on December 31, 2015 indicated a decrease of Rs. 13.5 million in the carrying
value of the brand.

Required:
Prepare the ledger accounts for goodwill and the brand, showing initial recognition and all subsequent
adjustments.

Important Definitions:
Amortization:
• Is the systematic allocation of the depreciable amount of an intangible asset
• Over its useful life

Useful Life:
• Is the period of time over which an asset is expected to be available for use by the entity; or
• The number of production or similar units the entity expects to obtain from the asset.

Impairment Loss:
It is the amount by which
• the carrying amount of an asset
• exceeds its recoverable amount

Carrying Amount:
• is the amount at which an asset is recognized in the statement of financial position
• After deducting any accumulated amortization and accumulated impairment losses thereon.

Recoverable Amount:
• of an asset is the Higher of:
• its fair value less costs to sell and
• its value in use

Fair Value:
Fair value is the price that would be received from selling an asset in an orderly transaction.

Recognition of an Intangible Asset:

Before an intangible item may be recognized as an intangible asset, it must meet the:
• definition of an intangible asset; and
• recognition criteria

The most important aspects to meet regarding the definition of an intangible asset are generally the following:
• the asset must not have a physical form
• the asset must be ‘identifiable’; and
• the asset must be controlled by the entity
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 Prayer can change your situation so remember Allah and offer prayers

A) The item must be without physical substance:

Expenditure is frequently incurred on items that have both tangible and intangible elements. This requires
assessing which elements is more significant: the physical (Tangible) or the non-physical (Intangible)
element. Depending on which element is more significant will determine which standard should be applied to
the asset:
• the standard on Intangible Asset (IAS-38); or
• the standard on Property, Plant & Equipment (IAS-16).

Example: Recognition of a fishing license

A company has acquired a fishing license. The directors insist that it is a physical asset since it is written on a
piece of paper. State and briefly explain whether or not you would recognize a fishing license as an intangible
asset.

Solution:
Although the fishing license has a physical form, (the related legal documentation), the license is considered
intangible rather than tangible since the most significant aspect is the licensed ‘ability’ to fish. Such a right
(whether documented or not) is always considered to be intangible.

Example: Recognition of Software

State and briefly explain whether or not you would recognize software as an intangible asset if it is incorporated
into a machine that is dependent on the software for its operation.

Solution:
The most significant element would be considered to be tangible machine, since the software is considered
integral to the machine, and thereof the cost of the software would be recognized as part of the cost of the
machine and therefore classified as tangible. If the software was ‘*stand-alone’ software rather than ‘in the
machine’, it would have been classified as an intangible asset (IAS-38).

*Standalone software means which is not necessary for the machine to operate e.g. MS office or adobe reader.
Operating system is not stand alone software.

B) The item must be identifiable:

Another important aspect of definition of ‘intangible assets’ as per IAS-38 is that asset must be identifiable. An
asset is considered to be identifiable if it
• Is ‘separable’, i.e. is capable of being separated or divided from the entity and sold or exchanged.

C) The item must be controllable:

Control over an intangible asset can be achieved if the entity has
• The ability to restrict access to the asset and its related future economic benefits; and
• The power to obtain future economic benefits

Example: Recognition of Training Costs

State and briefly explain whether or not you would recognize training costs as an intangible asset.

Solution:
Although training may be considered to be expenditure on an identifiable, non-monetary item that is without
physical substance, the definition of an asset is not met in terms of the Framework since the trained staff
members may not necessarily be under sufficient control of the entity to be considered to be an asset, unless
it is protected by legal rights to use it and to obtain the future economic benefits from it [Para 15].

Note: if question is silent regarding the protection of benefits by legal rights, then assume that they are not
protected by any future legal rights.

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 Prayer becomes powerful when it is done with patience and sincere faith in Allah

Q.3 FAZAL
The following information relates to the financial statements of Fazal for the year to 31 March 2015.

The IT division has begun a training course for all managers in a new programming language at a cost of Rs.
200,000. The consultants running the training course have quantified the present value of the training benefits
over the next two years to be Rs. 400,000. The project cost has been included in the statement of financial
position as a non current asset. The accounting policy note identifies that the costs will be written off over the
next two years to match the benefits.

Required
Explain the correct accounting treatment for the above (with calculations if appropriate).

Amortization and Impairment Testing:

An intangible asset may either be assessed as having:

a) A finite useful life
b) An indefinite useful life (This could be when there is no foreseeable limit to the period over which the
asset is expected to generate cash flows)

Assets that have finite useful life is amortized whereas those that have indefinite useful life are not
amortized.

Impairment Testing:
Intangible assets that have finite useful lives are tested in the same way as Property, Plant &
equipment are tested for impairment:
• Impairment test is first performed to identify whether there is any indication of impairment;
• Then, if there appears to be material impairment, the recoverable amount is calculated and compared to the
carrying amount.

The following intangible assets are not amortized:

• Purchased Goodwill
• Intangible assets not yet available for use; and
• Intangible assets with indefinite useful lives;

Instead, the recoverable amount must be estimated every year irrespective of whether there is any indication
that suggests a possible impairment.

Amortization:
Only intangible assets with finites lives are amortized. There are three variables to calculate the amortization
• Residual Value
• Period of amortization
• Method of amortization

The depreciable amount is:

• The cost of the asset
• Less its residual value.

Residual value [Para 100]

In the case of intangible assets, the residual value is assumed to be zero unless:
• A 3rd party has committed to purchase the asset at the end of its useful life; or
• There is an active market for that asset and

→ it is possible to determine the residual value using such market and

→ It is expected that such a market will still exist at the end of useful life.

Definition of Active market:[IFRS 13 Appendix A]

It is a market in which transactions for asset takes place with sufficient frequency to provide pricing information
on an ongoing basis.

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In process research & development
Whereas many companies do their own research and development, it is possible for a company to buy another
company’s research and development. If a company buys (either separately or as part of a business
combination) another company’s ‘in-process research and development’ project, the fair value of the initial
acquisition costs will be capitalised.

The entire purchase price is capitalised regardless of the portion of the fair value that relates to purchased
research.

Any subsequent expenditure on this purchased ‘in-process research and development’ project will, however,
be analyzed and recognized in the normal way:
• costs that relate to research must be expensed;
• costs that relate to development:
- must be expensed if all recognition criteria are not met; and
- Capitalised if all recognition criteria are met.

Example : in-process research and development acquired

A company bought an incomplete research and development project from another company for Rs 400
000 on 1 January 2011. The purchase price has been analyzed as follows:

Research 100 000

Development 300 000
Subsequent expenditure has been incurred on this project as follows:
Research: Further research into possible markets was considered necessary 200 000
Development: Incurred evenly throughout the year. All recognition criteria for 480 000
capitalization as a development asset were met on 1 June 2011.

Required:
Show all journals related to the in-process research and development for 2011.

Solution
1-1-2011 Debit Credit
Intangible Asset-Development cost 400 000
Bank/ liability 400 000
In-process research and development purchased (no differentiation
between research and development is made) when the project was
acquired as ‘in-process R&D’
31-12-2011
Research expense 200 000
Development expense [480 000 x 5/12] 200 000
Intangible Asset-Development cost [480 000 x 7/12] 280 000
Bank/ liability 680 000
Subsequent expenditure on an in-process research and development
project recognized as usually done: research is expensed and
development costs capitalised only if all criteria for capitalization of
development costs are met

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Self test question 1
INTANGIBLE ASSETS ACQUIRED IN A BUSINESS COMBINATION
Cost guidance
If an intangible asset is acquired in a business combination, its cost is the fair value at the acquisition date.
If cost cannot be measured reliably then the asset will be included within goodwill.

In-process research and development

The acquiree might have a research and development project in process. Furthermore, it might not recognise
an asset for the project because the recognition criteria for internally generated intangible assets have not
been met.

Illustration:
Company X buys 100% of Company Y.
Company Y has spent Rs. 600,000 on a research and development project. This amount has all been
expensed as the IAS 38 criteria for capitalising costs incurred in the development phase of a project have not
been met. Company Y has knowhow as the result of the project.

Company X estimates the fair value of Company Y’s knowhow which has arisen as a result of this project to
be Rs. 500,000.

Analysis
The in-process research and development is not recognised in Company Y’s financial statements.

From the Company X group viewpoint the in-process research and development is a purchased asset. Part
of the consideration paid by Company X to buy Company Y was to buy the knowhow resulting from the project
and it should be recognised in the consolidated financial statements at its fair value of Rs. 500,000.

Subsequent expenditure on an acquired in-process research and development project

Expenditure incurred on an in-process research or development project acquired separately or in a business
combination and recognised as an intangible asset is accounted for in the usual way by applying the IAS 38
recognition criteria.

This means that further expenditure on such a project would not be capitalised unless the criteria for the
recognition of internally generated intangible assets were met.

Illustration:
Continuing the previous example. Company X owns 100% of Company Y and has recognised an intangible
asset of Rs. 500,000 as a result of the acquisition of the company.

Company Y has spent a further Rs. 150,000 on the research and development project since the date of
acquisition. This amount has all been expensed as the IAS 38 criteria for capitalising costs incurred in the
development phase of a project have not been met.
Analysis
The Rs. 150,000 expenditure is not recognised as an intangible asset in Company Y’s financial statements.
From the Company X group viewpoint, further work on the in-process research and development project is
research and the expenditure of Rs. 150,000 must be expensed.

Illustration: internally generated brand

Company X buys 100% of Company Y.
Company Y owns a famous brand that it launched several years ago.

Analysis
The brand is not recognized in Company Y’s financial statements (IAS 38 prohibits the recognition of internally
generated brands).

From the Company X group viewpoint the brand is a purchased asset. Part of the consideration paid by
Company X to buy Company Y was to buy the brand and it should be recognized in the consolidated financial
statements at its fair value.

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Measurement Model
As with tangible assets covered in property, plant and equipment (IAS 16), there are two measurement models
for intangible assets:
• The cost model; and
• The revaluation model.

Cost Model
The intangible asset is shown at its cost less any accumulated amortization and any accumulated impairment
losses.
Revaluation model
If the intangible asset is measured under the revaluation model it is shown at its:
• fair value at date of revaluation
• Less any subsequent accumulated amortization and any accumulated impairment losses.

The revaluation must be performed with sufficient regularity that the intangible asset’s carrying amount does
not differ significantly from its fair value.
In revaluation model if an asset is to be revalued, all assets in that same class must be revalued at the same
time.

The mechanisms used in applying the revaluation model to intangible assets are just the same as those used
to apply the revaluation model to property, plant and equipment, with the one exception being that the fair
value of an intangible asset must be determined with reference to an active market ((there was no such
limitation in IAS 16: Property, plant and equipment). There is often no active market for the intangible asset
due to its uniqueness and therefore, although the revaluation model is allowed, it is often not possible to apply
in practice.

If, within a class of assets measured at fair value, there is an intangible asset that does not have a reliably
measurable fair value, then that asset will continue to be carried at cost less accumulated depreciation and
impairment losses (means not revalued).

If the revaluation model is used but at a later stage the fair value is no longer reliably determined (i.e. there is
no longer an active market), the asset should continue to be carried at the amount determined at the date of
the last revaluation less any subsequent accumulated amortization and impairment losses.

Accounting for a revaluation

The revaluation of an intangible asset is accounted for in the same way as that of a tangible asset (covered
by the standard on property, plant and equipment).

Period of amortization
Amortization of the intangible asset should begin from the date on which it becomes available for use (i.e. not
from when the entity actually starts to use the asset).
Amortization should cease when the asset is derecognized.
The amortization period should be the shorter of:
• The asset’s expected economic useful life; and
• Its legal life.

Where the asset has a limited legal life (i.e. where related future economic benefits are controlled via legal
rights granted for a finite period), the expected economic useful life will be limited to the period of the legal
rights, if this is shorter, unless:
• the legal rights are renewable by the entity; and
• there is evidence to suggest that the rights will be renewed; and
• The costs of renewal are not significant.

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Example: Renewable rights
Ace Ltd purchased a 5 year fishing licence for Rs 100 000. The company expects to renew the licence at the
end of the 5 year period for a further 5 years. The government has indicated that they will re-grant the licence
to Ace Ltd.

Required:
Discuss the number of years over which the licence should be amortized, assuming that the costs associated
with the renewal is:
(i) 100; or
(ii) 99 000.

Solution
i) Renewable rights - insignificant cost
As the costs associated with the renewal are insignificant, the asset must be amortized over the 10 year useful
life. The entity intends to renew the licence and the government intends to re-issue the licence to Ace Ltd, and
therefore it must be treated as an asset with a 10 year useful life.
ii) Renewable rights - significant cost
As the costs associated with the renewal are significant, and almost equaling the initial cost of the licence, the
asset must be amortized over the 5 year useful life. Although the entity intends to renew the licence, the
renewed licence, when it is acquired, must be treated a separate asset and amortized over a useful life of 5
years.

Method of amortization
The method used should be a systematic one that reflects the pattern in which the entity expects to use the
asset. The methods possible include:
• straight-line
• reducing balance
• Unit of production method or any other method reflecting the pattern of benefits

Annual review
At the end of each financial period, the following should be reviewed in respect of intangible assets with finite
useful lives:
• amortization period;
• amortization method;
• residual value; and

If there is any change in estimate, the change shall be treated as a change in accounting estimate as per IAS-
8 (means apply prospectively)

Intangible assets with indefinite useful life:

An intangible asset with an indefinite useful life is:
• Not amortized but
• Entity is required to test such an asset for impairment by comparing its recoverable amount with its
carrying amount annually.

Intangible assets not yet available for use:

An intangible asset that is still not available for use is:
• Not amortized, but it is
• Tested every year for impairment even if there is no indication of impairment.

Review of useful Life Assessment:

The useful life of an intangible asset that is not being amortized shall be reviewed each period to determine
whether events or circumstances continue to support an indefinite useful life assessment for that and if they
do not, the change in useful life assessment from indefinite to finite shall be accounted for as a change in
accounting estimate as per IAS-8.

Disclosures
→ Present carrying amount of intangible asset in Non-Current Assets in statement of financial position.
→ Schedule in Notes to Financial Statements (just like tangible assets). If an intangible asset is revalued
then same disclosures as in IAS-16

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 “You are never too late nor old to move forward and make your life best.”

Class of assets
The same model should be applied to all assets in the same class. A class of intangible assets is a
grouping of assets of a similar nature and use in an entity’s operations. Examples of separate classes
may include:
• brand names;
• mastheads and publishing titles;
• computer software;
• licences and franchises;
• copyrights, patents and other industrial property rights, service and operating rights;
• recipes, formulae, models, designs and prototypes; and
• Intangible assets under development.

Comprehensive Example: Zebra Limited

During the year ended 31 December 2017, following transactions were made by Zebra Limited (ZL):
On 1 April 2017 ZL acquired a licence for operating a TV channel for Rs. 86.3 million out of which Rs. 50
million was paid immediately. The balance amount is payable on 1 April 2019. A mega social media and print
media campaign was launched to promote the channel at a cost of Rs. 10 million.

The transmission of the channel started on 1 August 2017.

The license is valid for 5 years but is renewable every five years at a cost of Rs. 35 million. Since the
renewal cost is significant, the management intends to renew the license only once and sell it at the end of
8 years.
In the absence of any active market, the management has estimated that residual value of the license would
be Rs. 15 million and Rs. 20 million at the end of 5 years and 8 years respectively.
Applicable discount rate is 10% p.a.

These transactions should be recorded in ZL’s books of accounts for the year ended 31 December
2017 as follows:
Since a part of the payment for the license has been deferred beyond normal credit terms so the license will
be initially recognised at cash price equivalent of Rs. 80 million i.e. Rs. 50 million plus Rs. 30 million (i.e.
present value of Rs. 36.3 million discounted at 10% for 2 years.)

The advertisement cost of Rs. 10 million incurred on launching of the channel cannot be included in the cost
of the license and will be charged to Profit and loss account.
Since the renewal cost is significant so the useful life of the license will be restricted to the original
5 years only.

The residual value of the license will be assumed to be zero since there is no active market for the license
and there is no commitment by 3rd party to purchase the license at the end of useful life.

The amortization for the year will be Rs. 12 million [(80 – 0) /5 ×9/12] calculated from 1 April 2017 when the
license was available for use.

Unwinding of interest expense of Rs. 2.25 million (30 × 10% × 9/12) shall be recorded with increasing the
liability of payable for license with same amount.

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Self-Test Questions
Q.1
On 01 January 2012, Matchless Enterprises Limited (MEL) acquired research data along with partially
developed product design from a company for Rs. 2 million (Research costs - Rs. 0.5 million, development
costs - Rs. 1.5 million).
The product design was handed over to the production department on 01 November 2012. Subsequent to
acquisition, MEL incurred Rs. 0.7 million on research and Rs. 2.5 million on the development/finalization of
the product design. It is expected that this product design would provide economic benefits to the company
for next five years.

Required:
Prepare journal entries to record the above transactions for the year ended 31.12.2012.
Q.2
Raisin International
Raisin International (RI) is planning to expand its line of products. The related information for the year ended
31 December 2015 is as follows:
i. Research and development of a new product commenced on 1 January 2015. On 1 October 2015,
the project becomes available for use . It is estimated that the product would have a useful life of
7 years. Details of expenditures incurred are as follows:
Rs. m
Research work 4.50
Development work 9.00
Training of production staff 0.50
Cost of trial run (testing cost) 0.80
Total costs 14.80
ii. The right to manufacture a well-established product under a patent for a period of five years was
purchased on 1 March 2015 for Rs. 17 million. The patent has an expected remaining useful life of 10
years. RI has the option to renew the patent for a further period of five years for a sum of Rs. 12
million.
iii. RI has acquired a brand at a cost of Rs. 2 million. The cost was incurred in the month of June 2015.
The life of the brand is expected to be 10 years. Currently, there is no active market for this brand.
However, RI is planning to launch an aggressive marketing campaign in February 2016.
iv. In September 2014, RI developed a new production process and capitalised it as an intangible asset
at Rs. 7 million. The new process is expected to have an indefinite useful life. During 2015, RI incurred
further development expenditure of Rs. 3 million on the new process which meets the recognition
criteria for capitalization of an intangible asset.
Required
In the light of International Financial Reporting Standards, explain how each of the above transaction should
be accounted for in the financial statements of Raisin International for the year ended 31 December 2015.

Q.3
Opal Limited (OL) commenced research work on a new product on 1 July 2013 and entered the development
phase on 1 July 2014. In this respect, the following expenses were incurred and debited to capital work in
progress.
For the year ended
30 June 2015 30 June 2014
----------- Rs. In million -----------
Research and development cost 12.00 8.00
Training of technical staff 0.90 -
Cost of laboratory equipment* - 4.00
Cost of trial run 0.60 -
13.50 12.00
*Purchased on 1 January 2014, having estimated useful life of five year.
Criteria for recognition of the internally generated intangible asset have been met. The commercial production
was started from 1 January 2015. It is estimated that the related product would have a shelf life of 10 years.
Required:
Explain accounting treatment of the above in the financial statements for the year ended 30 June 2015 in the
light of International Financial Reporting Standards. (07)
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 Failure with efforts can be justified but
Failure without efforts cannot be justified
Solutions
A.3
In accordance with IAS 38, expenditure on intangible assets must be expensed unless it meets the recognition
criteria for capitalization. These criteria require the demonstration that future benefits will arise from the
incurred costs. It would be difficult to prove that this is the case in relation to training costs and IAS 38
specifically states that training costs should always be expensed as they are incurred and not treated as an
intangible asset (unless protected by legal rights)

Hence the treatment adopted by Fazal is not correct and the costs being carried forward must be expensed
to the year’s profits (in which it is incurred)

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Solutions
Self-Test Questions
A.2 Raisin International
(i) Since the product met all the criteria for the development of the product, it should be recognized
as an intangible in the statement of financial position (SOFP) of the company. However, RI should
capitalize only the development work as well as trial run (i.e. Rs. 9 plus 0.8 = 9.8 million) as
intangible asset. IAS-38 does not allow capitalization of cost relating to the research work, training
of staff. Since the product has a useful life of 7 years, the amortization expense amounting to Rs.
0.35 million (Rs. 9.8 million / 7 x 3/12) should be recorded in the statement of profit or loss.
(ii) This purchasing of right to manufacture should be recognized as an intangible in the SOFP
because:
▪ It is for an established product which would generate future economic benefits.
▪ Cost of the patent can be measured reliably.

Since there is a finite life, the patent must be amortized over its useful life. The useful life will be
shorter of its actual life (i.e. 10 years) and its legal life (i.e. 5 years. The amortization to be recorded
in SOCI is Rs. 2.83 million (Rs. 17 million / 5 x 10/12).

(iii) The acquired brand should be recognized as an intangible in the SOFP because acquisition price
is a reliable measure of its value. The amortization to be recorded in SOCI is Rs. 0.12 million (Rs.
2 million + 10 years x 7/12).
(iv) The carrying value of the intangible asset should be increased to Rs. 10 million in the SOFP.
Since there is an indefinite useful life of the intangible assets, it should not be amortized. Instead,
RI should test the intangible asset for impairment by comparing its recoverable amount with its
carrying amount.

A.3
Opal Limited
Accounting treatment for research and development expenses
Development cost recognition as intangible asset:
Since the new product met all the criteria for the development of a product, an intangible set should be
recognized at Rs. 13 million (12 + 0.4 + 0.6) as detailed under:
▪ Cost of Rs. 12 million incurred during the development phase that is 1 July 2014 to 31 December 2014.
▪ Depreciation of Rs. 0.4 million (4.0 ÷ 5 × 6/12) on laboratory equipment for the development phase of
six months from 1 July 2014 to 31 December 2014.
▪ Cost of trial run amounted to Rs. 0.6 million.

Amortization of Intangible Asset:

Since the product has a shelf life of 10 years, the amortization expense amounting to Rs. 0.65 million
(13 ÷ 10 × 6/12) should be charged to profit and loss account for the period of six months i.e. 1 January to 30
June 2015.

Laboratory equipment Cost Recognition as Tangible Asset:

Laboratory equipment cost should be capitalized as a tangible asset as it is having useful life of more than
one year and to be depreciated over its useful life of five years.

Research and Other Costs:

(i) IAS-38 does not allow capitalization of costs pertaining to research work. Therefore, these costs
should be charged to profit and loss account in the period in which they incurred.
However, research cost of Rs. 8 million and depreciation for the research phase of Rs. 0.4 million (4
÷ 5 × 0.5) pertained to last year, therefore, comparative figures for the year ended 30 June 2014
should be restated and retained earnings be adjusted for these amounts (as per IAS 8).
(ii) Cost for training of staff is also not allowed for capitalization and should be charged to profit and loss
account for the year ended 30 June, 2015.
(iii) Depreciation of Rs. 0.4 million on laboratory equipment for the period from the commencement of the
commercial production i.e. 1 January to 30 June 2015 should be charged to profit and loss account
for the year ended 30 June, 2015.

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ICAP Study Text
Example:
Ateeq Ltd acquires new technology that will significantly reduce its energy costs for manufacturing. Costs
incurred include:

Amount in Rs.
Cost of new technology 1,500,000
Trade discount provided 200,000
Training course for staff in new technology 70,000
Initial testing of new technology 20,000
Losses incurred while other parts of plant shutdown
during testing and training. 30,000

The cost that can be capitalised is:

Cost of a new technology 1,500,000
Less discount (200,000)
Plus initial testing 20,000
1,320,000

Scope [IAS 38: 2, 3, 6 & 9]

Entities frequently expend resources, or incur liabilities, on the acquisition, development, maintenance or
enhancement of intangible resources such as scientific or technical knowledge, design and implementation of
new processes or systems, licences, intellectual property, market knowledge and trademarks (including brand
names and publishing titles).

Common examples of items encompassed by these broad headings are computer software, patents,
copyrights, motion picture films, customer lists, mortgage servicing rights, fishing licences, import quotas,
franchises, customer or supplier relationships, customer loyalty, market share and marketing rights.

IAS 38 is required to be applied in accounting for intangible assets, except:

a) intangible assets that are within the scope of another Standard;
If another Standard prescribes the accounting for a specific type of intangible asset, an entity applies that
Standard instead of this Standard. For example, this Standard does not apply to:
a) intangible assets held for sale in the ordinary course of business (IAS 2 is applicable).
b) deferred tax assets (IAS 12 is applicable).
c) leases of intangible assets (IFRS 16 is applicable).
d) financial assets (IAS 32 or IFRS 10/IAS 27/IAS 28 is/are applicable)
e) goodwill acquired in a business combination (IFRS 3 is applicable).
f) assets arising from contracts with customers (IFRS 15 is applicable)
Rights held by a lessee under licensing agreements for items such as motion picture films, video recordings,
plays, manuscripts, patents and copyrights are within the scope of IAS 38 and are excluded from the scope
of IFRS 16.

Definition and concept of intangible asset [IAS 38: 8 & 10]

An intangible asset is an identifiable non‑ monetary asset without physical substance.
If an item does not meet the definition of intangible assets, it is charged as an expense when incurred.

Identifiable [IAS 38: 11 & 12]

An intangible asset must be identifiable to distinguish it from the goodwill. An asset is identifiable if it either:
• is separable (can be exchanged, rented, sold or transferred separately); or
• arises from contractual or other legal rights, regardless of whether those rights are transferable or
separable.

The purchased goodwill is not an identifiable asset as it cannot be exchanged, rented, sold or transferred and
it does not arise from contractual or legal rights. Therefore, IAS 38 is not applicable on acquired goodwill and
IFRS 3 provides guidance on it and as per IFRS 3, Goodwill = FV of consideration – net asset acquired at FV.

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⯈ Example:
An entity incurred Rs. 4 million on a massive marketing campaign to promote a new product. The accountant
wishes to capitalize these costs. The cost of the advertising campaign is not separable as it cannot be
separated from the entity and sold, transferred, rented or exchanged etc. Furthermore, the advertising
campaign does not arise from contractual or legal rights. Thus, the cost of the advertising campaign is not
identifiable and must be expensed out.

Non-monetary [IAS 38: 8]

Monetary assets are money held and assets to be received in fixed or determinable amounts of money, for
example, cash and trade receivable. Intangible asset must be a non-monetary asset.

Asset [IAS 38: 10, 13 & 17]

An intangible asset must meet the definition criteria of an asset i.e. identifiable (see 1.2.1), control over a
resource and existence of future economic benefits.

An entity controls an asset if the entity has the power to obtain the future economic benefits flowing from the
underlying resource and to restrict the access of others to those benefits.

The future economic benefits flowing from an intangible asset may include revenue from the sale of products
or services, cost savings, or other benefits resulting from the use of the asset by the entity.

⯈ Example:
Market and technical knowledge may give rise to future economic benefits. Control over such knowledge
exists if it is protected by legal rights such as copyrights or by a legal duty on employees to maintain
confidentiality.

⯈ Example:
The entity usually has insufficient control over the expected economic benefits from customer relationships
and loyalty for such items (e.g. portfolio of customers, market share) to meet the definition of intangible assets.

⯈ Example:
The exchange transactions for the same or similar non-contractual customer relationships provide evidence
that the company is able to control those benefits in the absence of such legal rights. Such exchange
transactions also provide evidence that the customer relationship is separable so, thus meeting the intangible
asset definition. This means that a purchased customer list would usually be capitalized.

⯈ Example:
An entity may have a team of skilled staff and may be able to identify incremental staff skills(skill labor no
guarantee) leading to future economic benefits from training. The entity may also expect that the staff will
continue to make their skills available to the entity. However, an entity usually has insufficient control over the
expected future economic benefits (e.g. an employee might leave the entity taking with him the skills obtained
from training) arising from a team of skilled staff and from training for these items to meet the definition of an
intangible asset. Similarly, specific management or technical talent is unlikely to meet the definition of an
intangible asset, unless it is protected by legal rights to use it.

Physical and non-physical elements [IAS 38: 4 & 5]

Some intangible assets may be contained in or on a physical substance such as a compact disc (in the case
of computer software), legal documentation (in the case of a licence or patent). Intangible assets may have
secondary physical element. Therefore, although these activities may result in an asset with physical
substance (e.g. a prototype), the physical element of the asset is secondary to its intangible component, i.e.
the knowledge contained in it.

In determining whether an asset that incorporates both intangible and tangible elements should be treated
under IAS 16 Property, Plant and Equipment or as an intangible asset under IAS 38, an entity uses judgement
to assess which element is more significant. For example, computer software for a computer‑ controlled
machine tool that cannot operate without that specific software is an integral part of the related hardware and
it is treated as property, plant and equipment. The same applies to the operating system of a computer. It is
included in PPE.

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⯈ Example:
An air-conditioning unit has software installed to control and display the temperature including its connectivity
with the remote. The software element of air-conditioning unit is insignificant and supportive only to its physical
parts including compressor etc. which achieve its primary purpose i.e. air cooling. The air-conditioning unit
shall be accounted for as PPE.

However, when the software is not an integral part of the related hardware, computer software is treated as
an intangible asset.

Recognition of subsequent expenditure [IAS 38: 20]

Subsequent expenditure is only capitalised if it can be measured and attributed to an asset and enhances the
value of the asset.

This would rarely be the case because:

• The nature of intangible assets is such that, in many cases, there are no additions to such an asset or
replacements of part of it.
• Most subsequent expenditure is likely to maintain the expected future economic benefits embodied in an
existing intangible asset rather than meet the definition of an intangible asset and the recognition criteria.
• Also, it is often difficult to attribute subsequent expenditure directly to a particular intangible asset rather
than to the business as a whole.
Maintenance expenditure is charged to profit or loss.

Initial measurement [IAS 38: 24]

An intangible asset shall be measured initially at cost. An intangible asset may be acquired in following ways:
• Acquired or Purchased separately
• Acquired in exchange of another asset
• Acquired by way of government grant
• Internally generated including Research & Development
• Acquired in business combination

Intangible assets acquired or purchased separately [IAS 38: 25 to 32]

Normally, the price an entity pays to acquire the intangible asset separately will reflect expectations about the
probability that the expected future economic benefits embodied in the asset will flow to the entity. Therefore,
the probability of economic benefits is always considered to be satisfied for separately acquired intangible
assets.
In addition, the cost of a separately acquired intangible asset can usually be measured reliably. This is
particularly so when the purchase consideration is in the form of cash or other monetary assets.

The cost of a separately acquired intangible asset comprises:

a) its purchase price, including import duties and non‑ refundable purchase taxes (e.g. input sales tax paid
by an unregistered person), after deducting trade discounts and rebates; and
b) any directly attributable cost of preparing the asset for its intended use. Examples of directly attributable
costs are:
• costs of employee benefits arising directly from bringing the asset to its working condition;
• professional fees (e.g. legal or consulting fees) arising directly from bringing the asset to its working
condition; and
• costs of testing whether the asset is functioning properly.

Examples of expenditures that are not part of the cost of an intangible asset are:
• costs of introducing a new product/service (including advertising/promotional activities);
• costs of conducting business in a new location or with a new class of customer (including costs of
staff training); and
• administration and other general overhead costs.

The following are important considerations regarding initial measurement of acquired intangible assets:
• Recognition of costs in the carrying amount of an intangible asset ceases when the asset is in the
condition necessary for it to be capable of operating in the manner intended by management. For
example, initial operating losses or cost of redeploying the asset.
• Income and expenses relating to incidental operations (not directly attributable) are recognised
immediately in profit or loss, and included in their respective classifications of income and expense.
• If payment for an intangible asset is deferred beyond normal credit terms, its cost is the cash price
equivalent. The difference is interest expense unless capitalised as per IAS 23.
----------( 325 )----------
Intangible asset acquired in exchange of another asset [IAS 38: 45 & 46]
In order to recognize an asset that was acquired in an asset exchange, it must meet both the definition and
recognition criteria. However, the asset acquired will only be recognized and the asset given up will only be
derecognized, if the transaction has commercial substance.

A transaction is said to have commercial substance if its future cash flows are expected to change as a result
of the transaction.
In the case of the exchange of assets, the cost of the intangible asset acquired will be:
• fair value of the asset given up ± Cash paid (received);
• fair value of the acquired asset, if this is more clearly evident;
• the carrying amount of the asset given up ± Cash paid (received), if neither of the fair values are available
or reliably measureable or the transaction lacks commercial substance.

Intangible asset acquired by way of government grant [IAS 38: 44]

In some cases, an intangible asset may be acquired free of charge, or for nominal consideration, by way of a
government grant. This may happen when a government transfers or allocates to an entity intangible assets
such as airport landing rights, licences to operate radio or television stations, import licences or quotas or
rights to access other restricted resources.

In accordance with IAS 20, an entity may choose to recognise both the intangible asset and the grant initially
at fair value. Alternatively, the entity recognises the asset initially at a nominal amount plus any expenditure
that is directly attributable to preparing the asset for its intended use.

Past expenses not to be recognised as an asset [IAS 38: 71]

Expenditure on an intangible item that was initially recognised as an expense shall not be recognised as part
of the cost of an intangible asset at a later date.

⯈ Example:
Sino Care Limited (SCL) started a R&D project for developing new product on 1st January 20X1. The following
expenditure was incurred during 20X1. Year-end is 31 December 20X1.
• Research phase (1 January to 31 March): Rs. 1 million per month
• Development phase (1 April to 31 October): Rs. 1.5 million per month.
The project become technically feasible on 31 August 20X1 when initial patent was also submitted for
registration.

Required: Discuss the accounting treatment.

⯈ ANSWER:
Expenditure incurred in research phase from 1 January to 31 March of Rs. 3 million (i.e. Rs. 1 million x 3
months) shall be charged to profit or loss.
Expenditure incurred in development phase from 1 April to 31 August of Rs. 7.5 million (i.e. Rs. 1.5 million x
5 months) shall be charged to profit or loss since in this period the capitalisation criteria was not met. Even
after the criteria for capitalisation has been met subsequently, this expenditure shall not be reinstated as an
asset.

Expenditure incurred in development phase after capitalisation criteria has been met from 1 September to 31
October of Rs. 3 million (i.e. Rs. 1.5 million x 2 months) shall be capitalised as intangible asset.

Recognition prohibition [IAS 38: 63 to 64, 48 to 50]

Internally generated brands, mastheads, publishing titles, customer lists and items similar in substance shall
not be recognised as intangible assets.

Expenditure on above items cannot be distinguished from the cost of developing the business as a whole.
Therefore, such items are not recognised as intangible assets.
Internally generated goodwill is not recognised as an asset because it is not an identifiable resource (i.e. it is
not separable nor does it arise from contractual or other legal rights) controlled by the entity that can be
measured reliably at cost.

Differences between the fair value of an entity and the carrying amount of its identifiable net assets at any
time may capture a range of factors that affect the fair value of the entity. However, such differences do not
represent the cost of intangible assets controlled by the entity.

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⯈ Example:
During 20X5 Henry has the following research and development projects in progress:

Project A was completed at the end of 20X4. Development expenditure brought forward at the beginning of
20X5 was Rs. 412,500 on this project. Savings in production costs arising from this project are first expected
to arise in 20X5. In 20X5 savings are expected to be Rs. 100,000, followed by savings of Rs. 300,000 in 20X6
and Rs. 200,000 in 20X7.

Project B commenced on 1 April 20X5. Costs incurred during the year were Rs. 56,000. In addition to these
costs a machine was purchased on 1 April 20X5 for Rs. 30,000 for use on the project. This machine has a
useful life of five years. At the end of 20X5 there were still some uncertainties surrounding the completion of
the project.

Project C had been started in 20X4. In 20X4 the costs relating to this project of Rs. 36,700 had been written
off, as at the end of 20X4 there were still some uncertainties surrounding the completion of the project. Those
uncertainties have now been resolved before a further Rs. 45,000 costs incurred during the year.

Required: Show movement and balance of non-current assets of Henry for the year to 31 December 20X5.

⯈ ANSWER:
Property, plant & Research &
equipment Development
Cost Rs. Rs.
On 1 January 20X5 - 412,500
Additions 30,000 45,000
On 31 December 20X5 30,000 457,500
Accumulated depreciation/amortisation
On 1 January 20X5 - -
Charge for the year 4,500 W1 68,750 W2
On 31 December 20X5 4,500 68,750
Carrying amount
On 31 December 20X5 25,500 388,750
On 31 December 20X4 - 412,500

Comments
The costs in respect of Project B cannot be capitalised as there are uncertainties surrounding the successful
outcome of the project – but the machine bought may be capitalised in accordance with IAS 16. The 20X5
costs in respect of Project C can be capitalised as the uncertainties have now been resolved. However, the
20X4 costs cannot be reinstated.

W1 – Depreciation charge (machine) Rs.

Rs. 30,000 / 5 years x 9/12 4,500
W2 – Amortisation charge (project A) Rs.
100,000 / (100,000 + 300,000 + 200,000) x Rs. 412,500 68,750

ACQUIRED IN BUSINESS COMBINATION

A transaction or other event in which an acquirer obtains control of one or more businesses is called business
combination, for example, when a company (the acquirer) buys a controlling interest (usually 50% or more
voting power) in another company (the acquiree), it is also called business combination and consolidated
financial statements are to be prepared by the acquirer.

Acquisition of intangible asset in a business combination [IAS 38: 33 & 34]

The cost of that intangible asset is its fair value at the acquisition date. The (fair value) of an intangible asset
will reflect market participants’ expectations at the acquisition date about the probability that the expected
future economic benefits embodied in the asset will flow to the entity.

Even an intangible asset that was not recognised in the financial statements of the subsidiary (acquiree) might
be recognised (separately from goodwill) in the consolidated financial statements of parent (acquirer) entity.

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⯈ Example:
Company X buys 100% of Company Y. Company Y owns a famous brand that it launched several years ago.
The fair value of the brand has been estimated at Rs. 6 million at acquisition date.

Required:
Discuss the recognition of brand in financial statements.

⯈ ANSWER:
The brand is not recognised in Company Y’s financial statements (IAS 38 prohibits the recognition of internally
generated brands).

From the Company X group viewpoint the brand is a purchased asset. Part of the consideration paid by
Company X to buy Company Y was to buy the brand and it should be recognised in the consolidated financial
statements at its fair value of Rs. 6 million.

Discussion of Revaluation model:

The revaluation model is applied after an asset has been initially recognised at cost. However, if only part of
the cost of an intangible asset is recognised as an asset because the asset did not meet the criteria for
recognition until part of the way through the process (e.g. development costs), the revaluation model may be
applied to the whole of that asset.

Also, the revaluation model may be applied to an intangible asset that was received by way of a government
grant and recognised at a nominal amount.

Active market valuation [IAS 38: 78, 82 to 84]

It is uncommon for an active market to exist for an intangible asset, although this may happen. An active
market may exist for freely transferable taxi licences, fishing licences or production quotas(however, an active
market cannot exist for brands, newspaper mastheads, music and film publishing rights, patents or
trademarks, because each such asset is unique)

The fact that an active market no longer exists for a revalued intangible asset may indicate that the asset may
be impaired and that it needs to be tested in accordance with IAS 36.

If the fair value of the asset can be measured by reference to an active market at a subsequent measurement
date, the revaluation model is applied from that date.

DISCLOSURE
General disclosure [IAS 38: 118]
An entity shall, for each class of intangible assets, distinguishing between internally generated intangible
assets and other intangible assets, disclose the following:
a) whether the useful lives are indefinite or finite and, if finite, the useful lives or the amortisation rates used;
b) the amortisation methods used for intangible assets with finite useful lives;
c) the gross carrying amount and any accumulated amortisation (aggregated with accumulated impairment
losses) at the beginning and end of the period;
d) the ( line item) (s) of the statement of comprehensive income in which any amortisation of intangible assets
is included.

Reconciliation [IAS 38: 118]

An entity shall, for each class of intangible assets, distinguishing between internally generated intangible
assets and other intangible assets, disclose a reconciliation of the carrying amount at the beginning and end
of the period showing:
a) additions, indicating separately:
i. internal development,
ii. acquired separately, and
iii. acquired through business combinations);
b) disposals;
c) increases or decreases during the period resulting from revaluations from impairment losses recognized
or reversed;
d) any amortization recognized during the period;
e) net exchange differences (under IAS 21);
f) other changes in the carrying amount during the period.

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⯈ Example:
On 1 July 2016, Sunshine Limited (SL) acquired four licenses namely A, B, C and D for a period of ten years.
The following information is available in respect of these licenses:

A B C D
Cost of license (Rs. in million) 200 230 90 60
Expected period of cash generation from 12 indefinite 6 12 years
acquisition date years years
Active market value at 30 June 2017 (Rs. in 170 300 65 No active
million) market
Renewal cost (Rs. in million) 65 85 2 1

The renewal would allow SL to use the licenses for another five years.
SL uses the revaluation model for subsequent measurement of its intangible assets. An independent valuer
has estimated the value of license ‘D’ at Rs. 130 million.

Required: Determine the amounts that should be recognised in respect of the licenses in the statement of
financial position and statement of profit or loss for the year ended 30 June 2017.

⯈ ANSWER:
Sunshine Limited
For the year ended 30 June 2017 Rs. In million
Amount to be recognized in SOFP
Intangibles – Licenses (170+300+65+55) 590
Revaluation surplus (W-1) 93

Amount to be recognized in SOPL

Amortization (W-1) 63
Revaluation Loss (W-1) 20

W-1 A B C D Total
--------------------------[Link]--------------------------
Cost of licenses 200 230 90 60 580
Amortization for the year (20) (23) (15) (5) (63)
(200÷10) (230÷10) (90÷6) * (60÷12) *
Cost less amortization 180 207 75 55 517
Active market value 170 300 65 N/A
Revaluation Loss (10) - (10) (20)
Revaluation surplus (OCI) - 93 - - 93
•Note 1: Benefit is only of 6 and 12 years respectively.
•Note 2: Shorter of: useful of life and legal life unless criteria is met.

DISCLOSURE REQUIREMENTS
Disclosure requirements
In the financial statements, disclosures should be made separately for each class of intangible asset. (Within
each class, disclosures must also be made by internally-generated intangibles and other intangibles, where
both are recognised.)

Most of the disclosure requirements are the same as for tangible non-current assets in IAS 16.

The only additional disclosure requirements are set out below.

▪ Whether the useful lives of the assets are finite or indefinite.
▪ If the useful lives are finite, the useful lives or amortisation rates used.
▪ If the useful lives are indefinite, the carrying amount of the asset and the reasons supporting the
assessment that the asset has an indefinite useful life.

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Example:
An example is shown below of a note to the financial statement with disclosures about intangible assets

Internally- generated Software

Goodwill Total
developmen costs Licences
Rs. m Rs. M Rs. m Rs. m
Cost
At the start of the year 290 64 900 1,254
Additions 60 14 - 74
Additions through business - - 20 20
combinations
Disposals (30) (4) - (34)
––– ––– ––– –––––
At the end of the year 320 74 920 1,314
––– ––– ––– –––––
Accumulated amortisation
and impairment losses
At the start of the year 140 31 120 291
Amortisation expense 25 10 - 35
Impairment losses - - 15 15
Accumulated amortisation 10 2 - 12
on disposals
––– ––– –––– ––––
At the end of the year 175 43 135 353
––– ––– –––– ––––
Net carrying amount
At the start of the year 150 33 780 963
––– ––– –––– ––––
At the end of the year 145 31 785 961
––– ––– –––– ––––

The total amount of research and development expenditure written off (as an expense) during the period must
also be disclosed.

Accounting policies
IAS 1 requires the disclosure of accounting policies used that are relevant to an understanding of the financial
statements. Intangible assets might be among the largest numbers in the statement of financial position and
result in significant expense in the statement of profit or loss.

One of the learning outcomes in this area is that you be able to formulate accounting policies for intangible
assets.
There are several areas that are important to explain to users of financial statements.

Amortisation policy
The depreciable amount of an intangible asset must be written off over its useful life.
Formulating a policy in this area involves estimating the useful lives of different categories of intangible assets.

Under the guidance in IAS 38 the estimated residual values of an asset would usually be zero and the straight
line method would usually be used.

Other explanations:
This is not so much about choosing a policy as explaining situations to users:
▪ Development expenditure: Does the company have any?
▪ Intangible assets acquired in business combinations in the period.
▪ Whether the company has intangible assets assessed as having an indefinite useful life.

Below is a typical note which covers many of the possible areas of accounting policy for intangible assets.

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Illustration: Accounting policy – Intangible assets
The intangible assets of the group comprise patents, licences and computer software.

The group accounts for all intangible assets at historical cost less accumulated amortisation and accumulated
impairment losses.

Computer software
Development costs that are directly attributable to the design and testing of identifiable and unique software
products controlled by the group are recognised as intangible assets when the following criteria are met:
▪ it is technically feasible to complete the software product so that it will be available for use;
▪ management intends to complete the software product and use or sell it;
▪ there is an ability to use or sell the software product;
▪ it can be demonstrated how the software product will generate probable future economic benefits;
▪ adequate technical, financial and other resources to complete the development and to use or sell the
software product are available; and
▪ the expenditure attributable to the software product during its development can be reliably measured.

Directly attributable costs that are capitalised as part of the software product include the software development
employee costs and an appropriate portion of relevant overheads.
Development expenditures that do not meet these criteria are recognised as an expense as incurred. Costs
associated with maintaining computer software programmes are recognised as an expense as incurred.

Useful lives
Amortisation is calculated using the straight-line method to allocate their cost or revalued amounts to their
residual values over their estimated useful lives, as follows:
▪ Patents: 25 to 30 years
▪ Licenses 5 to15 years
▪ Computer software 3 years

All intangible assets are estimated as having a zero residual value.

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 Don’t let failure discourage you but take failure as guidance to achieve the success

Extra Practice Questions

Q.1 Following information pertains to International Associates Limited (IAL):
(i) Intangible assets as at 30 June 2015 were as follows:
Brands Software License
Useful life (years) 10 5 Indefinite
--------- Rs. in million ---------
Cost 200 80 15
Accumulated amortization / impairment 40 48 -

(ii) Details of expenses incurred on a project to improve IAL’s existing production process are as
under:
Period Rs. in million
Up to June 2015 20
July 2015 – March 2016 45

Expenses were incurred evenly during the above period. On 30 September 2015, it was established that the
project is commercially viable. The new process became operational with effect from 1 April 2016 and it is
anticipated that it will generate cost savings of Rs. 10 million per annum for a period of 10 years.

(iii) On 1 August 2015, IAL entered into an agreement to acquire an ERP software which would replace its
existing accounting software. The new software became operational on 1 April 2016. IAL incurred following
expenditure in respect of the ERP software:
Description Rs. in million
Purchase price (including 15% sales tax) 115
Training of staff 2
Consultancy charges for implementation of ERP 5

ERP software has an estimated useful life of 15 years. However, IAL expects to use it for a period of 10 years.
The existing accounting software has become redundant and is of no use for the company.

(iv) During the year ended 30 June 2016, IAL spent Rs. 10 million on development of a new brand. Useful life
of the brand is estimated as ten years.

(v) The license appearing in IAL’s books was issued by the government for an indefinite period. However, on
1 January 2016 the Government introduced a legislation under which the existing license would have to
be renewed after ten years.

(vi) IAL uses cost model to value its intangible assets and amortises them on straight-line basis.

Required:
Prepare a note on ‘intangible assets’ for inclusion in IAL’s financial statements for the year ended 30
June 2016 in accordance with International Financial Reporting Standards. (16)

Q.2
Apple Limited (AL) is in the process of finalizing its consolidated financial statements for the year ended 30
June 2018. Following information pertains to the Group's intangible assets:

(i) As on 30 June 2017, revalued amount of AL’s license and related revaluation surplus were Rs. 450
million and Rs. 30 million respectively.
(ii) On 1 July 2017 AL acquired entire shareholding of Mango Limited (ML) for Rs. 1,950 million. Fair
values of net assets appearing in ML’s books on acquisition date are given below:

Rs. in million
Software (Rs. 100 million each) 200
Other net assets 1,545

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 “Success is achieved by honest efforts but not just dream

In respect of acquisition of ML, following information is also available:

• Till acquisition date, ML had incurred research & development cost of Rs. 80 million on product 'ABC'. ML
had not recognised this as an asset because criteria for recognition of the internally generated intangible
asset was met on.1 July 2017. On this date, AL estimated that the fair value of research and development
work on ABC was Rs. 95 million.
• On acquisition date, fair value of ML's customer list was assessed at Rs. 20 million.

(iii) ML incurred following expenditures on this project from 1 July 2017 till ABC’s launching date i.e. 1 May
2018.

Rs. in million
Market research 5
Product design 12
Cost of pilot plant (not for commercial production) 48
Refinement of product before commercial production 6
Training of production staff 8
Testing of pre-production 4
Production and launching of product 105
188

(iv) As on 1 July 2017, the fair value of AL's own customer list was assessed at Rs. 35 million.

(v) As on 1 July 2017, remaining useful life of all intangible assets except goodwill was 10 years.

(vi) On 31 March 2018, ML sold one of its software for Rs. 110 million.

(vii) Group follows the revaluation model for license whereas cost model is used for other intangible assets.

(viii) As on 30 June 2018:

▪ Fair value of licence was assessed at Rs. 350 million.
▪ Goodwill of ML has been impaired by 20%.

Required:
Prepare a note on intangible assets, for inclusion in AL's consolidated financial statements for the
year ended 30 June 2018 in accordance with the requirements of IFRSs.
(‘Total’ column is not required) (14)

Q.3
Draft financial statements of Tulip Limited (TL) for the year ended 31 December 2017 show the following
amounts:
Rs. in million
Total assets 2,700
Total liabilities 1,620
Net profit for the year 398

While reviewing the draft financial statements, following matters have been noted:

(i) TL commenced development of a new product on 1 January 2017. Following directly attributable costs
have been incurred upto the launching date of 1 October 2017 and have been capitalized as intangible
asset:
Rs. in million
Staff salary 30
Equipment (having useful life of 5 years) 360
Consumables 90
Consultant fee 212
Total 692

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 Worrying gives you tension and frustration while prayer gives you peace and stability.”

The recognition criteria for capitalization of internally generated intangible assets was met on 1 March 2017.
All costs have been incurred evenly during the period except equipment which was purchased specifically for
this product on 1 January 2017.

TL estimated that useful life of this new product will be 10 years. However, TL had
not charged any amortization in 2017. (06)

(ii) After preparation of draft financial statements, a claim of Rs. 20 million was lodged by a customer for
supplying defective units of a product in 2017. According to TL's lawyers, the chance that claim would
succeed is 80%.

At year-end, 800 units of this product were included in TL’s inventory at a cost of Rs. 150,000 per unit.
All these units have the same defects. Normal selling price of each unit is Rs. 200,000. TL has already
committed to sell 300 units to Jamal Enterprises at a price of Rs. 220,000 per unit.
TL has estimated that Rs. 80,000 per unit would be incurred to remove the above defect.
Further, each defective unit can be sold for Rs. 130,000 in current condition. (04)

Required:
Determine the revised amounts of total assets, total liabilities and net profit, after incorporating the impact of
above adjustment(s), if any.

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Practice Questions
1. Habib Limited
On 30 June 2004, Habib Limited (HL) discovered that it had been manufacturing a product illegally since this
product happened to be a patented product for which it did not have the necessary rights. HL immediately shut
down its factory and hired a firm of lawyers to act on its behalf in the acquisition of the necessary rights to
manufacture this patented product.

Legal fees of Rs.50,000 were incurred during July 2004.

The legal process was finalized on 31 July 2004, HL was then required to pay Rs.800 000 to purchase the
rights, including Rs.80,000 in refundable Taxes.
During the July factory shut-down:
• Overhead costs of Rs.40,000 were incurred;
• Significant market share was lost with the result that HL’s total sales over August and September was
Rs.20,000 but its expenses were Rs.50,000, resulting in a loss of Rs.30,000.
• To increase market share, HL spent an extra Rs.25,000 aggressively marketing their product. This
marketing campaign was successful, resulting in sales returning to profitable levels in October.

The accountant wishes to capitalize the cost of the patent at:

Purchase price: Rs.800 000 + Legal fees: Rs.50,000 + Overheads during the forced shut-down in July:
Rs.40,000 + Operating loss in Aug & Sept: Rs.30,000 + Extra marketing required: Rs.25,000 = Rs. 945,000

Required: Comment whether or not each of the cost identified can be capitalized.

Answer:
Rs.
Purchase price: The purchase price should be
capitalized, but this must exclude refundable taxes. 720,000 (800,000-80,000)
Legal costs: This is a directly attributable cost.
Directly attributable costs must be capitalized 50,000
Overhead costs: This is an incidental cost not necessary
to the acquisition of the rights (the shut-down was only
necessary because HL had been operating illegally) -
Operating loss: The operating loss incurred while
demand for the product increased to its normal level is
an example of a cost that was incurred after the rights
were acquired. (Costs incurred after the Intangible Asset
is available for use will not be capitalized) -
Advertising campaign: The extra advertising incurred in
order to recover market share is an example of a cost that
was incurred after the rights were acquired.
Furthermore, advertising costs are listed in IAS 38 as
one of the costs that may never be capitalized as an
intangible asset
-
Total cost 770,000

2. Saqib Limited [Application of para 65 to 67]

Question: Saqib Limited began researching and developing an intangible asset. The following is a
summary of the costs that the R&D Department incurred each year:
2011: Rs.180,000
2012: Rs.100,000
2013: Rs.80,000

Additional information:
The costs listed above were incurred evenly throughout each year.
• Included in the costs incurred in 2011 are administrative costs of Rs.60,000 that are not considered to be
directly attributed to the research and development process. The first two months of the year were
dedicated to research. Then development began from 1 March 2011 but all 6 recognition criteria for
capitalization of development costs were only met on 1 April 2011.

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 Prayer is a weapon for believers to overcome the hard situations.”

• Included in the costs incurred in 2012 are administrative costs of Rs.20,000 that are considered to be
directly attributed to the research and development process.
• Included in the costs incurred in 2013 are training costs of Rs.30,000 that are considered to be directly
attributed to the research and development process: in preparation for the completion of the development
process, certain employees were trained on how to operate the asset.

Required:
Prepare journal entries related to the costs incurred for each of the years ended 31 December 2011 to 2013 and
briefly comment on accounting treatment.

Answer:
2011 Debit Credit
Administration Exp.-Not directly attributable 60,000
Research Expense (180,000-60,000)*2/12 20,000
Development Expense (180,000-60,000)*1/12 10,000
Development cost (Asset) (180,000-60,000)*9/12 90,000
Bank 180,000
2012
Development cost (Asset) 100,000
Bank 100,000
2013
Training Expense 30,000
Development cost (Asset) [80,000-30,000] 50,000
Bank 80,000

Comment
Administration costs are capitalized if they are considered directly attributable (see 2012),
otherwise they are expensed (see 2011)

Training costs are always expensed even if they are considered to be directly attributable
(see 2013).

Research costs are always expensed

Development costs that are expensed due to being incurred before the recognition criteria were met may not
be subsequently capitalized, even if the recognition criteria are subsequently met. They remain expensed.

[Link]
Brooklyn is a bio-technology company performing research for pharmaceutical companies. The finance
director has contacted Ahmed’s financial consulting company to arrange a meeting to discuss issues relevant
to the preparation of the financial statements for the year to 30th June 2015. Ahmed’s initial telephone
conversation has provided the necessary background information:

On 1st August 2014 Brooklyn began investigating a new bio-process. On 1st September 2015, the new
process was widely supported by the scientific community and the feasibility project was approved. A grant was
then obtained relating to future work. Several pharmaceutical companies have expressed an interest in
buying the ‘know how’ when the project completes in June 2016. The nominal ledger account set up for the
project shows that the expenditure incurred between 1st August 2014 and 30th June 2015 was Rs. 300,000
per month.

Required: prepare for the meeting with the finance director which explain and justify the accounting treatment
of these issues, with appropriate calculations and identification of matters on which further information is
required are as follows:

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Answer:
IAS 38 on intangibles requires that research and development be considered separately:
• research – which must be expensed as incurred (related to August 2014)
• development – which must be capitalised where certain criteria are met.

It must first be clarified how much of the Rs.3 million incurred to date (10 months (from 01.09.2014 to
30.06.2015) at Rs.300,000) is simply research and how much is development. The development element will
only be capitalised where the IAS 38 criteria are met. The criteria are listed below together with the extent to
which they appear to be met:
• The project must be believed to be technically feasible. This appears to be so as the feasibility has
been acknowledged.
• There must be an intention to complete and use/sell the intangible. Completion is scheduled for June
2016
• The entity must be able to use or sell the intangible. Interest has been expressed in purchasing the
knowhow on completion
• It must be considered that the asset will generate probable future benefits. Confirmation is required
from Brooklyn as to the extent of interest shown by the pharmaceutical companies and whether this
is of a sufficient level to generate orders and to cover the deferred costs.
• Availability of adequate financial and technical resources must exist to complete the project. The
financial position of Brooklyn must be investigated. A grant is being obtained to fund further work
and the terms of the grant, together with any conditions, must be discussed further.
• Able to identify and measure the expenditure incurred. A separate nominal ledger account has been
set up to track the expenditure.

If all of the above criteria are met, then the development element of the Rs.3m incurred to date must be
capitalised as an intangible asset. Amortisation will not begin until commercial production commences.

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 Prayer is a weapon for believers to overcome the hard situations

Intangible Assets (IAS-38)

An identifiable non-current asset without physical substance. For example
• Software
• Manufacturing Licenses
• Import Licence
• Export Licence/ Export quota
• Airline routes
• Broadcasting Licenses
• Formulas/ Recipes (of medicines)

Asset is a resource controlled by the company as a result of past events and from which future benefits are
expected.

Recognition Criteria: [Para 21]

An intangible asset shall be recognized if and if only:
a) It is probable that future economic benefits will flow to the entity; and
b) Cost of an asset can be measured reliably.

An intangible asset is measured initially at cost.

Elements of cost: [Para 27 to 29](as in IAS 16)

Goodwill:
Internally Generated Goodwill: [Para 48]
It is not recognized as an intangible asset because it is not a separable resource of the business that can be
measured reliably.

Purchased Goodwill: if cost of investment and fair value of NCI is more than the FV of net assets of subsidiary
at the date of acquisition. It is recognized in consolidated statement of financial position as a non-current asset.

It is not amortized; instead it is tested for impairment annually.

The following internally generated items must not be capitalized: [Para 63]
• Good will
• Brands (particular make of product e.g. Bata, Service)
• Mast heads (display title of newspaper e.g. DAWN NEWS etc)
• Publishing titles (profession of publishing books e.g. PBP)
• Customer lists (customer relationships)

If however these items are purchased then these are capitalized.

Internally generated intangible items Other than Goodwill: {Research & Development}

A company may have an intangible item that has been internally generated. There are three distinct phases:
1) Research
2) Development
3) Commercial Production.

Once the research phase is successfully completed, the development phase may begin, the successful
completion of which then leads to the start of the Commercial production phase.

The Research Phase:

It is defined as
• Original and planned investigation
• Undertaken with the prospect of gaining
• New scientific or technical knowledge

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 Use patience and prayers to overcome hardships and sufferings we face

Accounting treatment of costs in research phase: [Para 54]

There is no guarantee at this stage that the future economic benefits can be obtained or are probable
(economic benefits are only possible).

Therefore research costs are always expensed out.

Normally they are written as a separate line item after selling & admin expenses in statement of PL (if material).

Examples of research activities: [Para 56]

The Development Phase:

Development is defined as:
• The application
• Of research finding
• To a plan or design for the production
• Of new or substantially improved products or services
• Prior to the commencement of commercial production or use.

Since development phase is after research phase therefore more advanced stage of creation, it may be
possible that item (formula) is expected to generate future economic benefits and therefore amount can be
capitalized,

if all the following criteria are fulfilled: [Para 57]

a) Technical feasibility of completing the asset;
b) The intention to complete the asset and to either use or sell it;
c) The ability to use or sell the asset;
d) How the asset will generate the future economic benefits;
e) The adequate availability of necessary resources to complete the development and to sell or use the asset
f) The ability to reliably measure the cost of the development of the asset.

If just one of these above mentioned criteria is not met even then the related development costs must
be expensed out.

Examples of development phase [Para 59]

Components of cost of an internally generated asset [Para 66 & 67]
Past Expense not to be capitalized: [Para 71]

Expenditures on an intangible item that are initially recognized as an expense shall not recognize as an asset
at a later date.

The commercial Production in which inventories are produced for sale.

Once development phase is successfully completed, the economic benefits from the use of the development
asset can start to flow into the entity. In order to achieve a better reflection of the diminishing value of the asset
as a result of usage, the development asset should be amortized.

The amortization of the development asset must being as soon as asset is available for use. It therefore does
not matter when we actually start production.

However, research and development project must be continuously tested during the course of completion for
impairment and whenever carrying amount exceeds its recoverable amount an impairment loss should be
recognized immediately.

A) The item must be without physical substance:

Expenditure is frequently incurred on items that have both tangible and intangible elements. This requires
assessing which elements is more significant: the physical (Tangible) or the non-physical (Intangible)
element. Depending on which element is more significant will determine which standard should be applied to
the asset:
• the standard on Intangible Asset (IAS-38); or
• the standard on Property, Plant & Equipment (IAS-16).

----------( 339 )----------

Example: Recognition of a fishing license
A company has acquired a fishing license. The directors insist that it is a physical asset since it is written on a
piece of paper. State and briefly explain whether or not you would recognize a fishing license as an intangible
asset.

Solution:
Although the fishing license has a physical form, (the related legal documentation), the license is considered
intangible rather than tangible since the most significant aspect is the licensed ‘ability’ to fish. Such a right
(whether documented or not) is always considered to be intangible.

Example: Recognition of Software

State and briefly explain whether or not you would recognize software as an intangible asset if it is incorporated
into a machine that is dependent on the software for its operation.

Solution:
The most significant element would be considered to be tangible machine, since the software is considered
integral to the machine, and thereof the cost of the software would be recognized as part of the cost of the
machine and therefore classified as tangible. If the software was ‘*stand-alone’ software rather than ‘in the
machine’, it would have been classified as an intangible asset (IAS-38).

*Standalone software means which is not necessary for the machine to operate e.g. MS office or adobe reader.
Operating system is not stand alone software.

B) The item must be identifiable:

Another important aspect of definition of ‘intangible assets’ as per IAS-38 is that asset must be identifiable. An
asset is considered to be identifiable if it
• Is ‘separable’, i.e. is capable of being separated or divided from the entity and sold or exchanged.

C) The item must be controllable:

Control over an intangible asset can be achieved if the entity has
• The ability to restrict access to the asset and its related future economic benefits; and
• The power to obtain future economic benefits

Example: Recognition of Training Costs

State and briefly explain whether or not you would recognize training costs as an intangible asset.

Solution:
Although training may be considered to be expenditure on an identifiable, non-monetary item that is without
physical substance, the definition of an asset is not met in terms of the Framework since the trained staff
members may not necessarily be under sufficient control of the entity to be considered to be an asset, unless
it is protected by legal rights to use it and to obtain the future economic benefits from it [Para 15].

Note: if question is silent regarding the protection of benefits by legal rights, then assume that they are not
protected by any future legal rights.

Amortization and Impairment Testing:

An intangible asset may either be assessed as having:

a) A finite useful life
b) An indefinite useful life (This could be when there is no foreseeable limit to the period over which the
asset is expected to generate cash flows)

Assets that have finite useful life is amortized whereas those that have indefinite useful life are not
amortized.

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 Prayer becomes powerful when it is done with patience and sincere faith in Allah

Impairment Testing:
Intangible assets that have finite useful lives are tested in the same way as Property, Plant &
equipment are tested for impairment:
• Impairment test is first performed to identify whether there is any indication of impairment;
• Then, if there appears to be material impairment, the recoverable amount is calculated and compared to the
carrying amount.

The following intangible assets are not amortized:

• Purchased Goodwill
• Intangible assets not yet available for use; and
• Intangible assets with indefinite useful lives;

Instead, the recoverable amount must be estimated every year irrespective of whether there is any indication
that suggests a possible impairment.

Residual value [Para 100]

In the case of intangible assets, the residual value is assumed to be zero unless:
• A 3rd party has committed to purchase the asset at the end of its useful life; or
• There is an active market for that asset and
→ it is possible to determine the residual value using such market and
→ It is expected that such a market will still exist at the end of useful life.

In process research & development

Whereas many companies do their own research and development, it is possible for a company to buy another
company’s research and development. If a company buys (either separately or as part of a business
combination) another company’s ‘in-process research and development’ project, the fair value of the initial
acquisition costs will be capitalised.

The entire purchase price is capitalised regardless of the portion of the fair value that relates to purchased
research.

Any subsequent expenditure on this purchased ‘in-process research and development’ project will, however,
be analyzed and recognized in the normal way:
• costs that relate to research must be expensed;
• costs that relate to development:
- must be expensed if all recognition criteria are not met; and
- Capitalised if all recognition criteria are met.

INTANGIBLE ASSETS ACQUIRED IN A BUSINESS COMBINATION

Cost guidance
If an intangible asset is acquired in a business combination, its cost is the fair value at the acquisition date.
If cost cannot be measured reliably then the asset will be included within goodwill.

In-process research and development

The acquiree might have a research and development project in process. Furthermore, it might not recognize
an asset for the project because the recognition criteria for internally generated intangible assets have not
been met.

Subsequent expenditure on an acquired in-process research and development project

Expenditure incurred on an in-process research or development project acquired separately or in a business
combination and recognized as an intangible asset is accounted for in the usual way by applying the IAS 38
recognition criteria.

This means that further expenditure on such a project would not be capitalized unless the criteria for the
recognition of internally generated intangible assets were met.

Measurement Model
As with tangible assets covered in property, plant and equipment (IAS 16), there are two measurement models
for intangible assets:
• The cost model; and
• The revaluation model.
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Cost Model
The intangible asset is shown at its cost less any accumulated amortization and any accumulated impairment
losses.

Revaluation model
If the intangible asset is measured under the revaluation model it is shown at its:
• fair value at date of revaluation
• Less any subsequent accumulated amortization and any accumulated impairment losses.

The revaluation must be performed with sufficient regularity that the intangible asset’s carrying amount does
not differ significantly from its fair value.
In revaluation model if an asset is to be revalued, all assets in that same class must be revalued at the same
time.

The mechanisms used in applying the revaluation model to intangible assets are just the same as those used
to apply the revaluation model to property, plant and equipment, with the one exception being that the fair
value of an intangible asset must be determined with reference to an active market ((there was no such
limitation in IAS 16: Property, plant and equipment). There is often no active market for the intangible asset
due to its uniqueness and therefore, although the revaluation model is allowed, it is often not possible to apply
in practice.

Definition of Active market:[IFRS 13 Appendix A]

It is a market in which transactions for asset takes place with sufficient frequency to provide pricing information
on an ongoing basis.

If, within a class of assets measured at fair value, there is an intangible asset that does not have a reliably
measurable fair value, then that asset will continue to be carried at cost less accumulated depreciation and
impairment losses (means not revalued).

If the revaluation model is used but at a later stage the fair value is no longer reliably determined (i.e. there is
no longer an active market), the asset should continue to be carried at the amount determined at the date of
the last revaluation less any subsequent accumulated amortization and impairment losses.

Accounting for a revaluation

The revaluation of an intangible asset is accounted for in the same way as that of a tangible asset (covered
by the standard on property, plant and equipment).

Period of amortization
Amortization of the intangible asset should begin from the date on which it becomes available for use (i.e. not
from when the entity actually starts to use the asset).

Amortization should cease when the asset is derecognized.

The amortization period should be the shorter of:
• The asset’s expected economic useful life; and
• Its legal life.

Where the asset has a limited legal life (i.e. where related future economic benefits are controlled via legal
rights granted for a finite period), the expected economic useful life will be limited to the period of the legal
rights, if this is shorter, unless:
• the legal rights are renewable by the entity; and
• there is evidence to suggest that the rights will be renewed; and
• The costs of renewal are not significant.

Method of amortization
The method used should be a systematic one that reflects the pattern in which the entity expects to use the
asset. The methods possible include:
• straight-line
• reducing balance
• Unit of production method or any other method reflecting the pattern of benefits

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Annual review
At the end of each financial period, the following should be reviewed in respect of intangible assets with finite
useful lives:
• amortization period;
• amortization method;
• residual value; and

If there is any change in estimate, the change shall be treated as a change in accounting estimate as per IAS-
8 (means apply prospectively)

Intangible assets with indefinite useful life:

An intangible asset with an indefinite useful life is:
• Not amortized but
• Entity is require to test such an asset for impairment by comparing its recoverable amount with its carrying
amount annually.

Intangible assets not yet available for use:

An intangible asset that is still not available for use is:
• Not amortized, but it is
• Tested every year for impairment even if there is no indication of impairment.

Review of useful Life Assessment:

The useful life of an intangible asset that is not being amortized shall be reviewed each period to determine
whether events or circumstances continue to support an indefinite useful life assessment for that and if they
do not, the change in useful life assessment from indefinite to finite shall be accounted for as a change in
accounting estimate as per IAS-8.

Disclosures
→ Present carrying amount of intangible asset in Non-Current Assets in statement of financial position.
→ Schedule in Notes to Financial Statements (just like tangible assets). If an intangible asset is revalued
then same disclosures as in IAS-16

Class of assets
The same model should be applied to all assets in the same class. A class of intangible assets is a
grouping of assets of a similar nature and use in an entity’s operations. Examples of separate classes
may include:
• brand names;
• mastheads and publishing titles;
• computer software;
• licences and franchises;
• copyrights, patents and other industrial property rights, service and operating rights;
• recipes, formulae, models, designs and prototypes; and
• Intangible assets under development.

⯈ Example:
An entity incurred Rs. 4 million on a massive marketing campaign to promote a new product. The accountant
wishes to capitalize these costs. The cost of the advertising campaign is not separable as it cannot be
separated from the entity and sold, transferred, rented or exchanged etc. Furthermore, the advertising
campaign does not arise from contractual or legal rights. Thus, the cost of the advertising campaign is not
identifiable and must be expensed out.

⯈ Example:
Market and technical knowledge may give rise to future economic benefits. Control over such knowledge
exists if it is protected by legal rights such as copyrights or by a legal duty on employees to maintain
confidentiality.

⯈ Example:
The entity usually has insufficient control over the expected economic benefits from customer relationships
and loyalty for such items (e.g. portfolio of customers, market share) to meet the definition of intangible assets.

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⯈ Example:
The exchange transactions for the same or similar non-contractual customer relationships provide evidence
that the company is able to control those benefits in the absence of such legal rights. Such exchange
transactions also provide evidence that the customer relationship is separable so, thus meeting the intangible
asset definition. This means that a purchased customer list would usually be capitalized.

⯈ Example:
An entity may have a team of skilled staff and may be able to identify incremental staff skills(skill labor no
guarantee) leading to future economic benefits from training. The entity may also expect that the staff will
continue to make their skills available to the entity. However, an entity usually has insufficient control over the
expected future economic benefits (e.g. an employee might leave the entity taking with him the skills obtained
from training) arising from a team of skilled staff and from training for these items to meet the definition of an
intangible asset. Similarly, specific management or technical talent is unlikely to meet the definition of an
intangible asset, unless it is protected by legal rights to use it.

⯈ Example:
An air-conditioning unit has software installed to control and display the temperature including its connectivity
with the remote. The software element of air-conditioning unit is insignificant and supportive only to its physical
parts including compressor etc. which achieve its primary purpose i.e. air cooling. The air-conditioning unit
shall be accounted for as PPE.

However, when the software is not an integral part of the related hardware, computer software is treated as
an intangible asset.

Recognition of subsequent expenditure [IAS 38: 20]

Subsequent expenditure is only capitalised if it can be measured and attributed to an asset and enhances the
value of the asset.
This would rarely be the case because:
• The nature of intangible assets is such that, in many cases, there are no additions to such an asset or
replacements of part of it.
• Most subsequent expenditure is likely to maintain the expected future economic benefits embodied in an
existing intangible asset rather than meet the definition of an intangible asset and the recognition criteria.
• Also, it is often difficult to attribute subsequent expenditure directly to a particular intangible asset rather
than to the business as a whole.

Maintenance expenditure is charged to profit or loss.

Initial measurement [IAS 38: 24]

An intangible asset shall be measured initially at cost. An intangible asset may be acquired in following ways:
• Acquired or Purchased separately
• Acquired in exchange of another asset
• Acquired by way of government grant
• Internally generated including Research & Development
• Acquired in business combination

Intangible asset acquired in exchange of another asset [IAS 38: 45 & 46]
In order to recognize an asset that was acquired in an asset exchange, it must meet both the definition and
recognition criteria. However, the asset acquired will only be recognized and the asset given up will only be
derecognized, if the transaction has commercial substance.

A transaction is said to have commercial substance if its future cash flows are expected to change as a result
of the transaction.

In the case of the exchange of assets, the cost of the intangible asset acquired will be:
• fair value of the asset given up ± Cash paid (received);
• fair value of the acquired asset, if this is more clearly evident;
• the carrying amount of the asset given up ± Cash paid (received), if neither of the fair values are available
or reliably measureable or the transaction lacks commercial substance.

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Intangible asset acquired by way of government grant [IAS 38: 44]
In some cases, an intangible asset may be acquired free of charge, or for nominal consideration, by way of a
government grant. This may happen when a government transfers or allocates to an entity intangible assets
such as airport landing rights, licences to operate radio or television stations, import licences or quotas or
rights to access other restricted resources.

In accordance with IAS 20, an entity may choose to recognise both the intangible asset and the grant initially
at fair value. Alternatively, the entity recognises the asset initially at a nominal amount plus any expenditure
that is directly attributable to preparing the asset for its intended use.

Acquisition of intangible asset in a business combination [IAS 38: 33 & 34]

The cost of that intangible asset is its fair value at the acquisition date. The (fair value) of an intangible asset
will reflect market participants’ expectations at the acquisition date about the probability that the expected
future economic benefits embodied in the asset will flow to the entity.

Even an intangible asset that was not recognised in the financial statements of the subsidiary (acquiree) might
be recognised (separately from goodwill) in the consolidated financial statements of parent (acquirer) entity.

Discussion of Revaluation model:

The revaluation model is applied after an asset has been initially recognised at cost. However, if only part of
the cost of an intangible asset is recognised as an asset because the asset did not meet the criteria for
recognition until part of the way through the process (e.g. development costs), the revaluation model may be
applied to the whole of that asset.

Also, the revaluation model may be applied to an intangible asset that was received by way of a government
grant and recognised at a nominal amount.

Active market valuation [IAS 38: 78, 82 to 84]

It is uncommon for an active market to exist for an intangible asset, although this may happen. An active
market may exist for freely transferable taxi licences, fishing licences or production quotas(however, an active
market cannot exist for brands, newspaper mastheads, music and film publishing rights, patents or
trademarks, because each such asset is unique)

The fact that an active market no longer exists for a revalued intangible asset may indicate that the asset may
be impaired and that it needs to be tested in accordance with IAS 36.
If the fair value of the asset can be measured by reference to an active market at a subsequent measurement
date, the revaluation model is applied from that date.

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 Use patience and prayers to overcome hardships and sufferings we face.”

SIC 32
Intangible Assets- Website Costs

ISSUE
An entity may incur internal expenditure on the development and operation of its own website for internal or
external access.
(a) A web site designed for external access may be used for various purposes such as to promote and
advertise an entity’s own products and services provide electronic services; and sell products and
services.
(b) A website designed for internal access may be used to store company policies and customer details.

Stages of website’s development:

a. Planning
b. Application and Infrastructure Development
c. Graphical Design Development
d. Content Development

[All these stages will be discussed on the next pages]

Once development of a web site has been completed, the Operating stage begins. During this stage, an
entity maintains and enhances the applications, infrastructure, graphical design and content of the web site.

Issues are:
a. whether the web site is an internally generated intangible asset that is subject to the requirements
of IAS 38; and
b. The appropriate accounting treatment of such expenditure.

Exclusion from scope of SIC 32 [para 5 and 6]

SIC 32 does not apply to expenditure on purchasing, developing, and operating hardware (e.g. web servers,
staging servers, production servers and Internet connections) of a web site. Such expenditure is accounted
for under IAS 16.

Additionally, when an entity incurs expenditure on an Internet service provider hosting the entity’s web site,
the expenditure is recognized as an expense.

IAS 38 does not apply to intangible assets held by an entity for sale in the ordinary course of business (see
IAS 2 and IFRS-15) or leases of intangible assets that fall within the scope of IFRS-16.

Consensus [Accounting Treatment] [para 7 and 8]

A web site arising from development shall be recognized as an intangible asset if and only if, in
addition to complying with the general requirements described in IAS 38.21 for recognition and initial
measurement, an entity can satisfy the requirements in IAS 38.57 related to capitalization of
development expenditures. In particular, an entity may be able to satisfy the requirement to demonstrate
how its web site will generate probable future economic benefits in accordance with IAS 38.57(d) when, for
example, the web site is capable of generating revenues, including direct revenues from enabling
orders to be placed. An entity is not able to demonstrate how a web site developed solely or primarily for
promoting and advertising its own products and services will generate probable future economic benefits,
and consequently all expenditure on developing such a web site shall be recognized as an expense when
incurred.

Summary: If Website is capable of earning direct revenues from orders to be placed; then recognize as an
intangible asset; however, if website is developed solely for the purpose of advertisement and promotion of
products; all expenditure, items must be recognized as an expense.

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 Prayer can change your situation so remember Allah and offer prayers

Stages in Website Development:[para 9]

a) Planning stage:
The Planning stage is similar in nature to the research phase in IAS 38. Expenditure incurred in this stage
shall be recognized as an expense when it is incurred.

b) Application and Infrastructure development stage, Graphical Design stage and content
development stage:
The Application and Infrastructure Development stage, the Graphical Design stage and the Content
Development stage, to the extent that content is developed for purposes other than to advertise and
promote an entity’s own products and services, are similar in nature to the development phase in
IAS 38. Expenditure incurred in these stages shall be included in the cost of a web site
recognized as an intangible asset. For example, expenditure on purchasing or creating content
(other than content that advertises and promotes an entity’s own products and services) specifically
for a web site, or expenditure to enable use of the content (e.g. a fee for acquiring a license to
reproduce) on the web site, shall be included in the cost of development when this condition is met.
However, in accordance with IAS 38, past expenses are recognized as an expense shall not be
recognized as part of cost of an intangible asset at a later date.

c) Content development stage:

Expenditure incurred in the Content Development stage, to the extent that content is developed to
advertise and promote an entity’s own products and services (e.g. digital photographs of products),
shall be recognized as an expense when incurred. For example, when accounting for expenditure on
professional services for taking digital photographs of an entity’s own products and for enhancing their
display, expenditure shall be recognized as an expense as the professional services are received during
the process, not when the digital photographs are displayed on the web site.

d) Operating stage:
The Operating stage begins once development of a web site is complete. Expenditure incurred in this
stage shall be recognized as an expense when it is incurred

A web site that is recognized as an intangible asset shall be measured after initial recognition by applying
the requirements of IAS 38.72–.87(means either at cost or revaluation model)

The best estimate of a web site’s useful life should be short.

Example of application of SIC -32

Stage/nature of expenditure Accounting treatment
Planning
• Undertaking feasibility studies Recognize as an expense when incurred
• Defining hardware and software specifications
• Evaluating alternative products and suppliers
• Selecting preferences

Application and infrastructure development

• Purchasing and developing hardware Apply the requirement of IAS 16

• Obtaining a domain name Recognize as an expense when incurred,

• developing operating software (e.g. unless the expenditure can be directly
operating system and server software) attributed to preparing the web site to operate
• developing code for the application in the manner intended by management, and
• installing developed applications on the web the website meets the recognition criteria in IAS
server 38.21 and IAS 38.57
• stress testing

Graphical design development

• designing the appearance (e.g. layout and Recognize as an expense when incurred,
colour) of web pages unless the expenditure can be directly
attributed to preparing the web site to operate
in the manner intended by management, and
the web site meets the recognition criteria in.
IAS 3S.21 and IAS 38.57
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 Content development
• Creating, purchasing, preparing (e.g. creating Recognize as an expense when incurred in
links and identifying tags) and uploading accordance with IAS 38.69(c) to the extent that
information either textual or graphical in nature, content is developed to advertise and promotes
on the web site before the completion of the web an entity’s own products and services (eg digital
site’s development. Examples of content include photographs of products). Otherwise recognize
information about an entity , products or as an expense when incurred, unless the
services offer for sale, and topics that subscriber expenditure can be directly attributed to
access preparing the web site to operate in the manner
intended by management, and the web site
meets the recognition criteria in IAS 38.21 and
IAS 38.57
Operating (the web site)
• updating graphics and revising content Assess whether it meets the definition of an
• adding new functions, features and content intangible asset and the recognition criteria
• registering the website with search engines set out in IAS 38.18, in which case the
• backing up data expenditure is recognized in the carrying
• reviewing security access amount of the web site asset, otherwise
• analyzing usage of the web site expense. Subsequent expenditure can only
be capitalized, if they meet the relevant
recognition criteria.

Other
• selling, administrative and other general
overhead expenditure unless it can be
directly attributed to preparing the web site
for use to operate in the manner intended)
management
• clearly identified inefficiencies and initial
operating losses incurred before the web Recognize as an expense when incurred
site achieves planned performance (e.g.
false start testing]
• training employees to operate the website

Point to remember: All expenditure on developing a website solely or primarily for promoting and advertising
an entity’s own products and services is recognized as an expense when incurred.

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 Prayer is the free wireless connection to reach
Allah who created me, you, all and everything.

Extra Practice Questions:

Q.1
Zinc Limited (ZL), is a broadcasting company. Following information pertains to ZL’s intangible assets:
(i) On 1 January 2018, ZL bought an incomplete research and development project from Bee Tech at its
fair value of Rs. 90 million. The purchase price was analysed as follows:

Rs. in million
Research 30
Development 60

Subsequent expenditures incurred on this project are as follows:

Rs. in million
Further research to identify possible markets 10
Development 48

Recognition criteria for capitalization of development was met on 1 March 2018. All costs are incurred
evenly from 1 January 2018 till project completion date i.e. 31 August 2018. It is expected that newly
developed technology will provide economic benefits to ZL for the next 10 years.

(ii) On 31 December 2018, ZL launched its new website for online streaming of TV shows, movies and web
series. The website’s content is also used to advertise and promote ZL’s products. The website was
developed internally and met the criteria for recognition as an intangible asset. Directly attributable costs
incurred for the website are as follows:
Rs. in
million
Undertaking feasibility studies 3
Evaluating alternative products 1
Acquisition of web servers 16
Registration of domain names 2
Stress testing to ensure that website operates in the intended 3
manner
Designing the appearance of web pages 5
Development cost of new content related to:
• online streaming 11
• advertising and promoting ZL’s products 8
Advertising of the website 6

(iii) During 2018, the licensing authority intimated that broadcasting license of one of ZL’s channels will
not be further renewed. The license is renewed after every five years.
ZL had obtained this license for indefinite period on 1 January 2012 by paying Rs. 150 million.
Upto last year, this license was expected to contribute to ZL’s cash inflows for indefinite period.

As on 31 December 2018, the recoverable amount of this license was assessed as Rs. 105
million.

Required:
In accordance with the requirements of IFRSs, prepare a note on intangible assets, for inclusion in ZL’s
financial statements for the year ended 31 December 2018 in respect of the above intangible assets.
(‘Total’ column is not required) (15)

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A. Zinc Limited
Notes to the financial statements
For the year ended 31 December 2018

Intangible assets:
Research & Development Website License
-------- Rs. In million ---------
Gross carrying amount - - 150.00
Acc. Amortization/Impairment - - -

Opening Carrying Amount - - 150.00

Additions 126 21.00 -
(90+48 × 6/8) (2+3+5+11)
Amortization 4.20 - 37.50
[126/10 × 4/12] (150/4)
Impairment - - 7.50
[105-112.5(150 – 37.5)]
Disposal - - -
Closing Carrying Amount 121.80 21.00 105.00
Gross carrying amount 126 21.0 150
Acc. Amortization/Impairment (4.2) - (45)
(37.5+7.5)
Closing Carrying Amount 121.80 21.00 105.00
Useful life 10 NA 4
Amortised method Straight line NA Straight line

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 You need not to fear from mistakes, Mistakes prove
that you have been trying to achieve the goal.”
Revaluation with Tax Effects
1-1-2018 C.A T.B Difference
Machinery Cost 500,000 500,000 -
Acc. Dep (500,000/5) (100,000) (100,000) -
WDV (31-12-2018) 400,000 400,000 - x30% = 0
1-1-2019
Revaluation Surplus 20,000
420,000 400,000 20,000 x30% = 6,000
Depreciation (420,000/4) (105,000) (100,000)
WDV (31-12-2019) 315,000 300,000 15,000 x30% = 4,500
Depreciation (105,000) (100,000)
WDV (31-12-2020) 210,000 200,000 10,000 x30% = 3,000
Depreciation (105,000) (100,000)
WDV (31-12-2021) 105,000 100,000 5,000 x30% = 1,500
Depreciation (105,000) (100,000)
WDV (31-12-2022) - - - x30% = 0

Current tax working

31-12-2018 31-12-2019 31-12-2020 31-12-2021 31-12-2022
Profit before tax (Assumed) 500,000 500,000 500,000 500,000 500,000
Accounting Dep 100,000 105,000 105,000 105,000 105,000
Tax Dep (100,000) (100,000) (100,000) (100,000) (100,000)
Taxable profit 500,000 505,000 505,000 505,000 505,000
Current tax @30% 150,000 151,500 151,500 151,500 151,500

Income statement (extracts)

2018 2019 2020 2021 2022
Profit before tax 500,000 500,000 500,000 500,000 500,000
Current tax (150,000) (151,500) (151,500) (151,500) (151,500)
Deferred tax - 1,500 1,500 1,500 1,500
(150,000) (150,000) (150,000) (150,000) (150,000)
Profit after tax 350,000 350,000 350,000 350,000 350,000
Other comprehensive income
Revaluation surplus - 14,000 - - -
(20,000 – 6,000)
Working:
D.T.L
b/d -
D.T.E 1,500 R.S 6,000
D.T.L c/d 4,500
b/d 4,500
D.T.E 1,500
D.T.L c/d 3,000
b/d 3,000
D.T.E 1,500
D.T.L c/d 1,500
b/d 1,500
D.T.E 1,500
D.T.L c/d -

The concept is:

If revaluation surplus would have been part of profit or loss (included within profit before tax) rather than other
comprehensive income, then:

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 You are never too late nor old to move forward and make your life best.”

Working of current tax:

2019
Profit before tax 500,000
R. Surplus (20,000)
Accounting depreciation 105,000
Tax depreciation (100,000)
Taxable profit 485,000
x 30% 145,500
Tax:
Current tax (145,000)
Deferred tax (4,500)
(150,000)

D.T.L
b/d -
c/d 4,500 D.T.E 4,500

In that case no issue; the issue is only because revaluation surplus is part of OCI; therefore, its tax effect
should also be part of OCI.

A change in the carrying amount of an asset or liability might be due to a transaction recognized outside the
statement of profit or loss (i.e. directly in other comprehensive income), i.e in case of revaluation as per IAS
16 and IAS 38.

Basic principle:
In this case, instead of recording the deferred tax effect in statement of profit or loss, the deferred tax effect is
also recorded in other comprehensive income.

Point to note:
Whenever there is a debit/credit effect to Rev. surplus other than in the entry of transfer of surplus to retained
earnings, tax effect of that adjustment will also be debited or credited to revaluation surplus.

Same rule is also applicable for IFRS 9 where gains or losses are sometimes recognized in other
comprehensive income.

Example:
A machine is purchased for Rs. 100,000 on 1 January 2011.
• Depreciation is provided on the machine at 25% per annum straight -line to a nil residual value.
• Machines are revalued to fair value using the net replacement value method. The fair values were:
1 January 2012: Rs. 120,000
1 January 2013: Rs. 60,000
• The revaluation surplus is transferred to retained earnings over the life of the asset.
• The tax authorities allow the cost to be deducted at 20% per annum on a straight line basis and levy tax
at 30%.

Required:
Calculate the deferred tax adjustments and balances, provide all journal entries from the year ended 31-12-
2011 to 31-12-2015.

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 The journey of millions of kilometers begins with one step.”

Question: [Past paper]

Mercury Water Limited (MWL) is a listed company and is engaged in the business of purifying and marketing
of bottled water.
MWL purchased a bottling plant on 1 July 2006 at a cost of Rs. 90 million. The plant has a useful life of ten
years with no residual value. Depreciation is provided on straight-line method over the plant’s useful life. MWL
revalues its plant at the end of every two years.
The revalued amounts determined by Jet Valuers, an independent firm of valuers, are as follows:
(i) On 30 June 2008: Rs. 64 million
(ii) On 30 June 2010: Rs 60 million

However, there was no change in the expected useful life and residual value of the plant.
Profit before tax for the years ended 30 June 2011 and 2010 was Rs. 80 million and Rs. 60 million respectively.
The tax authorities allow tax depreciation at 20% on reducing balance method. There are no temporary or
permanent differences other than those apparent from the above information. The tax rate applicable on MWL
is 40%.
Required:
a) Prepare journal entries from the year ended 30-6-2007 to 30-6-2011. (14 marks)
b) Prepare a note on taxation for the year ended 30 June 2011 in accordance with International Financial
Reporting Standards. (07 marks)
(Comparative figures are required. Accounting policies are not required)

Extra question 2:
Avi Limited operates in the food industry. It commenced operations on 1 January 2016. The following
information is available for its year ended 31 December 2018:
• Profit before tax for the year ended 31 December 2018 is Rs. 650,000. This is arrived at after correctly
taking into account all the information below.
• The tax assessment for 2017 arrived during 2018 and indicated taxable profits of Rs. 650,000. Current
tax of Rs. 195,000 was processed in 2017.
• A building was sold for Rs. 100,000. It was purchased for Rs. 220,000. On the date of sale, 1 January
2018, the building had a carrying amount of Rs. 120,000 and a tax base of Rs. 130,000.
• Plant was revalued to a fair value of Rs. 60,000 on 1 January 2018. This is the first revaluation of any item
of property, plant and equipment to date. The plant originally cost Rs. 100,000 and had a carrying amount
on 1 January 2018 of Rs. 50,000.
• No transfers of the realized portion of the revaluation surplus to retained earnings are made.
• No other items of property, plant and equipment were revalued.
• Depreciation is provided on the revalued property, plant and equipment. It had a remaining useful life of 5
years on 1 January 2018 (consistent with previous estimates of useful life).
• The tax authorities allow a tax depreciation on the item of plant (revalued above) at 25% p.a. on cost, but
the item of plant already had a tax base of zero on 1 January 2018.
• Accounting Depreciation and tax depreciation on all items of property, plant and equipment (other than
the revalued plant) were Rs. 50,000 and Rs. 35,000 respectively.
• Dividend income of Rs. 20,000 was earned in the current year.
• The following items appeared in the draft 31 December 2018 statement of financial position:
➢ Accrued income (taxed when earned) Rs. 10,000
➢ Expenses prepaid (deductible when paid) Rs. 30,000

• The following items appeared on the 31 December 2017 statement of financial position:
➢ Accrued income (taxed when earned) Rs. 20,000
➢ Expenses prepaid (deductible when paid) Rs. 0
➢ Property, plant and equipment (including plant and buildings) Rs. 700,000

• Property, plant and equipment (including plant and buildings) had a tax base of at 31 December 2017 of
Rs. 680,000.
• The current tax rate is 30% (2017: 29%) whereas dividend income is taxable at 10%.

Required:
a) Calculate the deferred tax balance at 31 December 2018 using the balance sheet approach.
b) Calculate the current tax expense for the year ended 31 December 2018.
c) Prepare a note of tax expense for the year ended 31 December 2018.
d) Prepare a reconciliation of accounting profit with tax expense for the year ended 31 December 2018.

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Answer 2:

a) Deferred tax: (Balance sheet approach) D.T.L

b/d 5,800
Opening deferred tax liability (1-1-20X8) 5,800 Cr. D.T.E 200

5,800
Effect of rate change ( ) x1% 200 Rate
29
6,000 Cr. R. S 3,000
Revaluation surplus (10,000 x 30%) 3,000 DTE 3,900
Other temporary differences (bal) 3,900 c/d 12,900
Closing balance 12,900 (3,900+9,000)

Workings:
W-1: PPE:
C.A T.B T.D D. Tax
Opening 1-1-20X8 (29%) 700,000 680,000 20,000 5,800 DL
Rate change 200
6,000
Building sold (120,000) (130,000)
Revaluation – Plant 10,000 -
Plant dep: 60,000/5 (12,000) -
Other depreciation (50,000) (35,000)
Balance 31-12-20X8 528,000 515,000 13,000 3,900 D.T.L

W-2: Expense Prepaid:

C.A T.B T.D D. Tax
Opening balance - - - -
Closing balance 30,000 - 30,000 9,000 D.T.L

W-3: Accrued Income:

C.A T.B T.D D. Tax

Opening balance - - - -
Closing balance 10,000 10,000 - -

b) Current tax: c) Tax Expenses:

Current tax (187,100)
Profit before tax 650,000 Deferred tax (4,100)
Dividend income (20,000) (3,900+200)
Prior period tax 6,500*

Depreciation – Accounting 62,000 184,700

(50,000+12,000) d) Reconciliation:
Tax depreciation (35,000) Accounting Profit x Rate
Loss on sale 20,000 650,000 x 30% = 195,000
Tax loss on sale (30,000)
Prepaid expenses (30,000) Tax effect of dividend = (4,000)
Taxable profit 617,000 20% x 20,000
x 30% 185,100 Effect of Rate change 200
Dividend income tax expense 191,200
(20,000 x 10%) 2,000
187,100
*recorded = 195,000
Assessed = 188,500 (650,000 x 29%)
Overprovision = 6,500

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 No father can give his children a better gift than good manners

Income statement approach: (not required for extra information)

Profit before tax 650,000
Less: Dividend (20,000)
630,000
Taxable profit 617,000
difference 13,000
X 30% 3,900 D.T.E

ICAP Study Text

Items recognised outside profit or loss
A change in the carrying amount of an asset or liability might be due to a transaction recognised outside the
statement of profit or loss (i-e. in other comprehensive income directly as per IFRS).
For example, IAS 16: Property, plant and equipment, allows for the revaluation of assets. The revaluation of
an asset without a corresponding change to its tax base (which is usually the case) will change the temporary
difference in respect of that asset. An increase in the carrying amount of an asset due to an upward revaluation
is recognised in other comprehensive income in accordance with IAS 16.

IFRS requires or permits various items to be recognised in other comprehensive income. Examples of
such items include:
• a change in carrying amount arising from the revaluation of property, plant and equipment (IAS 16);
• a change in carrying amount arising from the revaluation of intangible assets (IAS 38: Intangible assets)
though this is not the case in Pakistan;

IFRS requires or permits various items to be recognised directly in equity. Examples of such items
include:
• adjustment to the opening balance of retained earnings resulting from either a change in accounting
policy that is applied retrospectively or the correction of an error (see IAS 8: Accounting policies,
changes in accounting estimates and errors); and

Extra practice questions:

Question 1: On 30 June 2014 F Company had a credit balance on its deferred tax account of Rs.
1,340,600 all in respect of the difference between depreciation and capital allowances (means tax
depreciation).
During the year ended 30 June 2015 the following transactions took place.
(1) Rs. 45 million was charged against profit in respect of depreciation. The tax computation showed capital
allowances of Rs. 50 million.
(2) Interest income of Rs. 50,000 was reflected in profit for the period. However, only Rs. 45,000 of interest was
actually received during the year. Interest is not taxed until it is received.
(3) Interest expense of Rs. 32,000 was treated as an expense for the period. However, only Rs. 28,000 of
interest was actually paid during the year. Interest is not an allowable expense for tax purposes until it is
paid.
(4) During the year F incurred development costs of Rs. 500,600, which it has capitalised. Development

costs are an allowable expense for tax purposes in the period in which they are incurred.
(5) Land and buildings with a net book value of Rs. 4,900,500 were revalued to Rs. 6 million.
The tax rate is 30%. F has a right of offset between its deferred tax liabilities and its deferred tax assets.
Required:
Calculate the deferred tax liability on 30 June 2015. Show where the increase or decrease in the liability in
the year would be charged or credited.

----------( 355 )----------

 Cleanse your heart and remove negative thinking, Negative thinking leads you to failure.”

Answer 1:
Deferred tax: As on 31-12-2015

PPE (W.1) 59,468,667 50,000,000 9,468,667 TTD

Interest receivable 5,000 - 5,000 TTD
Interest payable 4,000 - 4,000 DTD
Development cost 500,600 - 500,600 TTD
Land and building 6,000,000 4,900,500 1,099,500 TTD
Total 11,069,767 TTD
X30% 3,320,930 DTL

DTL/DTA

b/d 1,340,600
R.S (1,099,500 x 329,850
30%)
c/d 3,320,930 DTE 1,650,480

PPE-WDV PPE-T.B

b/d 104,468,667 Dep 45,000,000 b/d 100,000,000 Dep 50,000,000

c/d 59,468,667 c/d 50,000,000

Deferred tax: As on 31-12-2014

PPE (reverse working) 104,468,667 100,000,000 4,468,667 X30% 1,340,600

TTD

Alternate method to calculate Deferred tax expense and closing balance of Deferred tax liability :

Profit before tax -

Accounting Depreciation 45,000,000

Capital allowance (tax depreciation) (50,000,000)

Interest Income (50,000)

Interest Received 45,000

Interest expense 32,000

Interest Paid (28,000)

Development Expenses (500,600)

Net Increase / (Decrease) in taxable Profits (add (5,501,600)
backs are less)

Tax rate @ 30 % 1,650,480 D.T.E.

D.T.E. 1,650480

D.T.L. 1,650,480

----------( 356 )----------

Deferred tax on Revaluation Surplus:

C.A T.B Difference

Land & Building 6,000,000 4,900,500 1,099,500 TTD
x 30% 329,850 D.T.L

Revaluation Surplus 329,850

D.T.L 329,850

D.T.L
b/d 1,340,600

D.T.E. 1,650,480

R.S 329,850
c/d 3,320,930

----------( 357 )----------

 “Don’t stress nor consider your life as burden, no matter what.”
Spring 2020
Q.1
Rocky Road Limited (RRL) had a stock of 2,000 cows on 1 January 2019.
On 1 May 2019, RRL purchased 750 cows at fair value of Rs. 56,000 per cow. Further Rs. 2 million were
incurred to transport the cows to the farm.

On 1 August 2019, RRL imported cattle feed of USD 150,000 against 70% payment. RRL also paid 5% custom
duty on import. The feed is specially designed to provide vital nutrients to cows that keep them healthy and
improve the quality of their produce. At year-end, 30% of the amount is payable whereas 40% of the feed is
unused.

Following average fair values per cow are available:

1-Jan-19 1-May-19 31-Dec-19 Average for the year

Rs. 50,000 Rs. 56,000 Rs. 61,000 Rs. 57,000

Auctioneers charge a 2% commission on fair value from seller. Further, there is a government levy of 3% at the
time of purchase and 4% at the time of sale on fair value.

Following exchange rates are available:

Date 1-Aug-19 31-Dec-19 Average Aug-Dec Average for the year

1 USD Rs. 164 Rs. 152 Rs. 157 Rs. 159

Required:
Prepare journal entries in RRL's books to record the above information for the year ended 31 December 2019.
(08)
Q2
Bilal has recently joined your organization. He has prepared a summary of classification and measurement
requirements of financial assets which will help him in handling the transactions related to the financial assets.
He has requested you to review the following summary:

Amortized cost FV through OCI FV through P/L

Business model Hold to collect and sell Hold to collect Hold to sell
Cash flows Solely payment of No condition No condition
principal and interest
Categories Debt and equity Debt securities Equity securities
securities
Initial measurement Fair value plus transaction Fair value Fair value plus
cost transaction cost
Subsequent Amortized cost Fair value less Fair value
measurement transaction cost
Required:
Prepare the corrected summary in the light of IFRSs. (07)

Q 3.
Atif Anwar, ACA is Finance Manager at Hot Coffee Limited (HCL) and reports to Jamal Ahmed, FCA who is
the CFO.

On returning from leaves, Atif noted that draft financial statements for the year ended 31 December 2019 have
been prepared. He found that financial statements have not been updated for the revision in decommissioning
cost related to a plant, as advised by the engineering department at the start of 2019. Atif discussed the matter
with Jamal who advised him to finalize the financial statements without revising the decommissioning cost as
HCL’s profit would be decreased if revised cost would be taken into account.

Decommissioning cost related to the plant has increased from initial estimate of Rs. 50 million to Rs. 88 million.
Applicable discount rate is 12%. This plant had a useful life of 6 years when it was purchased on 1 July 2017
at a purchase price of Rs. 860 million. HCL uses cost model for subsequent measurement of its property, plant
and equipment and follows straight line method for charging depreciation.

----------( 358 )----------

 “Never do cheating with anyone in your life

Required:
a) Compute the change in net profit, assets and liabilities if revised decommissioning cost is included in
the financial statements for the year ended 31 December 2019. (05)
b) Briefly explain how Jamal may be in breach of the fundamental principles of ICAP’s Code of Ethics for
Chartered Accountants. (03)

Q4.
Select the most appropriate answer from the options available for each of the following Multiple Choice
Questions (MCQs).
(i) Which of the following is a monetary item?
(a) biological assets (b) Advance paid
(c) Income tax payable (d) Inventories (01)

(ii) A conditional grant related to a biological asset measured at its ‘fair value less estimated point-of-sale
costs’ should be recorded as income:
(a) over the period in which conditions would be fulfilled
(b) only when the grant becomes receivable
(c) only when the conditions are met
(d) over the life of related biological asset (01)

(iii) The applicable financial reporting framework and schedule of the Companies Act, 2017 for Large Sized
Company are:
(a) IFRS and Fourth Schedule
(b) IFRS and Fifth Schedule
(c) Revised AFRS for SSE and Fourth Schedule
(d) Revised AFRS for SSE and Fifth Schedule (01)

(iv) Zameer Ansari is a car dealer. Cars are sold both on cash and finance lease basis. He has been selling
a car at the following terms:

Fair value Rs. 5,000,000

Annual lease rental in arrears Rs. 1,646,199
Market rate 12% per annum
Lease term 4 years

What would be the effect on sales revenue and finance income if annual lease rental is increased to
Rs. 1.8 million and all other terms remain the same?
(a) Increase in sales revenue and increase in finance income
(b) Decrease in sales revenue and increase in finance income
(c) No change in sales revenue and increase in finance income
(d) Increase in sales revenue and no change in finance income (02)

(v) An entity purchased patent for its product A in 2014 for 20 years. In 2019, the entity purchased
patent of a competing product for 20 years to eliminate competition for product A. However,
the entity does not intend to manufacture the competing product. The cost of purchasing
second patent for competing product should be:
(a) expensed out in 2019
(b) capitalized and amortized over 20 years
(c) capitalized and amortized over 15 years
(d) capitalized and only assessed for impairment at year end (01)

(vi) Computer hardware and related operating system, which is an integral part of the computer
hardware, are treated under:
(a) IAS 16 as a combined asset
(b) IAS 38 as a combined asset
(c) IAS 16 for computer hardware and IAS 38 for operating system
(d) IAS 16 or IAS 38 at the option of the entity (01)

----------( 359 )----------

 (vii) According to IFRSs, if a financial report contains both consolidated financial statements of a
parent, as well as parent’s separate financial statements, segment information is required:
(a) only in the consolidated financial statements
(b) only in the parent’s separate financial statements
(c) in both sets of financial statements
(d) Either in the consolidated or parent’s separate financial statements (01)

Q.5 On 1 January 2019, French Vanilla Leasing Limited (FVLL) purchased a machine costing Rs.
200 million having useful life of 8 years. Residual value of the machine at end of its useful life
is estimated at Rs. 16 million.

On 1 February 2019, FVLL entered into a lease agreement for this machine with Cotton
Candy Limited (CCL) for a non-cancellable period of 2.5 years with effect from 1 March
2019. Under the agreement, eight instalments of Rs. 12 million are to be paid quarterly in
arrears commencing from the end of 3rd quarter i.e. 30 November 2019.
FVLL has incorporated an implicit rate of 15% per annum which is not known to CCL.
Incremental borrowing rate of CCL is 16% per annum.

On 1 April 2019, CCL completed installation of the machine at a cost of Rs. 4 million and put it
into use.

Both companies follow straight line method for charging depreciation.

Required:
Prepare journal entries for the year ended 31 December 2019 in the books of FVLL and
CCL to record the above transactions. (15)

Q 7.
The following balances have been extracted from the trial balance of Mint Lemonade Limited (MLL) as at
31 December 2019:
Rs. in million
Trade receivables 1,200
Capital work in progress 910
Allowance for bad debts as on 1 January 2019 44
Sales 2,500
Cost of goods sold 1,320
Research and development 180
Dividend receivable 10
Administrative expenses 302
Selling and distribution expenses 200
Finance cost 48
Dividend income 30
Capital gain 50
Other income 36

While finalizing the financial statements of MLL, the following issues have been noted:
(i) Trade receivables include a balance of Rs. 40 million which needs to be written off. MLL maintains
a provision for doubtful debts at 5% of trade receivables.
As per tax laws, only write offs are allowed as deduction.
(ii) Capital work in progress includes interest cost of Rs. 84 million on specifically acquired bank loan
during the year. However, interest of Rs. 16 million earned by investing surplus funds available
from the bank loan has been included in other income.
As per tax laws, borrowing costs are allowed when incurred.
(iii) Research and development represents cost incurred for a new product started on 1 February
2019. The recognition criteria for capitalization of internally generated intangible asset was met on
1 May 2019. The product was launched on 31 October 2019. It is estimated that the useful life of
this new product will be 5 years. It may be assumed that all costs accrued evenly over the period.
Research and development cost is allowed as tax deduction over 10 years.
(iv) Tax depreciation for the year ended 31 December 2019 exceeded accounting depreciation
already recorded in books, by Rs. 200 million.

----------( 360 )----------

 (v) Office building of ML had net book value of Rs. 900 million on 31 December 2018 with remaining
useful life of 12 years. During 2019, MLL decided to opt revaluation model for its building.
Consequently, fair value of building at start of 2019 was determined at Rs. 1,200 million. Such
revaluation has not yet been accounted for. Depreciation on office building under cost model has
already been recorded in the books.
Revaluation does not affect taxable profit.
(vi) Capital gain is exempt from tax. Dividend was taxable on receipt basis at 15% in 2019. However,
with effect from 1 January 2020, dividend received would be taxable at 20%.
(vii) Applicable tax rate is 32% except stated otherwise.

Required:
(a) Prepare MLL’s statement of profit or loss and other comprehensive income for the year ended 31
December 2019.
(b) Prepare note on taxation for inclusion in MLL’s financial statements for the year ended 31
December 2019 including a reconciliation to explain the relationship between tax expenses and
accounting profit.

Q8 For the purpose of this question, assume that the date today is 1 February 2020.

You are the Finance Manager of Wonderland Limited (WL). Your assistant is preparing financial statements
of WL for the year ended 31 December 2019. He has brought following matters for your consideration:

(i) In mid of 2019, WL launched new model of laptops with the name of Champ which became popular
among customers.

In November 2019, WL started receiving complaints about incidents of electric shock and excessive
heating. Some of these incidents resulted in serious injuries to customers. Several customers filed claims
for damages with WL for injuries. The matter was highly publicized in media as well.

On 1 December 2019, WL suspended sales of Champ. WL conducted an inquiry which led to the
conclusion that these incidents were happening because of defective chargers. On 25 December 2019,
WL announced that all customers can collect the replacement charger from 15 January 2020 and
onwards from WL's service center without any additional cost. The sales of Champ will also resume on
the same date at a reduced price. Further, it has been internally decided that a free USB shall be given
to customers coming for collecting replacement chargers as a good gesture.

The matter was raised with the supplier of chargers i.e. Battery Limited (BL). On 20 January 2020, BL
admitted the fault and agreed to only adjust the cost of the defective chargers against the future
purchases.

In respect of this matter, your assistant has proposed a provision of Rs. 105.3 million in financial
statements for the year ended 31 December 2019 having the following breakup:
Rs. in million
1. Cost of replacement chargers to be acquired for:
▪ customers 6.8
▪ wholesaler and retailers 2.3
▪ closing stock of Champ with WL 4.9
2. Recovery from BL (11.5)
3. Cost of USBs to be given 5.8
4. Expected litigation cost and settlements in respect of claims for
damages for injuries to customers including Rs. 5.4 million for
claims made in January 2020 and Rs. 10 million for claims expected 25.9
to be received in future.
5. Decrease in WL share price in December 2019 38.4
6. Marketing cost to be incurred in 2020 to counter the negative
publicity by the incidents 15.5
7. Decrease in gross profit for 2020 due to reduction in selling price 17.2
105.3

(10)

----------( 361 )----------

(ii) In November 2019, WL introduced a promotion scheme in which a scratch card was included in each
pack of one of its products. These cards carry cash prizes ranging from Rs. 100 to Rs. 50,000 and are
valid for claims till 29 February 2020.
All scratch cards were printed by system and packed directly into the product without any human
interaction. As per the scheme, WL had decided to include total prizes of Rs. 25 million.
As at year-end, WL had already received claims for prizes worth Rs. 32 million. An inquiry has led to
the conclusion that the software for printing scratch card has certain programming errors which has led
to printing of unknown amount of total prizes as compared to the original plan of WL.

Further, claim of Rs. 12 million had been received till 31 January 2020. Considering the reputation, WL
would honour all the claims. (04)

Required:
Discuss how the above issues should be dealt with in the financial statements of WL for the year ended
31 December 2019. Support you answer in the context of relevant IFRSs.

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 Pray regularly and bring righteousness in your life.”
A.1
1-5-2019

Biological Asset (cow) (56,000 x 750 - 39,480,000

42,000,000 x 4% - 42,000,000 x 2%)
Loss on initial recognition 3,780,000

Cash (56,000 x 750) 42,000,000

Cash (Government levy)(3% x 1,260,000
42,000,000)
(Commissions is charged from seller, therefore at the time of purchase not relevant)
Carriage in wards 2,000,000
Cash 2,000,000
(25,830,000 x 60%)

1-8-2019
Cattle feed stock 25,830,000
(150,000x164+24,600,000x5%)
Cash(150,000x70%x164) 17,220,000
Cash(Custom duty) 1,230,000 18,450,000
Payable(150,000 x30%x164) 7,380,000

31-12-2019
Cattle feed expense 15,498,000
Cattle feed stock 15,498,000
(25,830,000 x 60%)

31-12-2019
Payable 540,000
Exchange gain 540,000
(150,000 x 30% x 152 - 7,380,000)

31-12-2019
Biological Asset(cows) 20,680,000
FV Gain(P/L) 20,680,000
(2,000 x 61,000 x 94% - 2,000 x 50,000 x 94%)

(From opening)
31-12-2019
Biological Asset(cows) 3,525,000
FV Gain(P/L) 3,525,000
(750 x 61,000 x 94% - 39,480,000)

(Purchased during the year)

A.2
Amortized Cost F.V through OCI F.V through P/L
Business model Hold to collect Hold to collect and Hold to sell
sell
Cash flows Solely payment of Solely payment of No condition
principal and interest principal and interest
Categories Only debt securities Debt and equity Debt and equity
securities securities
Initial Fair value plus Fair value plus Fair value
Measurement transaction cost transaction cost
Subsequent Amortized cost Fair value Fair value
measurement

----------( 363 )----------

 Strive to bring goodness in your behavior and character.”

A.3

Change:
Net Profit
Increase in Dep (152.62 - 147.55) 5.07
Increase in Finance Cost (6.34 - 3.61) 2.73
Assets:
Increase in plant 22.77
Increase in Acc. Dep (152.62 - 147.55) 5.07
Increase in Plant 17.7
Liabilities
Increase in Provision (22.77 + 6.34 - 3.61) 25.5

(a) Workings:
1-7-2017
Plant 860
Cash/Payable 860

1-7-2017
Plant 25.33
Provision 25.33
50(1 + 0.12)-6 = 25.33

31-12-2017
Dep 73.78
Acc. dep 73.78
(860 + 25.33) ÷ 6 x 6/12)

31-12-2017
Finance cost 1.52
Provision 1.52
25.33 x 12% x 6/12 = 1.52

31-12-2018
Dep 147.55
Acc. dep 147.55

31-12-2018
Finance cost 3.22
Provision 3.22
(25.33 + 1.52) x 12% = 3.22

Already recorded:
31-12-2019
Dep 147.55
Acc. dep 147.55

31-12-2019
Finance cost 3.61
Provision 3.61
(25.33 + 1.52 + 3.22) x 12%

1-1-2019
Change in Estimate
Already Provision (25.33 + 1.52 + 3.22) or 50 (1.12)-4.5 = 30.07

To be recorded
88 (1 + 0.12)-4.5 52.84
Increase 22.77

----------( 364 )----------

 1-1-2019
Plant 22.77
Provision 22.77

31-12-2019
Dep 152.62
Acc. dep 152.62
(860 + 25.33 - 73.78 - 147.55 + 22.77) = 686.77 ÷ 4.5 =
152.62

31-12-2019
Finance cost 6.34
Provision 6.34
(52.84 x 1.12)

Change in liabilities:
Increase in decommissioning liability 22.82+2.74 25.56

Or
(a) Change in net profit: Rs. in million
Increase in depreciation expense 22.82(W-1)÷4.5 (5.07)
Increase in finance cost 22.82(W-1)×12% (2.74)
Decrease in net profit (7.81)

Change in assets:
Increase in property, plant and equipment 22.82–5.07 17.75

W-1: PV of change in decommissioning liability 22.82[(88–50) ×1.12‒4.5]

(b) In the given scenario, Jamal may be in breach of the following fundamental principles of Code of
Ethics for Chartered Accountants:

(i) Principle of integrity:

Chartered Accountant should be straight forward and honest in all professional and business
relationships. It seems that the decision to defer incorporation of new decommissioning cost
would make financial statements misleading.

(ii) Principle of professional behaviour:

This principle imposes an obligation on all chartered accountants to comply with the relevant laws
and regulation and avoid any action that discredits the profession. Jamal has breached this
principle as his decision to defer incorporation of new decommissioning cost is not in
accordance with IFRSs.

A.4
(i) (c) Income tax payable
(ii) (c) Only when the conditions are met
(iii) (b) IFRS and Fifth Schedule
(iv) (c) No change in sales revenue and increase in finance income (W -1)
(v) (c) Capitalized and amortized over 15 years (because it will provide benefits to the company
indirectly over the remaining life of product A.)(as there is no competition now)
(vi) (a) IAS 16 as a combined asset
(vii) (a) Only in the consolidated financial statements

----------( 365 )----------

 Be polite and behave people with good manners.”

W -1: Original:
Lower of:
PV of LP
1 − ( 1 + 0.12)−4
1,646,199 ( )
0.12
= 5,000,000
FV = 5,000,000
Sale revenue 5,000,000

UFI = G.I – N.I

= 1,646,199 x 4 – 5,000,000
UFI = 1,584,796

Revised:
Lower of:
PV of LP
1 − ( 1 + 0.12)−4
1,800,000 ( )
0.12
= 5,467,229
FV = 5,000,000

Sale revenue 5,000,000

UFI = G.I - N.I

= 1,800,000 X 4 – 5,467,227
= 1,732,773

A.5
a) Entries in the books of lessor (FVLL):
It is an operating lease for lessor as none of the conditions of finance lease are met.
’ Rs in millions’
1-1-2019
Machine 200
Cash 200
31-5-2019
Rental receivable 9.6
Rent income 9.6
12 x 8 instalments = 96/10 quarterly period = 9.6

31-8-2019
Rental receivable 9.6
Rent income 9.6
30-11-2019
Cash 12
Rent income 9.6
Rent receivable 2.4

31-12-2019
Rent receivable 3.2
Rent income 3.2
(9.6 ÷ 3) = 3.2
31-12-2019
Depreciation 23
Acc. Dep 23
(200 – 16) ÷ 8

----------( 366 )----------

 A person should never feel proud of his time.”

b) Entries in the books of Lessee(CCL):

1-3-2019
Right of use 74.70
Lease obligation 74.70
1 − ( 1 + 0.04)−8
12 ( ) = 80.79 (1 + 0.04)-2 = 74.70
0.04
1-4-2019
Right of use 4.0
Cash/Bank 4.0
31-5-2019
Interest expense 2.99
Interest payable 2.99
31-8-2019
Interest expense 3.11
Interest payable 3.11
30-11-2019
Interest expense 3.23
Interest payable (2.99+3.11) 6.1
Lease liability (8.77-6.1) 2.67
Cash 12.0
31-12-2019
Interest expense 0.96
Interest payable 0.96
(2.88 ÷ 3 x 1)
31-12-2019
Depreciation expense 23.61
Acc. depreciation 23.61
(74.7 + 4) ÷ 2.5 x 9/12
Amortization table:
Date Rental Principal Interest Balance
1-3-2019 - - - 74.70
31-5-2019 - - 2.99 77.69
31-8-2019 - - 3.11 80.80
30-11-2019 12 8.77 3.23 72.03
29-2-2020 12 9.12 2.88 62.91
31-5-2020 12 9.48 2.52 53.43
31-8-2020 12 9.86 2.14 43.57
30-11-2020 12 10.26 1.74 33.31
28-2-2021 12 10.67 1.33 22.64
31-5-2021 12 11.09 0.91 11.55
31-8-2021 12 11.54 0.46 -

A.7
a) Mint Lemonade Limited
Statement of Comprehensive Income
For the year ended 31-12-2019
“Rs in Million”
Sales 2,500
Cost of sales (1,320)
Gross profit 1,180
Other income (30 + 50 + 36 – 16) 100
Selling and distribution exp (200)
Admin expenses (W – 1) (381)
Research and development (180 – 120 + 4) (64)
Finance cost (48)
Profit before tax 587
Taxation (b) (167.24)
Profit after tax 419.76

----------( 367 )----------

 Other comprehensive income
Revaluation surplus (300 – 96) 294
Total comprehensive income 623.76
Working 1:
Administrative expenses:
Given 302
Additional dep. On office building (300 ÷ 12) 25
Bad depts. Exp 54
Total 381
b)
Mint Lemonade Limited
Notes to financial statements
For the year ended 31-12-2019
Taxation:
Current tax (W – 1) (106.68)
Deferred tax (W – 2) (60.56)
(167.24)
Relation between accounting profit and tax expense:
Profit before tax 587
Tax @32% 187.84
Exempt income (Capital gain) [50 x 32%] (16.0)
Dividend income [20 x 17% (32% - 15%)] (3.4)
[10 x 12% (32% - 20%)] (1.2)
167.24
W–1
Current tax:
Profit before tax 587
Bad debts expense 54
Bad debts written off (40)
Research and development exp 60
Accounting amortization 4
Tax amortization (180 ÷ 10) (18)
Capital gain exempt (50)
Borrowing cost (84)
Investment income deduction from borrowing cost 16
Additional depreciation on revalued building 25
Tax depreciation exceeded accounting dep (200)
Dividend income taxable at different rate (30)
Taxable income 324
Tax @ 32% 103.68
Tax on dividend income received ( 30 – 10) 20 x 15% 3.0
Total tax 106.68

W–2
Deferred tax:
As on 31-12-2019
Provision 58 - 58 DTD
CWIP (910 – 16) 894 826 (910-84) 68 TTD
Research & development 116 162 46 DTD
(120 – 4) (180 – 18)
Acc. Dep - 200 200 TTD
Building revalued(300-25) 275 - 275 TTD
439 TTD
X 32% = 140.48 DTL
Dividend receivable 10 - 10 X 20% = 2 DTL
Total 142.48 DTL

----------( 368 )----------

 DTL/DTA
b/d (W – 2.1) 14.08 R.S (300 x 32%) 96
c/d 142.48 DTE 60.56*

Alternative approach [by using profits]

Profit before tax 587
Adjustment of permanent differences:
Capital gain exempt (50)
Dividend income taxable at different rate (30)
Profit before tax after adjustment of permanent differences 507
Taxable income 324
Differences 183
Tax @ 32% 58.56
Tax on dividend income receivable (10 x 20%) 2.0
Total tax expense 60.56
W – 2.1
Provision 44 - 44 DTD
x 32% 14.08 DTA
Workings:
i) Provision 40
Debtors 40

Allowance
Debtors 40 b/d 44
c/d 58 Exp 54 (in admin exp)
(1200 – 40 x 5%) = 58

Expense 54
Provision 54

ii) Other income 16

Capital WIP 16

iii) Intangible asset 120

Research & development 120

180 ÷ 9 = 20 x 3 = 60(Research exp)

20 x 6 = 120
Amortization 4
Acc. Amortization 4
120 ÷ 5 x 2/12 = 4

v) WDV on 31-12-2018 = 900

FV = 1,200
R. Surplus 300

Building 300
R.S (OCI) 300

R.S 96
DTL 96
(300 x 32%)
Depreciation (Admin exp) 25
Acc. dep 25
(300 ÷ 12)
[depreciation based on cost model has already been charged]

----------( 369 )----------

 Trust in the plans of Allah. Be patient, Keep smiling and never overthink.”

A.8 (i)The treatment of each of item would be as follows:

1. Cost of replacement chargers to customers, wholesaler and retailers would be provided in 2019
due to the constructive obligation arising out of the announcement made on 25 December 2019.
Cost of replacement chargers would be included as deduction in calculating NRV of the closing
stock of Champ and would be compared with the cost of the stock in books for assessing potential
NRV adjustment.

2. Reimbursement from BL would be recognized in 2019 only when it is virtually certain as at 31

December 2019 that BL would reimburse the cost which does not seems to be the case here due
to subsequent agreement of BL on 20 January 2020 for the adjustment.

3. WL has no obligation as 31 December 2019 to give USBs to the customers. As giving

of USBs has not been announced. Therefore, provision need not be made at 31 December 2019.

4. Provision for expected litigation and settlement cost in respect of claim of Rs. 15.9(25.9 – 10)
million should be made in 2019. However, Rs. 10 million for claims expected to be received in
future should be disclosed as contingent liability.
Sale of defective laptop is the obligating event in this respect which were made in 2019. The filing
of claims in 2020 would be considered as adjusting event for 2019 financial statements.

5. The loss would not be recorded in WL’s book as market of company’s shares is not reflected in the
books of accounts.

6. Marketing cost to be incurred in 2020 would not be recorded in 2019 as it is a

Future operating cost and there is no obligation to incur marketing cost at 31 December 2019.

7. No entry needs to be made for decrease in gross profit for 2020 due to reduction in selling price.
However, the effect of decrease in selling price should be considered for calculating NRV of the
closing stock of Champ as at 31 December 2019.

(ii) In respect of claim received till year end of Rs. 32 million, WL should record an expense.

Further claim of Rs. 12 million received during January 2020 would be considered as an adjusting event
and should be recorded as an expense in 2019.

In respect of remaining claims which have not yet been received:

▪ WL has a present obligation to honor the claim for prizes as a result of past event i.e. sale of product;
▪ It is probable that an outflow of economic benefits will be required to settle the obligation;
▪ As cards of higher amount were printed and issued as compared to original plan, but amount could
not be determined due to absence of human intervention in printing the cards.

It should be disclosed as contingent liability along with description that the amount is not measurable
due to the circumstances discussed above.

----------( 370 )----------

 “Always do your work with passion, courage, and honesty in efforts

Autumn 2020
Q.1

On 1 January 2019, Jannat Limited (JL) issued 1.6 million debentures of Rs. 100 each at a premium of Rs.
10 each. The transaction cost associated with the issuance of these debentures was Rs. 5.5 per debenture.
The coupon interest rate is 16% per annum payable annually on 31 December. Khushi Limited (KL)
purchased 0.32 million of these debentures on 1 January 2019.

On 1 January 2019, the approximate effective interest rates were 15% and 14% per annum for JL and
KL respectively. As on 31 December 2019, the debentures were quoted on Pakistan Stock Exchange
at Rs. 112 each.

Debentures are subsequently measured at amortized cost by JL and fair value through profit or loss
by KL.

Required:
Prepare journal entries in the books of JL and KL for the year ended 31 December 2019. (07)

Q.2

On 16 June 2020, an aircraft of Sukoon Airlines Limited (SAL) made an emergency landing near a factory
building. Though all persons on board were safe, the nearby factory was damaged. As a result, two factory
workers lost their lives and five workers were injured.

After one week of this accident, SAL’s CEO informed in a press conference that SAL will pay Rs. 1.5 million
for each loss of life and Rs. 1 million for each injured worker.

On 8 July 2020, the factory owner filed a claim of Rs. 25 million for factory damages. The case is still
pending; however, SAL’s legal advisor is of the view that there is 70% probability that the amount of
damages would be Rs. 20 million and 30% probability that the amount would be Rs. 15 million.

Due to this accident, the aircraft was damaged beyond repairs and consequently SAL cannot use this aircraft
anymore. The aircraft was acquired on lease on monthly rental of USD 0.5 million for 10 months expiring on
31 October 2020. As per lease agreement, if aircraft faces any accident, SAL is required to pay monthly
rentals to the lessor till settlement of insurance claim. The insurance claim was settled on 31 August 2020.
Required:
In the context of relevant IFRSs, discuss how the above issues should be dealt with in the financial
statements of SAL for the year ended 30 June 2020. (07)

Q.3

Roshni Limited (RL) is a listed company and is engaged in manufacturing of textile products. RL generates 30%
of its revenue from exports to Middle East, out of which 60% are made to only one customer i.e. Hakeem
Limited. RL has various operating segments. Apart from external sales, some of these segments make internal
sales as well.

Following amounts have been extracted from RL's draft financial statements for the year ended 30 June
2020:
Rs. in million
Revenue 2,530
Operating expenses (2,050)
Profit before tax 455
Total assets 1,600
Total liabilities 980

----------( 371 )----------

 Oh ALLAH, I ask you for a Good end.

Detailed financial information is reported internally to the chief operating decision maker of each segment.
However, following disclosure on operating segments is prepared for inclusion in notes to the financial
statements for the year ended 30 June 2020:

Spinning Weaving Others Total

--------------------- Rs. in million ---------------------
External revenue 1,010 560 960 2,530
Operating expenses (760) (460) (830) (2,050)
Net interest (43) 18 - (25)
Profit before tax 207 118 130 455
Assets 700 350 490 1,540

Required:
Prepare list of errors and omissions in the above disclosure. (Redrafting of disclosure is not required) (08)

Q.4
Select the most appropriate answer from the options available for each of the following Multiple Choice
Questions.

(i) In relation to IAS 21, which of the following statements is correct?

(a) Exchange gains and losses arising on the retranslation of monetary items are recognised in
other comprehensive income for the period
(b) Non-monetary items carried at fair value in a foreign currency are retranslated at the date when
the fair value was measured
(c) An intangible asset is a monetary item
(d) Non-monetary items carried at cost in a foreign currency are retranslated at the reporting date
(01)

(ii) An entity acquires property on lease for a non-cancellable period of 3 years. The lease payments are
payable semi-annually in arrears beginning from first year. What would be the impact of this transaction
on lessee’s current and gearing ratios upon commencement of lease?
(e) Decrease in current ratio as well as gearing ratio
(f) Decrease in current ratio and increase in gearing ratio
(g) Increase in current ratio and decrease in gearing ratio
(h) Increase in current ratio as well as gearing ratio (02)

(iii) Fazl Limited owns a herd of cows recorded at Rs. 36 million on 1 January 2019. At 31 December 2019,
these cows have a fair value of Rs. 50 million. A commission of 4% would be payable upon sale.
What is the correct accounting treatment for the cows at 31 December 2019 according to IAS 41?
(a) Hold at Rs. 36 million
(b) Re-measure to Rs. 50 million, taking gain of Rs. 14 million to the profit or loss
(c) Re-measure to Rs. 48 million, taking gain of Rs. 12 million to other comprehensive
income
(d) Re-measure to Rs. 48 million, taking gain of Rs. 12 million to the profit or loss (01)

(iv) Which of the following is one of the conditions set out in IFRS 16 for an arrangement to be classified
as a lease?
(a) The lessee has the right to obtain substantially all of the economic benefits from use of the asset
(b) The lease term covers substantially all of the economic life of the asset
(c) The lessor has a substantive right of substitution
(d) The lessor has the right to direct the use of the asset (01)

(v) Which of the following is NOT a disclosure requirement under the Fifth Schedule of the Companies Act,
2017?
(a) Distinction between capital and revenue reserves
(b) General nature of any un-availed credit facilities
(c) Capacity of an industrial unit
(d) Remuneration of chief executive, directors and executives (01)

----------( 372 )----------

(vi) Which of the following is correct in accordance with IAS 21?
(a) Functional currency and presentation currency of an entity must be same
(b) Functional currency and presentation currency of an entity must be different
(c) Functional currency of an entity is identified by reference to environment of the business
(d) Functional currency of an entity is identified by reference to the functional currency of its
parent entity (01)

(vii) IAS 41 applies to:

(a) change in fair value of a herd of livestock
(b) logs held for sale in a wood yard
(c) cost of developing a new type of crop seed
(d) cost of making irrigation system having life of more than 1 year (01)

(viii) You are working in finance department of Kamyaab Motors Limited (KML), a listed company. The draft
results of KML for the year are encouraging and are likely to increase KML’s share price upon public
announcement. Your best friend is heavily in debt and has recently asked for your assistance. He has
helped you on numerous occasions in the past. In the context of ICAP’s Code of Ethics, you should:
(a) keep confidentiality about KML’s results; however, you can buy KML’s shares to use the gain upon
disposal to help your friend
(b) tell your friend about KML’s results and let him decide whether he should buy KML’s shares or
not
(c) keep confidentiality about KML’s results by all means
(d) keep confidentiality about KML’s results but just tell your friend to buy the KML’s shares (02)

Q.5
The following amounts are extracted from the records of Manzil Limited (ML), Himmat Limited (HL) and
Koshish Limited (KL) for the year ended 31 December 2019:

ML HL KL
---------- Rs. in million ----------
Sales 800 315 132
Cost of sales (540) (180) (97)
Operating expenses (114) (60) (6)
Other income 41 - 8
Finance cost (20) (12) (5)
Retained earnings as at 31 December 2019 3,600 322 200

Additional information:
Details of ML’s investments are as follows:

Date of investment Share capital (Rs. 10 each) of

Holding % Investee investee
1 Aug 2015 25% KL Rs. 400 million
1 May 2019 60% HL Rs. 600 million

Consideration for acquisition of HL’s shares comprises of:

▪ Transfer of ML’s building having carrying value and fair value of Rs. 150 million and Rs. 226 million
respectively at acquisition date. The disposal of building has been recorded at carrying value.
▪ Issuance of 16 million ordinary shares of ML after one month of acquisition. The market price of ML’s
shares at the date of acquisition was Rs. 30 each. However, the market price increased to Rs. 32 when
shares were issued.

At the date of acquisition of HL, carrying value of its net assets was equal to fair value except the following:
▪ A manufacturing plant whose fair value exceeded its carrying value by Rs. 60 million. The
remaining useful life of the plant on the acquisition date was 8 years.
▪ A contingent asset of Rs. 50 million as disclosed in HL's financial statements which had an estimated
fair value of Rs. 15 million. At year-end, this contingent asset is disclosed in HL's financial statements
at Rs. 46 million.

----------( 373 )----------

Impairment test carried out at year-end has indicated that goodwill of HL has been impaired by 10%.

On 15 August 2019, HL and KL paid 5% dividend for the half year ended 30 June 2019. ML recorded its share
as other income.

On 30 June 2019, KL sold a machine having carrying value of Rs. 60 million to ML for Rs. 68 million. The
remaining useful life of the machine at the time of disposal was 5 years.

On 15 November 2019, HL and KL purchased 600,000 and 400,000 ordinary shares of Jazba Limited (JL)
respectively at price of Rs. 150 each plus 2% transaction cost. HL and KL classified the investment as financial
asset at fair value through other comprehensive income. These investments have not been re-measured at
year-end. Market price of JL’s share was Rs. 138 at year-end. Total share capital of JL consists of 20 million
shares.

ML measures non-controlling interest at the proportionate share of acquiree’s identifiable net assets.

Required: Prepare ML’s consolidated statement of profit or loss and other comprehensive income for the year
ended 31 December 2019. (19)

Q.6
Qabil Limited (QL) is in process of finalizing its financial statements for the year ended 31 December
2019. Following information pertains to QL’s intangible assets:
[Link] assets as at 31 December 2018 were as follows:

Product ERP
design software
---- Rs. in million ----
Cost 750 200
Accumulated amortization / impairment 75 80
------- Years -------
Useful life 10 8

Cost incurred on development of product design was capitalised in 2018. The competition for the product is
increasing. QL has estimated the following net cash inflows from the product:

Year 2020 2021 2022 2023 2024 2025 & onwards

Net cash inflows 190 170 140 100 80 Nil
(Rs. in million)
Pre-tax and post-tax discount rates are 12% and 10% respectively.
2. On 1 January 2019, QL entered into an agreement to replace existing ERP software with a new ERP software
at a cost of Rs. 360 million. According to the agreement, 40% payment was made on signing of the contract while
the remaining amount was paid on [Link].2019.

The entire cost of project was financed through a running finance from Honehaar Bank at mark- up of 15% per
annum. The software became operational on 1 November 2019. QL expects to use it for a period of 9 years.
The existing ERP software will be continued till 31 December 2020.

3. On 1 January 2019, QL acquired a licence for Rs. 600 million for a period of 5 years. QL made an initial
payment of Rs. 100 million and the remaining amount will be paid in two equal instalments on 1 January 2020
and 2021. Cash price equivalent of the license is Rs. 520 million.
On expiry of 5 years, the license is renewable for further five years at an insignificant cost of Rs. 15 million. QL
intends to renew the license and sell it at the end of 8th year.

In the absence of any active market, QL has estimated that residual value of the license would be Rs. 80 million
and Rs. 60 million at the end of 8th year and 10th year respectively.

Required:
Prepare a note on ‘Intangible assets’ for inclusion in QL’s financial statements for the year ended 31 December
2019 in accordance with the requirements of IFRSs. (15)

----------( 374 )----------

 Change yourself to please ALLAH but not to please the people.

Q.7
Following information have been extracted from the financial statements of Fakhr Limited (FL) for the year
ended 31 December 2019:

(i) 2019 2018 2017

Draft Audited Audited
--------- Rs. in million ---------
Net profit 84 98 72
Revaluation surplus arising during the year* 25 (14) -

*Transfer to retained earnings is made upon de-recognition of related asset.

(ii) Share capital and reserves as at 1 January:

2018 2017
----- Rs. in million -----
Share capital (Rs. 10 each) 300 300
Revaluation surplus 102 102
Retained earnings 348 276

(iii) On 1 March 2018, FL declared a final cash dividend of 10% for the year ended 31 December 2017. On
1 November 2018, FL issued 40% right shares to its ordinary shareholders at Rs. 24 per share. On 1
August 2019, an interim bonus of 15% was declared.

Following matters need to be incorporated in the draft financial statements of FL:

(i) To provide more relevant and reliable information about investment property, it has been decided
to change the measurement basis for investment property from cost model to fair value model.
The only investment property of FL is a building purchased on 1 January 2016 at a cost of Rs.
150 million. 60% of the cost represents building component having estimated useful life of 20 years
and residual value of Rs.
10 million. The depreciation is included in the above draft financial statements. The fair value of
the investment property has increased by 6% in each year since acquisition.
(ii) It was identified that annual payments in respect of machine acquired on lease have been
recorded as rent expense.
FL entered into a lease agreement for a machine with Aaqil Limited (AL) for a non-cancellable
period of 7 years on 1 January 2018. Instalment of Rs. 25 million is to be paid annually on 31
December each year. Implicit rate is 12% per annum.

Required:
Prepare FL’s statement of changes in equity (including comparative figures) for the year ended 31 December
2019. (‘Total’ column is not required) (18)

Answers:
A.1 JL Books General Journal

Date Description Debit Credit

----- Rs. in ‘000 -----
1-Jan-19 Cash/Bank 1,600×110 176,000
Debenture – amortized cost 176,000

1-Jan-19 Debenture – amortized cost 1,600×5.5 8,800

Cash/Bank 8,800

----------( 375 )----------

 Follow Islam and speak the truth, life will become great.

31-Dec-19 Interest expense 167,200(176,000–

8,800)×15% 25,080

Debenture – amortized cost 25,080

31-Dec-19 Debenture – amortized cost 25,600

Cash 160,000×16% 25,600
(1600 x 100) x 16% ( At
coupon rate )

KL Books General Journal

Date Description Debit Credit

----- Rs. in ‘000 -----
1-Jan-19 Investment/Debenture – FVTPL 35,200
Cash/Bank 320×110 35,200

31-Dec-19 Cash/Bank (320×100×16%) 5,120

Interest income 5,120

(0.32 x 100 x 16%)

31-Dec-19 Investment/Debenture –FVTPL 640
Gain on fair value adj.(P & L) 320×2(112 – 110)
640

A.2 Loss/injuries of workers

As CEO committed in a press conference, it is constructive obligation/valid expectation that SAL would
compensate factory workers. Therefore, SAL should make a provision of Rs. 8 million (2×1.5+5×1) in this
regard.

Factory damages
The claim was filed subsequent to year-end but the obligating event i.e. emergency landing occurred before
the year-end so this is an adjusting event.

As per legal advisor advice, SAL would be liable to pay damages in any case but amount is uncertain. So
SAL should make a provision for most likely amount [Link].18.5 million(20 x 70% + 15 x 30%).

Aircraft lease
Since aircraft is no more usable for SAL and insurance claim is expected to settle by 31 August 2020, the
contract became onerous. Therefore, SAL should make a liability for rentals of July and August i.e. USD 1
million (0.5 × 2).

USD amount should be translated into PKR by applying closing exchange rate.

A.3 List of errors/omissions

▪ Revenue from transactions with other operating segments have not been disclosed separately.
▪ Revenue from reportable segments is comprised of 62% (1,010 + 560)/2,530 of total revenue against the
requirement of 75% so another segment needs to be disclosed separately (even if it does not meet the
10% criteria).
▪ Interest income of spinning and weavings segments are reported on net basis. Rather, interest income and
expense needs to be disclosed separately.
▪ Total assets in disclosure does not match with total assets reported in financial statements.
▪ Segment wise liabilities have not been disclosed.
▪ A reconciliation is not prepared.
▪ Since export represents 30% of sales, geographical segment should also be disclosed.
▪ Sales to HL consist of 18% (30% x 60%) of total sales so it should also be disclosed separately (as a
significant customer).

----------( 376 )----------

▪ Depreciation and amortization should also be disclosed.
▪ Income tax expense should also be disclosed.
▪ Material items of income and expense should also be disclosed.

A.4
(I) (b) Non-monetary items carried at fair value in a foreign currency are retranslated at the date when the
fair value was measured
(ii) (b) Decrease in current ratio and increase in gearing ratio (because of increase in non current
liabilities)
Right of use xx
Lease liability xx
Lease liability xx
Cash xx

(iii) (d) Re-measure to Rs. 48 million, taking gain of Rs. 12 million to the profit or loss
(iv) (a) The lessee has the right to obtain substantially all of the economic benefits from use of the asset
(v) (b) General nature of any un-availed credit facilities
(vi) (c) Functional currency of an entity is identified by reference to environment of the business
(vii) (a) change in fair value of a herd of livestock
(viii) (c) keep confidentiality about KML’s results by all means

A.5 Manzil Limited

Consolidated statement of profit or loss and other comprehensive
income For the year ended 31 December 2019
Rs. in million
Sales 800+315×8/12 1,010.0
Cost of sales 540+180×8/12+5 (665.0)
Gross profit 345.0
Operating expenses 114+60×8/12+12.4 (166.4)
Other income 41+76 –18 – 5 94.0
Share of associate’s profit (W-2) 6.2
Finance cost 20+12×8÷12 (28.0)
Net Profit 250.8

Other Comprehensive Income

Loss on re-measurement of investment (9.0)

Share of associate’s OCI (1.5)
(10.5)
Total comprehensive income 240.3

Profit or loss attributable to:

Owner of the parent (Bal.) 236.0
Non-controlling interests (63 x 8/12 - 5) x 40% 14.8
250.8

Total Comprehensive income attributable to:

Owner of the parent (Bal.) (236 – 9 x 60% - 1.5) 229.1
Non-controlling interests 14.8–3.6(9×40%) 11.2
240.3

----------( 377 )----------

 Do good deeds to please Allah but not the people

W-1 Analysis of Equity of ML: At P (60%) NCI (40%)

acquisition: 1-5-2019
Share Capital 600
Retained Earnings (289 (W1) + 63(W1) x 310
4/12)
910
R.S 60
970 582 388
Cost of investment 706
Goodwill 124

As Acquisition is during the year and income statement is to be prepared therefore no need of further working.

Profit for the year of ML :

(315 – 180 – 60 – 12 ) = 63

Retained earning up to the beginning of the period.

Retained Earnings
b/d 289
Dividend (600 x 5% ) 30
PAT 63
c/d 322

Analysis of equity of KL :
No need because if goodwill then not to be presented separately and if prior period profits then in opening
CRE and changes in equity is not required . However , current period is relevant .
(132 – 97 – 6 – 5 + 8) = 32 x 25% = 8

Investment in Associate 8
Share of profit 8

Dr. Cr.
Investment 76
Gain (P.L) 76
[ 226 – 150 ]
Investment 480
(16x30)
S.C and S.P 480
Total Consideration
150(Already recorded) + 76 + 480 = 706
Plant 60
R.S 60
Depreciation (COS) 5
Plant 5
60 / 8x8/12 = 5
[NCI will be affected]
No adjustment for contingent asset
Impairment Loss 12.4
Goodwill 12.4
(124 x 10%)
[NCI will not be affected as it is not at FV]

----------( 378 )----------

Dividend by HL:
600 x 5% x 60% = 18M
Dividend income [ML] 18
Dividend declared [HL] 18
[In SOCE]

Dividend by KL :
400 x 5% x 25% = 5
Dividend income 5
Investment 5

A P

Gain to be reversed 8 Dr.

Depreciation to be reversed 0.8 Cr.
( 8/5 x 6/12 )
7.2 Dr. x 25% =1.8

Share of profit (A) 1.8

Machine 1.8

Working of Point number (vii) :

HL KL
31.12.2019 (Post Acq. Loss) 31.12.2019
FV loss (OCI) 9 Share of loss (OCI) 1.5
Invstment 9 Investment in Associate 1.5
[600,000 x(150 + 3) – (600,000 x 138) ] = 9 [(400,000 x 153) – (400,000 x 138)] = 6 x 25% = 1.5

A.6
Qabil Limited
Notes to Financial Statements
For the year ended 31-12-2019

Intangible Assets:
Product design ERP Software Licence Total
Gross Carrying Amount: 750 200 - 950
Accumulated (75) (80) - (155)
Amortization/Impairment
Opening Carrying Amount 675.0 120 795
Addition - 391.5 (W-1) 520 911.5
Amortization (W-3) (112.5) (67.25) (65) (244.75)
Impairment (W-2) (49.5) - - (49.5)
Disposal - - - -
Closing Carrying Amount 513.0 444.25 455.0 1,412.25
Gross Carrying Amount 750 591.5 520 1,861.5
Accumulated (237) (147.25) (65) (449.25)
Amortization/Impairment
Closing Carrying Amount 513.0 444.25 455.0 1,412.25
Useful Life 6 Years 2 & 9 Years 8 Years
Amortization method Straight Line Straight Line Straight
Line
Measurement Model Cost Model Cost Model Cost Model

----------( 379 )----------

Workings:
W-1: Cost of software Rs. in million
Purchase price 360.00
Borrowing cost: On advance (360×40%×15%)×(10÷12) 18.00
On remaining payments [(360×60%×15%)×5÷12] 13.50

391.50

W-2: Value-in-use of product

Years Cash flow Discount factor @ Amount
Rs. in million 12% (Note 1) Rs. in million
2020 190 0.89 169
2021 170 0.80 136
2022 140 0.71 99
2023 100 0.64 64
2024 80 0.57 45
513

Note 1: Pre tax discount rate is to be used.

Note 2: If fair value less cost to sell is not available then use value in use as recoverable amount.

Note 3: Carrying Amount (675 – 112.5) = 562.5

Recoverable Amount = 513.0
Impairment Loss = 49.50

W-3: Amortization:
a) Product design: (750 - 75) = 675 ÷ 6* = 112.5
*Remaining life from 2019 to 2024 (because after 2024 no economic benefits are expected).
b) ERP Software:
Existing (200 - 80) = 120 ÷ 2* = 60
*Remaining life from 2019 to 2020.
New (391.5 ÷ 9 x 2/12) = 7.25
Total 67.25
b) Licence:
(520 – 0*) = 520 ÷ 8** = 65
*Residual value is assumed to be zero because the given figures are not in accordance with
active market.
**Amortization should not be charged at shorter of useful life and legal life because:
i) License is renewable.
ii) Q.L has an intention to renew the licence and
iii) Cost of renewal is insignificant.

----------( 380 )----------

 A.7 Fakhr Limited
Statement of Changes In Equity
For the year ended 31 December 2019

Ordinary share Share Revaluation Retained

capital premium surplus earnings
---------- Rs. in million ----------
Balance as at 31 December 2017 (As 300.00 - 102.00 348.00
given)
Effect of change in accounting policy - - - 26.54
[ 13 + 13.54 ] (Workings)
Balance as at 31 December 300.00 - 102.00 374.54
2017 – Restated
Final cash dividend @ 10% for 2017 - - - (30.00)
( 300 x 10% )
Right issue @ 40% 120.00 168.00 - -
( 300 / 10 x ( 300 / 10
40% x 10) x
40% x 14)
Total comprehensive income for the year
ended 31 December 2018
– Net profit: Restated (98 + 9.12) - - - 107.12
(Workings)
- Revaluation Surplus - - (14.00) -
Balance as at 31 December 420.00 168.00 88.00 451.66
2018 – Restated
Interim bonus dividend @ 15% 63.00 - (63.00)
for 2019 (420 x 15%)
Total comprehensive income for the year
ended 31 December 2019
– Net profit (84 + 11.09) - - - 95.09
- Revaluation Surplus - - 25.00 -
Balance as at 31 December 2019 483.00 168.00 113.00 483.75

(i) Change in Policy of Investment Property :

At Cost Model : At FV Model :

1-1-2016 1-1-2016
Investment Property 150 Investment Property 150
Cash 150 Cash 150
31.12.2016 31.12.2016
Depreciation 4 X
Accumulated Depreciation 4
(150 x 60% - 10/12)
31.12.2016
Investment Property 9
X FV Gain 9
FV [150 X 1.06] = 159
C.A = 150
FV Gain = 9

31.12.2017 X
Depreciation 4
Accumulated Depreciation 4
31.12.2017
Investment Property 9.54
X FV Gain 9.54
FV [ 159 x 1.06 ] = 168.54 C.A = 159.00
9.54

----------( 381 )----------

31.12.2018
Depreciation 4 X
Accumulated Depreciation 4
31.12.2018
Investment Property 10.11
X FV Gain 10.11
FV [168.54 x 1.06] = 178.65
C.A = 168.54
10.11
31.12.2019
Depreciation 4 X
Accumulated Depreciation 4
31.12.2019
Investment Property 10.72
X FV gain 10.72
FV [ 178.65 x 1.06 ] = 189.369 C.A = 178.65
10.72

Effect on Profits :

2016 2017 2018 2019

Reversal of Dep 4 Cr. 4 Cr. 4 Cr. 4 Cr.
Recording of gain 9 Cr. 9.54 Cr. 10.11 Cr. 10.72 Cr.
Net effect on Profit 13 Cr. 13.54 Cr. 14.11 Cr. 14.72 Cr.

(ii) Machinery on lease :

Dr. Cr.
1-1-2018
Right of Use 114.10
Lease Liability 114.1
[ 25 x [1-(1 + 0.12)-7/0.12] 0
[At Present Value of lease payments]
31.12.2018
Lease Liability 11.31
Interest Expense 13.69
Rent expense 25
31.12.2018
Depreciation 16.3
Accumulated Depreciation 16.3
[114.10 / 7]
31.12.2019
Lease Liability 12.67
Interest Expense 12.33
Rent Expense 25
31.12.2019
Depreciation 16.3
Accumulated Depreciation 16.3

Lease Amortization Table:

Rentals Principal Interest Balance

1-1-2018 114.10
31-12-2018 25 11.31 13.69 102.79
31-12-2019 25 12.67 12.33 90.12

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 Imagine sleeping without praying isha and waking up in your grave.
Effect on Profits:

2018 2019
Reversal of Rent expense 25 Cr. 25 Cr.
Charge of Interest expense 13.69 Dr. 12.33 Dr.
Charge of depreciation 16.3 Dr. 16.3 Dr.
Net effect on profit 4.99 Dr. 3.63 Dr.

Finally year wise effect on Net Profit:

2016 2017 2018 2019

Effect of investment Property 13 Cr. 13.54 Cr. 14.11 Cr. 14.72 Cr.
Effect of lease - - 4.99 Dr. 3.63 Dr.
Net effect on profits 13 Cr. 13.54 Cr. 9.12 Cr. 11.09 Cr.

----------( 383 )----------

Q.1 With reference to IAS 41, identify whether each of the following statements is TRUE or
FALSE:
(i) Both fish farming and ocean fishing are agricultural activities.
(ii) IAS 41 does not apply on bearer plant; however, it applies on produce growing on bearer
plant.
(iii) A biological asset should initially be measured at cost of purchase.
(iv) A biological asset should subsequently be measured at fair value.
(v) The gain or loss on subsequent re-measurement of a biological asset should be taken to
profit and loss account.
(vi) All government grants related to biological assets are accounted for under IAS 41.
(vii) Once wool is extracted from the sheep, subsequent processing of wool into carpets is
accounted for under IAS 2. (08)

Q.2 For the purpose of this question, assume that the date today is 1 February 2021.
You are finance manager of Tibet Limited (TL). You are finalizing the financial statements of TL for
the year ended 31 December 2020. The Chief Executive of TL has sent you the following email:

2020 was a tough year for TL due to COVID-19. The net profit of TL is expectedly very low
as compared to previous years. However, I have identified the following matters which may
improve TL’s net profit for 2020:
(i) On 25 January 2021, Government has enacted amendments in the income tax laws to
reduce the rate of income tax for companies by 10% for 3 years including 2020.
(ii) The exchange rate has risen from Rs. 150 per USD as on 31 December 2020 to Rs.
162 per USD. TL has significant receivables in USD due to export sales.
(iii) A major local customer has settled his full balance after receiving bank loan last week. At
year-end, the customer was facing financial difficulty and therefore TL had provided
40% of his balance as doubtful receivable.
(iv) In December 2020, Government has announced a compensation scheme for entities
which have not terminated any employee in 2020. Under the scheme, these entities would
be reimbursed 25% of salaries expense of 2020. TL would initiate the process of obtaining
the reimbursement after completion of audit. The reimbursement might take few
months.

Required:
Discuss how each of the above matters would affect TL’s net profit for the year ended 31 December
2020. Support your answer with justifications. (08)
(Discussion on disclosure requirements is not required)

Q.3 Dove Limited (DL) commenced development of a new product on 1 January 2020. In this regard,
following expenditures have been incurred:
Description Incurred in [Link] million
Evaluation of possible alternatives January 2020 2
Pre-production prototypes February and March 2020 17
Pilot plant April to July 2020 40
Fee to register legal rights August 2020 15
Cost of manufacturing samples August to October 2020 *32

Brand building cost October to December 2020 16

*NRV of RS.20 Million
DL has also incurred directly attributable salaries and overheads of Rs. 5 million and Rs 1.5 million
respectively in each month over the development period of new product.
The recognition criteria for capitalization of internally generated intangible asset was met on
1 April 2020 and commercial production of the product was commenced from
1 November 2020.

Required: Compute the cost of the new product for initial measurement. Also discuss the reason(s) for
ignoring any of the above expenditures in the computation. (8)

----------( 384 )----------

Q.4 Capri Ice, a notable ice cream parlour, enters into a contract with Yardley Limited (YL) to use a space
in a shopping mall owned by YL for a period of five years. The contract specifies the dimensions of space
and location. However, YL has discretion to relocate the space to any other floor to accommodate
other customers who would be conducting promotional events and activities in the mall.
Required:
Discuss whether the contract between Capri Ice and Yardley Limited constitute lease or not. (3)

Q.5 (a) On 1 January 2020, Dettol Limited (DL) acquired a machine on lease from Lifebuoy Leasing Limited
(LLL) for 3 years. The first annual instalment amounting toRs. 35 million was paid on 1 January
2020 and all subsequent annual instalments are payable on 1 January subject to increase of 10% each
year.
DL incurred initial direct cost of Rs. 5 million. As an incentive to DL for entering into the lease, LLL
reimbursed Rs. 2 million.

LLL has incorporated an implicit rate of 11% per annum which is not known to DL.
The residual value of the machine at the end of 3 years is estimated at Rs. 30 million,out of which DL
has guaranteed Rs. 20 million.(which means lessee is not expected to pay anything because
expected residual value is more than amount guaranteed by lessee)

DL is also obliged to incur decommissioning cost of Rs. 4 million at the end of the lease term.
Discount rate of 12% may be assumed wherever required but not given.

Required:
Prepare relevant extracts from DL’s statement of profit or loss for the year ended
31 December 2020 and statement of financial position as on that date. (9)

(b) Using the information given in part (a) above, prepare note(s) for inclusion in the financial
statements of Lifebuoy Leasing Limited (LLL) for the year ended 31 December 2020. (8)

Q.6 Safeguard Limited (SL) is listed on Pakistan Stock Exchange and has registered office in Lahore.
SL is engaged in the manufacture of polyester and soda ash. Production plants are located in Lahore
and Karachi. Following is the SL’s draft statement of financial position as on 31 December 2020:

Equity and liabilities Rs. in Assets Rs. in

million million
Share capital (Rs. 10 each) 5,000 Property, plant and equipment 4,520
Reserves 2,050 Loan to employees 330
Long term liabilities 1,440 Trade and other receivables 3,265
Trade and other payables 1,610 Stock-in-trade 2,250
Bank overdraft 265
10,365 10,365

Additional information:
(i) Authorised share capital consists of 900 million shares of Rs. 10 each.
(ii) 130 million shares were issued at premium of Rs. 5 as consideration for purchase ofbuilding
and plant. Remaining shares were allotted at par for consideration paid in cash.
(iii) Reserves include revaluation surplus on property, plant and equipment of Rs. 190
million.
(iv) Long term liabilities comprise of:
▪ loan from bank of Rs. 1,100 million, out of which Rs. 250 million is payable on 30
November 2021.
▪ long term deposit of Rs. 340 million from dealers.
(v) Trade and other payables include unpaid dividend of Rs. 18 million.
(vi) Loan to employees include loans to directors of Rs. 140 million. All of these loans are interest
free house financing for 10 years as per company’s policy. 30% of the amount was disbursed
during the year. Repayment will start after two years.
(vii) Bank overdraft is net of cash in hand of Rs. 30 million.

----------( 385 )----------

(viii) SL has two operating segments on the basis of geographical locations. Informationfor 2020
extracted from reports to the segment controllers is as follows:

North South
---- Rs. in million ----
Sales 1,950 1,300
Cost of goods sold (1,640) (840)
Gross profit 310 460
Expenses (175) (390)
Profit 135 70
(ix) Assets, other income and expenses of Rs. 300 million, Rs. 40 million andRs. 74
million respectively cannot be allocated to any segment.
(x) Assets and liabilities of North and South were in the ratio of 4:3.
(xi) North’s sales include sales of Rs. 50 million to South at a profit of Rs. 5 million.

Required:
Prepare the revised statement of financial position as at 31 December 2020 along with the
relevant notes showing possible disclosures as required under the IFRSs and the Companies
Act, 2017. (Comparative figures and note on accounting policies are not required ) (20)

Q.7 Following are the summarized statements of financial position of Himaliya Limited (HL)and
Method Limited (ML) as on 31 December 2020:

HL ML
--- Rs. in million ---
Property, plant and equipment 2,400 1,750
Investments 4,320 -
Inventories 1,050 700
Trade receivables 840 525
Cash and bank balances 210 175
8,820 3,150

Share capital (Rs. 10 per share) 4,700 1,400

Share premium 720 -
Retained earnings 2,210 1,190
Liabilities 1,190 560
8,820 3,150
Additional information:
(i) On 1 April 2020, HL acquired 90% shareholdings in ML at Rs. 2,220 million which was
recorded as cost of investment by HL. It includes professional fee of Rs. 30 million
for advice on acquisition of ML. At acquisition date, ML’s retained earnings were Rs. 700
million.
(ii) On acquisition date, carrying value of ML’s net assets was equal to fair value except a brand
which had not been recognized by ML. The fair value of the brand was assessed at Rs. 160
million. HL estimated that benefit would be obtained from the brand for the next 5 years.
(iii) Upon acquisition, HL had a plan to restructure ML at a cost of Rs. 80 million. Up to
31 December 2020, ML has incurred and recorded cost of Rs. 70 million for restructuring as
per HL’s plan.
(iv) On 1 January 2020, HL acquired 35% shareholdings in Pears Limited (PL) by investing Rs.
1,500 million. This investment is carried at cost on 31 December [Link] of PL’s net asset
on 31 December 2020 are as follows:
Assets and liabilities Rs. in million
Property, plant and equipment 2,625
Inventories 1,190
Trade receivables 700
Cash and bank balances 595
Liabilities (630)
Net assets 4,480

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 (v) During the year ended 31 December 2020, PL earned a net profit of Rs. 910 million.
(vi) PL paid dividend of Rs. 490 million for the half year ended 30 June 2020. HL recorded its share
as other income.
(vii) Subsequent to investments made by HL in ML and PL, inter-company sales of goods are
invoiced at a mark-up of 25%. The relevant details are as under:

Rs. in million
ML’s inventory on 31 December 2020 includes goods
purchased from HL 50
HL’s inventory on 31 December 2020 includes goods
purchased from PL 120
Receivable from ML on 31 December 2020 as per HL’s books 74
Payable to PL on 31 December 2020 as per HL’s books 98

(viii) HL values non-controlling interest at the acquisition date at its fair value which was Rs. 240
million.

Required:
(a) Prepare HL’s consolidated statement of financial position as at 31 December 2020 in
accordance with the requirements of IFRSs. (17)
(b) List down the additional information having no effect in your working in (a) above. (02)

Q.8 Following information has been gathered for preparing the disclosures related to taxation of Lux
Limited (LL) for the year ended 31 December 2020:
(i) Accounting profit before tax for the year amounted to Rs. 1,270 million.
(ii) Accounting depreciation exceeds tax depreciation by Rs. 100 million (2019: Rs. 150
million). Accounting depreciation also includes incremental depreciation of Rs. 40 million
(2019: Rs. 60 million). As on 1 January 2019, carrying value of property, plant and equipment
exceeded their tax base by Rs. 500 million.
(iii) Liabilities of LL as at 31 December 2020 include:
balances of Rs. 100 million (2019: Rs. 70 million) which are outstanding for more
than 3 years. As per tax laws, liabilities outstanding for more than
3 years are added to income and are subsequently allowed as expense on
payment basis.
unearned commission of Rs. 80 million (2019: Rs. 15 million). Commission is taxable
on receipt basis.
(iv) Interest accrued as at 31 December 2020 amounted to Rs. 40 million (2019: Rs. 30
million). Interest income for the year is Rs. 55 million. Interest income is taxable at 20% on
receipt basis.
(v) Expenses include payments of donations of Rs. 50 million (2019: Rs 80 million). Donation
is allowable in tax by 200% of actual amount.
(vi) LL recorded an expense of Rs. 35 million (2019: nil) to bring an inventory item to its net
realizable value. This adjustment is not allowable for tax purposes.
(vii) LL acquired 5% equity in Palmolive Limited for Rs. 425 million on 1 August 2020. The
investment was classified at fair value through other comprehensive income. As at 31
December 2020, LL recorded Rs. 65 million as gain for change in fair value. As per tax laws,
gain or loss on investment is taxable at the time of sale.
(viii) Applicable tax rate is 30% except stated otherwise.

Required:
(a) Prepare a note on taxation for inclusion in LL’s financial statements for the year ended 31
December 2020 and a reconciliation to explain the relationship between the (09)
tax expense and accounting profit.
(b) Compute deferred tax liability/asset in respect of each temporary difference as at 31
December 2020 and 2019. (08)

----------( 387 )----------

A.1 (i) False
(ii) True
(iii) False
(iv) False
(v) True
(vii) False
(viii) True

A.2 (i) Reduction of income tax rate after the year end is a non-adjusting event as it was
enacted after reporting date i.e. 31 December 2020 so it would not affect profit for
2020.
(ii) Increase in exchange rate after the year end is a non-adjusting event so it would not
affect the profit for 2020.
(iii) The financial position of customer has improved after year-end upon obtaining the bank
loan so it is a non-adjusting event. The provision on this customer balance would
remain
in the books and it would not affect the profit for 2020.
(iv) Though government has announced the grant/compensation scheme in 2020, the grant
would be recognized when there is reasonable assurance that the grant will be
received.
As the process has not yet initiated and would take few months, it seems that there is
no
reasonable assurance as at 31 December 2020 that the grant will be received.
Therefore,
it would not affect the profit for 2020.

A.3 Cost of product: Rs. in million

Pilot plant 40.0
Fee to register patent 15.0
Cost of manufacturing the samples 32–20 12.0
Salaries and administrative overheads 6.5(5+1.5)×7 45.5
(from April to October 2020)
112.5

Reasons for ignoring cost:

Description Rs. in million Reasons
Evaluation of possible 2 This is part of research and therefore should not be
alternatives capitalized.
Since this cost was incurred before
Pre-production 17 meeting of recognition criteria, this should be charged to P &
prototypes L.
Brand building 16 This is cost of internally generated brand and therefore should
not be capitalized.
Since salaries and overheads from January 2020 to March 2020
19.5 were incurred before meeting of
Salaries and overheads [6.5(5+1.5)×3] recognition criteria, this should be charged to P & L.

A.4 In this contract, the dimension of space and location in shopping mall are specified but still Capri
does not have the right to use the identified space because
YL has the substantive right to substitute the space on following grounds:
(i) YL has the discretion to relocate Capri to any other floor.
(ii) YL would benefit economically from substituting the space i.e. accommodate other
customers for conducting promotional events and activities in the mall.
In light of the above, this contract does not constitute a lease.

----------( 388 )----------

A.5
(a)
Dettol Limited
Statement of financial position As on 31 December 2020
Rs. in million
Asset:
Right of use asset (W-1) 72.66

Non-current liabilities
Lease liability (W-2) 37.82
Provision for decommissioning (2.85 (w-1) + 0.34 (2.85 x 0.12)) 3.19

Current liabilities
Lease liability (w-2) 30.32
Interest payable on lease (w-2) 8.18

Dettol Limited
Rs. in
Statement of Profit or loss for the year ending 31-December 2020 million
Depreciation expense (36.33)
Interest expense- on lease (8.18)
Interest- unwinding of discount(2.85 x 12%) (0.34)
W-1: Right of use asset
Years Installment P.V @ 12%
------------------ Rs. in million ------------------
1 January 2020 35.00 35.00
1 January 2021 38.50 (35 x 1.1) 34.38
(38.5 x 1.12-1)
1 January 2022 42.35 (38.5 x 1.1) 33.76
(42.35 x 1.12-2)
115.85 103.14
Initial direct cost 5.00
Reimbursement from lessor (2.00)
Decommissioning cost 4×1.12–3 2.85
108.99
Less: Accumulated depreciation 108.99/3 (36.33)
72.66

W-2) Amortization schedule Rs. in million

Rentals Principal Interest Balance
1-1-2020 - - - 103.14
1-1-2020 35 35 - 68.14
1-1-2021 38.5 30.32 8.18 37.82

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 (b) Lifebuoy Leasing Limited
Notes to the financial statements
For the year ended 31 December 2020
Lease is a finance lease as lease term (3 years) is equal to useful life as evidenced from
decommissioning at the end of lease term (i.e 3 years)

Net investment in lease: Rs. in million

Lease payments (W-1)38.5+42.35+20 100.85
Unguaranteed residual value of machinery 10.00
Gross investment in lease 110.85
Unearned finance income (6.88 + 2.97) (9.85)
Net investment in lease 90.99(W-2)+10.01(W-2) 101.00
Current portion of net investment in lease (28.49)
Interest receivable (10.01)
Non current portion of Net investment in Lease 62.5

Maturity analysis - contractual undiscounted cash flows Rs. in million

Less than one year 38.50
One to two year 42.35(W-1)+20 62.35
100.85

The company has entered into a finance lease agreement with Detto,l limited. The lease bears
interest @ 11% per annum. Rentals are payable in advance. There is a guaranteed residual value of
20 million in the lease agreement.
W-1: Lease payment receivable
Years Rental P.V @ 11%
------------------ Rs. in million ------------------
1 January 2020 35.00 35.00
1 January 2021 38.50(35 x 1.1) 34.68
(38.5 x 1.11-1)
1 January 2022 42.35 (38.5 x 1.1) 34.37
(42.35 x 1.11-2)
104.05
Add: Residual value (Guaranteed + unguaranteed) (30×1.11– 21.94
3)
Net investment in lease at inception 125.99

W-2) Amortization schedule Rs. in million

Rentals Principal Interest Balance
1-1-2020 125.99
1-1-2020 35 35 - 90.99
1-1-2021 38.5 28.49 10.01 62.50
1-1-2022 42.35 35.47 6.88 27.03
31-12-2022 30 (20 + 10) 27.03 2.97 -
Total 145.85 125.99 19.86

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A.6 Safeguard Limited
Statement of financial position As on 31 December 2020
Rs. in million
Non-current Assets Note
Property, plant and equipment 4,520
Loan to directors and employees 2 330
4,850
Current Assets
Stock-in-trade 2,250
Trade and other receivable 3,265
Cash in hand 30
5,545
10,395
Share capital and reserves:
Share capital 3 5,000
Share premium 130×5 650
Unappropriated profit/Other reserves (2,050–650–190) 1,210
Revaluation surplus on property, plant & equipment 190
7,050
Long term liabilities:
Loan from bank 1,100–250 850
Long term deposits from dealers 340

Current liabilities
Trade and other payables 1,610–18 1,592
Unpaid dividend 18
Bank overdraft 265+30 295
Current maturity of loan from bank 250
2,155
10,395

Safeguard Limited
Notes to the financial statements
For the year ended 31 December 2020
1. Legal status and nature of business:
Safeguard Limited (SL) is listed on the Pakistan Stock Exchange having registered office in
Lahore. SL operates its plant located at Lahore and Karachi. SL engages in manufacturing
of polyester and soda ash.

2. Long term loans and advances - secured Rs. in million

Directors 2.1 140
Employees (330 - 140) 190
330
2.1 Reconciliation of loan to directors: Rs. in million
Opening balance (bal.) 98
Add: Disbursements during the year (140 x 30%) 42
Less: Repayments -
Closing balance-(Given) 140
These interest free loans are granted to directors / employees as per the company’s
policy and are repayable in 10 years.

----------( 391 )----------

3. Share capital Rs. in million
Authorized share capital
900 million ordinary shares of Rs. 10 each 9,000

Issued, subscribed and paid up capital

370 million shares allotted for consideration paid in cash (bal.) 3,700
130 million shares allotted for consideration other than cash 1,300

(130 x 10)
4. Operating segments 5,000
The company has two operating segments on the basis of geographical locations i.e.
North and south segments.

North South Total

------ Rs. in million ------
Revenue from external customers[1,950 – 50] 1,900 1,300 3,200
Inter segment revenue 50 - 50
Total revenue 1,950 1,300 3250
Other Material Information
Expenses 175 390 565
Profit 135 70 205
Assets[10,395 – 300] 5,769 4,326 10,095
(4/7) (3/7)
Liabilities [10,395 – 7,050] 1,911 1,434 3,345
Or [850 +340 +2,155] (4/7) (3/7)

Reconciliation of reportable segments:

Reportable Other Elimination Other SL’s Total
segments segments of inter adjustments
segment
transaction
Revenue 3,250 - (50) - 3,200
(1,950
+1,300)
Expenses 565 - - 74 639
(175 + 390)
Profit 205 - (5)* (34)** 166
(135 + 70) (40 - 74)
Assets 10,095 - - 300 10,395
(5,768 +
4,326)
Liabilities 3,345 - - - 3,345
(1,911 +
1,434)

*Elimination of profit on intercompany sale (Given).

**Unallocated other income will increase and unallocated expenses will decrease the profit of the
business as a whole.

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Answers-7:
Himaliya Limited
Consolidated statement of financial position As on 31 December 2020
Assets Rs. in million
Non-current assets:
Property, plant and equipment (2,400 + 1,750) 4,150
Goodwill 170
Brand (160 - 24) 136
Investment in associate [1,500 + 318.5 – 171.5] 1,647
Investments[others] (4,320 – 2,220 – 1,500) 600
Current assets:
Inventories (1,050 + 700 – 10 – 8.4) 1,731.6
Trade receivables(840 + 525 - 74 ) 1,291.0
Cash and Bank balances(210 + 175) 385.0
TOTAL ASSESTS 10,110.6
Equity and liabilities
Share capital (Rs. 10 each) 4,700
Share premium 720
Consolidated Retained earnings(w-3) 2,728

8,148
Non-controlling interest(w-4) 286. 6
8,434.6
Other liabilities:
(1,190 + 560 - 74) 1,676
TOTAL EQUITY AND LIABILTIES 10,110.6

b)
i. Restructuring cost
ii. Payable to PL(Associate)
iii. PL’S net assets as on 31.12.2020

Workings
W-1) Analysis of equity of ML :
HL (90%) NCI (10%) TOTAL
At Acq: [1- 04 -2020]
Share capital 1,400
Share premium -
Retained Earnings 700
2,100
[Link] 160
2,260
Investment [2,220 – 30] 2,034 226 2,260
FV of NCI (Given) 2,190
2,190
240 240
Goodwill 156 14 170

Since Acq. till SOFP date:

R. E (1,190 - 700) 490
441 49

W-2) Analysis of equity of PL :

HL (35%))
Since Acq. till SOFP date:
Net Assets
[4,480 – 3,570] 910

Investment 318.5
318.5
Share from Associate(CRE) 318.5
----------( 393 )----------
Accounting entries:
1) Consolidated R/E 30
Investment 30
2) a) Brand 160
[Link] 160
b) CRE(90%) 21.6
NCI(10%) 2.4
Brand 24
(160/5 x 9/12 = 24)
3) An acquirer shall not recognize a liability for the cost of restructuring a subsidiary as a result of
acquisitions.

4) CRE (other income) 171.5

Investment 171.5
(490 x 35%) = 171.5

5) a) Goods sold by P(HL) to S(ML)

50/125 x 25 = 10
CRE 10
Stock 10
b) Goods sold by Associate (PL) to Investor (HL)
120/125 x 25 = 24 x 35% = 8.4
Share of profit (CRE) 8.4
Stock 8.4
c) Intercompany receivable and payable will be cancelled out between parent and subsidiary while
preparing consolidated SOFP.
d) Intercompany receivable and payable between Investor and Associate company will not be
cancelled out.

W-3) Consolidated retained earnings:

HL’S retained earnings 2,210
Professional fee (30)
Share of profit from associate 138.6
[318.5 – 171.5 – 8.4]
Post-acquisition profits of subsidiary(ML) 441.0
Unrealized gain on stock (10)
Amortization of brand (21.6)
Total 2,728

W-4) Non-Controlling interest:

At acquisition 240
Post-acquisition profits of subsidiary (ML) 49
Amortization of brand (2.4)
286.6

A.8 (a) Tax expense:

Rs. in million
Current tax (W-1) (427.5)
Deferred tax [req. (b) w-2] 67
(360.5)

Reconciliation between tax expense and accounting profit: Rs. in million

Profit Before Tax 1,270
Tax @ 30% 381
Donation allowed at 200% (100 – (15)
50)×30%
Interest income is subject to lower rate of tax 55× 10% (30%- (5.5)
20%)
360.5

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 W-1: Current Tax: Rs. in million
Profit before tax 1,270
Accounting depreciation exceed tax depreciation 100
Increase in liabilities outstanding more than 3 years 30
(means this amount will be further taxed in current year) (100 – 70)
Commission income (15)
Commission received 80
Interest income (55)
Donation expense 50
Donation allowed (50 x 200%) (100)
NRV adjustment disallowed 35
Taxable income 1,395
Tax @ 30% 418.5
Interest receipt is subject to tax at 20% (w-1.1)45× 20% 9.0
427.5

W-1.1:
Interest Receivable
b/d 30
Income 55
Cash 45
c/d 40
(b) Deferred tax liability / (assets) as at 31 December 2020:
Carrying Tax base Difference Tax rate DTL /(A)
value
------------------- Rs. in million -------------------
Gain on re-measurement of
equity investment(425 + 65) 490 425 65TTD 30% 19.5D.T.L

PPE (350–100) 250 - 250TTD 30% 75 D.T.L

Liabilities outstanding more
than 3 years 100 - 100DTD 30% 30 D.T.A
Unearned commission 80 - 80DTD 30% 24 D.T.A
Interest receivable 40 - 40TTD 20% 8 D.T.L
Stock - 35 35DTD 30% 10.5D.T.A
38 D.T.L

Deferred tax liability / (assets) as at 31 December 2019:

Carrying Tax base Difference Tax rate DTL/(A)
value
------------------- Rs. in million -------------------
PPE (500–150) 350 - 350TTD 30% 105 D.T.L
Liabilities outstanding more
than 3 years 70 - 70DTD 30% 21 D.T.A
Unearned commission 15 - 15DTD 30% 4.5 D.T.A
Interest receivable 30 - 30TTD 20% 6 D.T.L
85.5 D.T.L

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W-2:
D.T.L
b/d 85.5
FV (in OCI) 19.5
D.T.E (bal.)
67
c/d
38

Accounting Entries:

Investment 65
Fair value gain 65
Fair Value Gain (OCI) 19.5
D.T.L 19.5 (65 x 30%)
D.T.L 67
D.T.E 67

----------( 396 )----------

 Q.1 Ajwa Limited (AL) is engaged in the business of manufacturing and trading of consumer goods.
On 1 July 2021, AL launched its own website for online sale of its products. The website was
developed internally which met the criteria for recognition as an intangible asset on 1 May 2021.
Directly attributable costs incurred for the website are as follows:

*Incurred in 2021 Rs. in million

Defining hardware and software specifications January to March 0.5
Salaries and general overheads January to June 6.0
Development of the content May to June 7.0
Registering website with search engines June 1.0
Annual fees for website hosting June 0.6
Employees training costs June to July 1.5
Discount offers for logging on the website July to August 2.0
*All costs were incurred evenly throughout the mentioned period.

Required:
Compute the cost of the website for initial measurement. Also discuss the reason(s) for not
inclusion of any of the above costs in the computation. (07)

A.1

Cost of website: Rs. in million

Salaries and general overheads 6/6×2 2.0
Development of the content 7.0
Registering website with search engines 1.0
10.0

Defining hardware and software specifications This activity relates to planning phase (which is
similar in nature to research phase) so should be
expensed out.

Salaries and general overheads Salaries and general overheads of Rs. 4 million
from January 2021 to April 2021 should be
expensed out as incurred before meeting
recognition criteria.

Annual fees for hosting website This is operating expense which is of recurring
nature so should be expensed out.

Employees training costs This is not eligible cost for capitalization due to
lack of control so should be expensed out.

Discount offers for logging on the website This is promotional activity and relates to post
development so should be expensed out or
adjusted from transaction price. (means revenue)

Q.3 Rabbi Limited (RL) has made the following investments for the first time:
(a) RL purchased 1 million ordinary shares of Kholas Limited at the fair value of Rs.
23 per share. RL also incurred transaction cost of Rs. 0.5 million. RL considers this
investment as a strategic equity investment and not held for trading.
(b) RL also purchased 1 million bonds of Barhi Limited having face value of Rs. 100 eachat
Rs. 95. These bonds are redeemable in five years’ time. RL also incurred transaction cost
of Rs. 0.8 million. RL intends to hold the bonds till maturity in order to collect contractual
cash flows.

Required:
In respect of each of the above investments, discuss the possible classification option(s)
available to RL for accounting purposes. Also compute the amount at which these
investments would be initially recognized under each option. (08)

----------( 397 )----------

A.3(a) Option (i)
As this investment is not “held for trading”, the investment can be irrevocably elected to measure at fair value
through other comprehensive income. In this case, investment should initially be measured at fair value
plus transaction cost i.e. Rs. 23.5 million.

Option (ii)
If election under option (i) is not made then it should be classified as measured at fair value through profit or
loss and will initially be measured at fair value i.e. Rs. 23 million.

(b) Option (i)

Since the objective of business model is to hold the investment till maturity, the investment can be classified
as financial asset at amortized cost and will initially be measured at fair value plus transaction cost i.e. Rs.
95.8 million.

Option (ii)
The investment can be designated as financial asset at fair value through profit or loss if classifying at
amortized cost would have caused an accounting mismatch. In this option, the bonds will initially be measured
at fair value i.e. Rs. 95 million.

Q.6 Sagahi Autos Limited (SAL) is a dealer of specialized vehicles. SAL acquires each unit of
vehicle ‘Alpha’ from manufacturer at a cost of Rs. 26 million and sells it for Rs. 30 [Link]
estimated economic life of Alpha is five years.
Few prospective customers did not have adequate funds to purchase Alpha on cash. Therefore,
SAL entered into the following arrangements during the year ended 31 December 2020:
(i) On 1 January 2020, SAL leased Alpha to Haris for a non-cancellable period of four
years. The rate of interest implicit in the lease is 10% per annum. The payment is to be
made in four equal annual instalments payable on 31 December each year. The residual
value at the end of four years is estimated at Rs. 5 million which is guaranteed by a
third party related to SAL. (considered as URV).
ii) On 1 April 2020, SAL leased Alpha to Yasir for a non-cancellable period of three
years. The rate of interest implicit in the lease is 18% per annum. Annual instalment of
Rs. 10 million is to be paid in advance. At the end of the lease term, Yasir has an option
to purchase Alpha at Rs. 7.14 million. It is reasonably certain that Yasir will exercise
this option.
(iii) On 1 August 2020, SAL leased Alpha to Faisal for a non-cancellable period of one and a
half years. Quarterly instalment of Rs. 3 million is to be paid in arrears. SAL will dispose
this unit of Alpha at the end of two years at an estimated residual value of Rs. 11
million.
Direct cost of Rs. 1 million was incurred by SAL for each of the above arrangements. Market rate of
interest is 15% per annum.

Required:
Prepare journal entries for each of above lease transactions in the books of SAL for the year
ended 31 December 2020. (8)

A.6 (i) it is a finance lease as term covers major part of economic life
Sagahi Autos
General Journal

Date Description Debit Credit

----- Rs. in million -----

1 Jan 20 Lease receivable 26.81

Cost of sales[26-2.86]
23.14
Sales 23.94*
Inventory 26.00
1 Jan 20 Selling expenses / Direct cost (P&L) 1.00
Bank 1.00

----------( 398 )----------

 31 Dec 20 Bank (W-1) 8.39
Lease receivable (bal) 4.37
Finance income (26.81)×15% 4.02

*Calculation of sale
FV = 30
PV of LP = 23.94
Lower is 23.94
Workings :

1) Calculation of Rental :
FV = PV of LP + PV of URV

1−(1+0.1)−4
30= x ( ) +5(1+0.1)-4
0.1

30= 3.17x + 3.42

30−3.42
(Rentals) x= = 8.39
3.17

2) Net investment (at market rate of 15%)

1−(1+0.15)−4
8.39( +5(1+0.15)-4
0.15

=23.95 + 2.86
= 26.81
ii) It is a finance lease as there is a reasonably certain purchase option at the end of lease term.
01-04-2020
Lease Receivable (W- 30
1)
Sales (W-2) 30
Cost of Sale 26
Inventory 26

01-04-2020
IDC Exp 1
Cash 1

01-04-2020
Cash 10
Lease Receivable 10

31-12-2020
Interest Receivable 2.7
Interest Income 2.7
[(30 - 10) x 18% (@ Implicit
Rate) x 9/12]
Working -1:
Net Investment = PV of LP (At higher implicit rate) + PV of URV
10+10 [1−(1+0.18)−2
= + 7.14 (1 + 0.18) − 3
0.18
= 30
Working -2:
Sales: At lower of:
Fair Value 30 million
(sale is fair value as dealer lessor)
PV of LP at market interest rate
[1−(1+0.15)−2
= 10 + 10 + 7.14 (1 + 0.15) − 3
0.15
= 30.95
Lower is 30 million (which means sales should
----------( 399be)----------
recorded at 30 million)
(iii) It is an operating lease of lessor as none of the conditions of finance lease are fulfilled.

Date Description Debit Credit

----- Rs. in million -----
1 Aug 20 Property, plant and equipment - Vehicle 26.00
Inventory 26.00

1 Aug 20 Property, plant and equipment – Vehicle 1.00

Bank /Cash 1.00

31 Oct 20 Cash/Bank 3.00

Rental income 3.00

31 Dec 20 Rent receivable 3/3×2 2.00

Rental income 2.00

31 Dec 20 Depreciation expense 3.40

(26-11)/2 X 5/12) + (1/1.5
x 5/12)
Accumulated depreciation 3.40

Q.7
Following information has been gathered for preparing the disclosures related to taxation of Mabroom
Limited (ML) for the year ended 31 December 2020:
(i) Accounting profit before tax for the year amounted to Rs. 50 million.
(ii) Accounting amortization exceeded tax amortization by Rs. 20 million (2019:Rs. 12 million). As at 31
December 2020, carrying values of intangible assets exceeded their tax base by Rs. 145 million.
(iii) During the year, ML incurred advertising cost of Rs. 12 million. This cost is to be allowed as tax
deduction over 3 years from 2020 to 2022.
(iv) During the year, entertainment expenses amounting to Rs. 10 million pertaining to year ended 31
December 2018 were disallowed. Similar entertainment expenses for the current year were
amounted to Rs. 7 million.
(v) Provision for warranty as at 31 December 2020 was Rs. 23 million i (2019: Rs. 18 million). Under tax
laws, warranty expense is allowed on payment basis.
(vi) During the year, MI. recorded dividend income of Rs. 6 million out of which Rs. 2 million was not
received till 31 December 2020. Under tax laws, dividend is taxable on receipt basis at the rate of
15%.
(vii) On 1 April 2020, a manufacturing plant was acquired on lease for a period of 4 years at an annual
lease rental of Rs. 40 million, payable in arrears. Interest rate implicit in the lease is 10% per annum.
Under tax laws, all lease rentals are allowed on payment basis.
(viii) Applicable tax rate (other than dividend income) is 35% for 2020 and prior years. However this rate
has been reduced by 5% for 2021 and future years through finance Act enacted on 20.12.2020

Required:
a) Prepare a note on taxation for inclusion in ML's financial statements for the year ended 31 December
2020 and a reconciliation to explain the relationship between the tax expense and accounting profit.
(11)
b) Compute deferred tax liability/asset in respect of each temporary difference as at 31 December 2020
and 2019. (07)

A.7 (a) Note of Taxation:

Current Tax (w.1) (41.65)

Deferred Tax (b) 26.94
(14.71)
Prior Period Tax (10 x 35%) (3.50)
18.21
----------( 400 )----------
Reconciliation:
Profit before tax 50
Tax rate 35%
Expected Tax 17.5
Dividend Income ( 6 x 20% ( 35% - 15%) (1.2)
Entertainment Expense ( 7 x 35%) 2.45
* Effect of rate change of future (4.04)
(24.51 (b) – 0.3)/30 x 5
Actual tax expense 14.71
* ( It is not a change in tax rate in current year, it is effect of change in rate of future which is to be
considered in working of deferred tax.)

(w.1) Current Tax:

Profit before tax 50
Accounting amortization exceed tax amortization 20
Advertising cost expense 12
Advertising cost allowed (12÷3) (4)
Entertainment expenses 7
Warranty expense 23
Warranty paid (18)
Dividend income (6)
Interest on lease (w.2) 9.51
Depreciation on leased plant 23.78
Taxable profit 117.29
Tax @ 35% 41.05
Tax on dividend income ( 4x15%) 0.60
Total tax 41.65

w.2:
1.4.2020
Right of use 126.80
Lease liability 126.80
31.12.2020
Depreciation 23.78
Accumulated depreciation 23.78
( 126.80÷4x 9/12)
31.12.2020
Interest expense 9.51
Interest payable 9.51
( 126.80 x 10% x 9/12)

b) Deferred tax liability (Assets) as on 31.12.2020

Carrying Tax base Difference Rate Deferred tax

amount Liability /Assets

Intangible assets 145.0 - 145 TTD 30% 43.50 DTL

Advertisement - 8.0 8 DTD 30% 2.40 DTA
cost
Provision for 23 - 23 DTD 30% 6.90 DTA
warranty
Dividend 2 - 2TTD 15% 0.30 DTL
receivable
ROU (126.8- 103.02 - 103.02TTD 30% 30.90 DTL
23.78)
Lease liability 126.80 - 126.8DTD 30% 38.04 DTA
Interest payable 9.51 - 9.51DTD 30% 2.853 DTA
Closing balance of D.T.L 24.51

----------( 401 )----------

 Deferred tax liability
Deferred tax b/d (W-3)
26.94 51.45
expense

c/d
W.3) Deferred tax 24.51 liability (Assets) as
on 31.12.2019
Carrying Tax base Difference Rate Deferred tax
amount Liability
/Assets
Intangible 165 - 165 TTD 35% 57.75 DTL
assets
Provision for 18 - 18 DTD 35% 6.30 DTA
warranty
Closing balance of D.T.L 51.45

Q.8
For the purpose of this question, assume that the date today is 1 August 2021.
On 1 January 2021, Holwah Automobiles Limited (HAL) launched vehicle with the brandname of ‘Deluxe’. In
March 2021, reports were circulated in social media that carbon emissions from Deluxe exceed the regulatory
limits. In May 2021, HAL announced to halt the sales of Deluxe upon receiving an inquiry from regulatory
authority.

On 1 June 2021, HAL announced that:

▪ high emissions were confirmed in those batches of Deluxe which were produced from March 2021 and
onwards due to defect in assembling of emission kit.
▪ customers can get the defect fixed from the authorized dealers free of cost from 1 July 2021.
▪ sales of Deluxe will also resume from 1 July 2021.
The senior management has summarized the following financial implications of the above matter:
(i) On 10 June 2021, a penalty of Rs. 20 million was imposed by the regulatory authority. On 25 July 2021, an
additional penalty of Rs. 2 million was imposed due to non-payment of penalty within 40 days. HAL has
decided to challenge the additional penalty on the relevant forum.
(ii) Defect in the existing inventory of Deluxe will be fixed by HAL at its factory in the month of August 2021.
The rework cost will be Rs. 15 million and loss of profit due to temporary suspension of production will be
Rs. 30 million.
(iii) Defect in all vehicles sold during March to May 2021 will be fixed by the authorized dealers in July and
August 2021. The cost will be re-imbursed to dealers at the end of each month on the basis of actual number
of vehicles fixed. Though HAL is legally bound to fix the defect in all vehicles which will cost
approximately Rs. 50 million, management estimates that only 85% of customers will get their vehicle
fixed.
(iv) Market value of internally generated brand of Deluxe would reduce by Rs. 150 million.
(v) Value in use of the production line of Deluxe would reduce by Rs. 80 million.
(vi) In June 2021, the regulatory authority has introduced new emission protocol to ensure that the emissions are
within the limits and needs to be complied by 30 September [Link] new protocol will require modification in
the existing production line at a cost of Rs. 100 million.
Required:
In the context of relevant IFRSs, discuss how the above financial implications should be dealt with in the financial
statements of HAL for the year ended 30 June 2021
A.8 The treatment of the given financial implications in the financial statements for the year ended 30
June 2021 would be as follows:
(i) Penalty of Rs. 20 million should be recognised due to legal obligation arising on 10 June 2021.
Additional penalty of Rs. 2 million should not be recognised as it is a possible obligation.
(ii) Rework cost of Rs. 15 million should not be recognised. Rework cost should be deducted in calculating
NRV of inventory of Deluxe and would be compared with the cost for identifying any potential NRV
adjustment. No provision needs to be made for loss of profit of Rs. 30 million as future operating losses
does not require any provision.
(iii) Repair cost which will be reimbursed to dealers should be provided because constructive / legal
obligation arose due to announcement made on 1 June. The amount recognised as provision shall be
the best estimate based on the most likely outcome hence provision should be recorded at 85% of
Rs. 50 million i.e. 42.5 million.
----------( 402 )----------
(iv) Internally generated brands are not recognised in financial statements; hence no question arises of
their impairment.
(v) Reduction in value in use of Rs. 80 million should not be recorded. The reduced value in use of the
production line should be compared with the fair value less cost of disposal for assessing recoverable
amount. If carrying amount exceeds recoverable amount than recognize impairment loss.
(vi) The modification cost of Rs. 100 million should not be provided despite announcement made by
regulatory authority before year end. HAL has no present obligation for future expenditures as it can
avoid the expenditure by its future actions i.e. by changing operations.

----------( 403 )----------

 SPRING - 2022
Q.1 On 1 January 2020, Grateful Industries Limited (GIL) completed installation of a plant which will
be required to be dismantled at the end of its ten years’ useful life. GIL paid Rs. 2,000 million for
the plant. On 1 January 2020, it was estimated that the cost of dismantling would amount to Rs. 200
million. Applicable discount rate was 10% per annum when initial estimate of dismantling costs was
made.

The fair value of the plant as on 31 December 2020 was assessed at Rs. 1,845 million
(including dismantling cost).

Estimates of dismantling cost and applicable discount rate were reviewed as at31
December 2021 and were revised to Rs. 150 million and 12% per annum respectively.

GIL has a policy to subsequently measure plant using the revaluation model and depreciation is
provided on straight line basis.

Required:
Prepare accounting entries in the books of GIL, for the year ended 31 December 2021 in
accordance with IFRSs. (08)

Q.2 On 1 November 2021, Excitement Limited (EL) entered into a contract with Pride Limited (PL) to
manufacture and sell 100 units of a specialized machine at a total consideration of Rs. 300 million.
The machines will be delivered in lots of 20 units at the end of each quarter. PL has paid 10% non-
refundable consideration in advance while the remaining consideration will be paid in five equal
instalments, only after delivery of each lot and not before.

The sales team of EL worked hard and spent 1600 hours costing Rs. 4 million for preparing proposal
for the contract. The team was also rewarded with a bonus of Rs. 6 million upon obtaining the
contract. Upto year ended 31 December 2021, EL had manufactured 15 units of the machine to be
delivered on 31 January 2022.

EL’s CFO, a chartered accountant, has suggested that revenue for 15 units should be recognized
in 2021 as the machines are of specialized nature and have no alternate use for EL. Further, the
sales team cost of Rs. 10 million should be taken to statement of profit or loss in 2021 as this has
been fully recovered through 10% advance received from PL.

Required:
(a) Analyse the treatments suggested by the CFO in respect of the above contract. (07)
(b) Briefly explain how CFO may be in breach of the fundamental principles of Code of Ethics
for Chartered Accountants and how he should respond. (02)

Q.3 Draft financial statements of Determined 31 Limited (DL) for the year ended
December 2021 show the following amounts:
Rs. in '000
Total assets Total 43,500
liabilities 12,300
Net profit for the year 4,573

While reviewing the draft financial statements, following issues were identified:
(i) DL has classified investment in Jubilant Limited (JL) as an investment in associate and
accounted for using equity method despite having no significant influence over JL.
On 1 February 2021, DL purchased 40,000 shares of JL representing 15%
shareholdings at Rs. 80 per share. On 30 September 2021, JL announced interim cash
dividend of Rs. 5 per share. JL reported net profit of Rs. 2.4 million for the year ended
31 December 2021. The fair value of each share of JL was Rs. 70 as on
31 December 2021.

DL should classify these shares at fair value through profit or loss.

----------( 404 )----------
 (ii) Transaction cost incurred on bonds issued by DL was recorded as an asset and being
amortized over five years. Further, half of interest to be paid on 30 June 2022 has been
accrued.
On 1 July 2021, DL issued 6,000 bonds of Rs. 1,000 each at a discount of Rs. 50 each
with maturity in five years. The transaction cost associated with the issuance of these
bonds was Rs. 20 per bond. The coupon interest rate is 11% per annum payable
annually on 30 June. The approximate effective interest rate was 13% per annum.
Bonds are subsequently measured at amortized cost.
Required:
Determine the revised amounts of total assets, total liabilities and net profit, after
incorporating the required corrections. (07)

Q.4 The following transactions pertain to Amused Limited (AL):

(i) In 2020, AL started development of a new product. The recognition criteria for
capitalization of internally generated intangible asset was met on 1 January 2021. On this
date, AL started development of a plant which completed in 3 months. It is pilot plant for
testing the new product and is not of a scale economically feasible for commercial
production. AL incurred cost of Rs. 3 million and Rs. 7 million on design and construction
of plant respectively. AL expects to operate the plant for two years till end of
development phase. During 2021, AL incurred Rs. 5 million in operating the pilot plant.
(ii) On 1 March 2021, AL acquired a patent with indefinite life in exchange of its old
equipment and cash consideration of Rs. 25 million. The fair values of the patent and
equipment were assessed at Rs. 57 million and Rs. 35 million respectively. On the date of
exchange, the equipment had a carrying value of Rs. 30 million. AL believes that its future
cash flows will change as a result of this exchange. AL incurred cost of Rs. 2
million for transferring the title of the patent to its name.
(iii) On 1 June 2021, the government granted a license to AL free of cost to import raw
material upto 10 tons from international market for its intended use. The license is non-
transferable. There are no further conditions attached by the government. The fair value of
the license is Rs. 50 million.
Required:
Explain how each of the above transactions should be accounted for in the financial
statements of AL for the year ended 31 December 2021, in accordance with the
requirements of IFRSs. (09)

Q.5 Calm Limited (CL) is a listed company and engaged in manufacturing of textile products. Following
disclosures have been extracted from CL’s draft financial statements for the year ended 31 December
2021:

16 - Long term loans and advances – secured

2021 2020
----- Rs. in '000 -----
Loans and advances – considered good:
Directors 89,600 95,100
Executives and other employees 81,900 87,600
171,500 182,700
Reconciliation
Balance at 1 January 88,500 92,300
Disbursements 18,700 22,400
Repayments (25,300) (27,100)
Balance at 31 December 81,900 87,600

----------( 405 )----------

 29 - Remuneration of Chief Executive, Directors and Executives
The aggregate amounts charged in these financial statements are given below:
Chief Directors &
Executive Executives
----- Rs. in '000 -----
Managerial remuneration including bonuses 28,320 70,150
House rent and other allowances 17,700 38,975
Contribution to retirement benefit plans 1,888 3,680
47,908 112,805

Executives are also entitled for other benefits.

Required:
Prepare list of errors and omissions in the above disclosures. (07)
(Redrafting of disclosures is not required)

Q.6Select the most appropriate answer(s) from the options available for each of the followingMultiple Choice
Questions.

(i) Government grants related to ‘Bearer plants’ are accounted for under:
(a) IAS 41 (b) IAS 20
(c) IAS 16 (d) IAS 41 and IAS 20 (01)

(ii) With regards to accounting regulation in Pakistan, the Institute of CharteredAccountants of

Pakistan is responsible for:
(a) establishing accounting rules that must be followed by the companies in Pakistan.
(b) recommending accounting standards to the Securities and Exchange
Commission of Pakistan for notification.
(c) issuing notification in the official gazette in respect of accounting standards tobe applicable in
Pakistan.
(d) approving accounting standards applicable in Pakistan. (01)

(iii) Which of the following statements is/are correct?

(I) Ocean fishing is an agricultural activity.
(II) Biological assets are never depreciated.
(a) Only (I) is correct (b) Only (II) is correct
(c) Both are correct (d) None is correct (01)
(iv) As per IAS 21, non-monetary items carried at fair value are retranslated at the exchange rate
prevailing:
(a) at year-end
(b) during the year i.e. average rate
(c) at the date when fair value was determined
(d) at acquisition date (01)
(v) Which TWO of the following are non-adjusting events?
(a) Directors approved the plan to close down the major segment before year-endbut
announcement to public was made after year-end.
(b) A company made an out of court settlement with a customer after year-end,for defective
products supplied before year-end.
(c) The discovery of fraud after year-end which shows that financial statements
are incorrect.
(d) A change in income tax rate announced after year-end. (02)

----------( 406 )----------

(vi) Which of the following statements is/are correct?
(I) An investment in equity instruments of another entity cannot be classified as subsequently
measured at amortized cost.
(II) An investment in debt instruments of another entity cannot be classified as subsequently
measured at fair value through other comprehensive income.
(a) Only (I) is correct (b) Only (II) is correct
(c) Both are correct (d) None is correct (01)

(vii) Which of the following statements is/are correct under IAS 21?
(I) Exchange differences on retranslation of all items are taken to profit or loss.
(II) Dividend received on foreign investments are recognized at average exchange rate for the
year.
(a) Only (I) is correct (b) Only (II) is correct
(c) Both are correct (d) None is correct (01)

(viii) On 1 January 2022, a company entered into a non-cancellable contract with its client to implement a
software by 30 June 2022. As per contract, client was required to pay 10% advance on 31 January
2022. The client paid the advance on 15 February 2022. How will company record transaction on 31
January 2022?
Debit Credit
(a) Accounts receivable Contract liability
(b) Contract asset Revenue
(c) Accounts receivable Revenue
(d) No entry (01)

(ix) An operating segment has just started operations but has not earned any revenues yet. Which of
the following statements is correct?
(a) It may be a reportable segment if quantitative threshold is met.
(b) It is a reportable segment even if quantitative threshold is not met.
(c) It is not a reportable segment even if quantitative threshold is met.
(d) It will be a reportable segment only after earning revenues. (01)

Q.7 Following information has been gathered for preparing the disclosures related to taxation of
Surprise Limited (SL) for the year ended 31 December 2021:
(i) Accounting profit before tax for the year amounted to Rs. 130 million.
(ii) Tax depreciation exceeds accounting depreciation by Rs. 9 million and revaluation loss
recognized against revaluation surplus is Rs. 6 million. Under tax laws, revaluation has
no effect.
(iii) Interest income exceeds interest receipt by Rs. 12 million while commission receipt
exceeds commission income by Rs. 15 million. Under tax laws, both are taxable on
receipt basis.
(iv) Out of total donations of Rs. 5 million, only 60% are allowable in tax.
(v) Development cost of Rs. 25 million incurred in 2021 has been expensed out. Under tax
laws, development cost are amortized at the rate of 28% per annum on reducing balance
basis.
(vi) Capital work in progress as at 31 December 2021 includes borrowing cost of Rs. 8
million incurred in 2021. Under tax laws, borrowing cost is allowed in the year in which it
is incurred.
(vii) On 1 January 2021, SL acquired shares in Funny Limited (FL) for Rs. 70 million. The
investment in FL was subsequently measured at fair value through profit or loss. During
the year, SL received Rs. 4 million as dividend from FL. At year-end, a gain of Rs. 10
million was recognized as fair value adjustment. Under tax laws, capital gain is taxable at
15% at the time of sale while dividend received is taxable at 10%. The intention of SL
for holding investment in FL is to take benefit in the form of capital gain.
----------( 407 )----------
 (viii) Deferred tax liability/(asset) in respect of temporary differences for SL as at31
December 2020 was as follows:
Rs. in million
Property, plant and equipment 18
Interest receivable 3
Unearned commission (9)
12

(ix) Applicable tax rate is 30% except stated otherwise.

(x) Unused assessed tax losses were Rs. 50 million till 31 December 2020.
Required:
(a) Prepare a note on taxation for inclusion in SL’s financial statements for the year ended31
December 2021 and a reconciliation to explain the relationship between the tax
(10)
expense and accounting profit.
(b) Compute deferred tax liability/asset in respect of each temporary difference as at31
December 2021. (07)

Q.8 Following balances are extracted from the records of Happiness Limited (HL), SatisfiedLimited
(SL) and Furious Limited (FL) for the year ended 31 December 2021:

HL SL FL
-------- Rs. in million --------
Sales 4,100 2,250 2,100
Cost of sales 2,880 1,125 1,365
Operating expenses 800 550 303
Other income 414 216 95
Gain/(loss) on re-measurement of investment in
195 (80) 20
listed securities
Finance cost - 50 35
Surplus arising on revaluation of property,
- - *100
plant and equipment for the year
*The revaluation was performed on 31 December 2021

Additional information:
(i) Details of HL’s investments are as follows:

Share capital Retained

Date of Holding % Investee (Rs. 10 each) earnings of
investment of investee investee
---- Rs. in million ----
1 July 20 75% SL 1,500 1,200
1 March 21 30% FL 1,000 950
(ii) Following was the consideration for acquisition of SL’s shares:
▪ Immediate payment of Rs. 1,700 million and another payment of Rs. 843
million after 3 years.
▪ An amount of Rs. 500 million payable on 1 May 2021 that was contingent upon the
post-acquisition performance of SL. Fair value of this consideration was estimated at
Rs. 290 million on acquisition date as well as on 31 December 2020.
However, due to improvement in business conditions in 2021, the target was
achieved and full amount was paid. HL has included the full payment in cost of
investment in SL.

----------( 408 )----------

 (iii) At the date of acquisition of SL, carrying values of its net assets were equal to fair values
except the following:
▪ An in-process development project for a software had a fair value of Rs. 180
million. The cost of Rs. 140 million incurred before acquisition by SL on development
had been expensed out in SL’s books since the project did not meet the criteria for
capitalization. After acquisition, SL incurred further Rs. 20 million which resulted in
completion of project on 1 January 2021. The software has a useful life of 4 years.
▪ Fair value of inventory was higher than its carrying value by Rs. 200 million. 50%
and 10% of the inventory were included in the inventory of SL at 31
December 2020 and 2021 respectively.
(iv) HL has designated its investment in listed securities as subsequently measured at fair value
through profit or loss whereas SL and FL irrevocably elected their respective investments at
initial recognition on 1 June 2021 as subsequently measured at fair value through other
comprehensive income.
(v) SL paid cash dividend of 8% for the half year ended 30 June 2021. HL recorded its share
as other income.
(vi) On 25 August 2021, FL delivered goods having sale price of Rs. 150 million at a markup
of 20% to HL. 40% of these goods are included in the HL’s inventory as at 31 December
2021.
(vii) An impairment test has indicated that goodwill of SL was impaired by 15% on 31
December 2021. There was no impairment in the previous year.
(viii) The income and expenses of all companies had accrued evenly during the year
except stated otherwise.
(ix) HL measures non-controlling interest at the proportionate share of acquiree’s
identifiable net assets.
(x) Discount rate of 12% per annum may be used wherever required.
Required:
Prepare HL’s consolidated statement of profit or loss and other comprehensive income forthe
year ended 31 December 2021. (18)

Q.9 Optimism Limited (OL) entered into following arrangements:

(i) On 1 January 2020, OL leased a machine from Fascinated Bank Limited (FBL).
Details are as follows:
The lease period is agreed as six years. However, the lease contains an option for
OL to terminate the lease at the end of four years upon payment of Rs. 1 million. OL
is reasonably certain to exercise this option due to anticipated technological
changes.
First annual instalment amounting to Rs. 12 million was paid on
1 January 2020 and all subsequent annual instalments are payable on 1 January
subject to decrease of Rs. 2 million in each year.
Market rate for similar transaction is 12% per annum but as an incentive to OL for
entering into the lease, FBL has incorporated an implicit rate of 11% per annum
which is known to OL.
The fair value and useful life of the machine are Rs. 40 million and seven years
respectively.
OL incurred initial direct cost of Rs. 3 million.
(ii) On 1 May 2021, OL entered into an arrangement with Energetic Limited (EL) for the use
of five photocopy machines for a non-cancellable period of three years. Semi-annual
instalment of Rs. 2 million is to be paid in advance. As per agreement, EL has a
substantive substitution right to replace the machines.
Required:
(a) Prepare relevant extracts (including comparative figures) from OL’s statement of
financial position, statement of profit or loss and notes to the financial statements forthe (12)
year ended 31 December 2021.
(b) Compute the unguaranteed residual value estimated by FBL at the end of six years if
FBL had incurred Rs. 2 million of initial direct cost. (Assume that FBL is reasonably (03)
certain that OL will not exercise termination option)

(THE END)

----------( 409 )----------

 Suggested Answers
Answer-1
Journal Entries for the
Year ended 31-12-2021

Dr. Cr.
Date Description
Rs. in million
31-12-21 Depreciation expense (P&L) (1,845/9) 205.0
Acc. Depreciation 205.0
31-12-21 Interest expense (P&L) 8.5
(77.11+7.71) x 10%
Provision for decommissioning
8.5
31-12-21 Provision for Dismantling (W-1) 32.7
Revaluation Loss (P&L) (W-3) 21.69
Revaluation surplus(bal.) 11.01
(OCI)

W-1: Dismantling cost Rs. in million

Already recorded Provision (77.11 + 7.71 + 8.5) 93.3
Provision should be [150 (1 + 0.12)-8] (60.6)
Decrease in provision 32.7

(W-2):

Dr. Cr.
Date Description
Rs. in million
01-01-20 Plant 2,000
Cash 2,000
01-01-20 Plant 200(1+0.10)-10 77.11
Provision 77.11
31-12-20 Depreciation 207.71
2000+77.11 207.71
Plant( )
10
31-12-20 Finance cost 7.71
Provision (77.71 x 10%) 7.71

31-12-20 [Link] (P/L) 24.4

Plant 24.4

Carrying Amount [2,000+77.11-207.71] = 1,869.4

Fair Value = 1,845
[Link] 24.4

W–3) Revaluation surplus 32.7

Reversal of loss 24.4 Cr. Revaluation Surplus 11.01

Depreciation to be
Charged (207.71 - 205) 2.71 Dr.
Net Reversal of loss 21.69 Cr.

----------( 410 )----------

Answer-2
(a) Revenue recognition
As per IFRS 15, in cases where entity’s performance does not create an asset with alternative use, the entity
can recognize revenue over time if the entity also has an enforceable right to payment for performance
completed to date. As per agreement, EL is entitled for remaining consideration only after delivery of each lot so
revenue should not be recognized over time as suggested by CFO. Proportionate revenue should be
recognized upon transferring control i.e. delivery of each lot consisting of 20 machines to PL. Goods manufactured
till year-end should be included in EL’s closing inventory and the advance received from PL should be shown as
contract liability.

Contract cost
The cost of Rs. 4 million for 1600 hours spent is correctly expensed out as such cost would have been incurred
whether contract was obtained or not. However, Rs. 6 million paid for should be capitalized as contract cost
being an incremental cost of obtaining a contract cost (incremental to contract) and should be amortized over
contract period on a systematic basis. This contract costs should not be amortized in year 2021 as no
related revenue has been recognized in 2021.
(b) In given situation, CFO is in breach of principle of professional competence and due care as CFO has a duty
to maintain his professional knowledge and skill at such a level that employer receives a competent service in
accordance with applicable technical and professional standards.

CFO should be involved in continuing professional development activities which will develop and maintain his
capabilities enabling him to perform competently within the professional environment.

Answer-3
Total Total
Net Profit
Assets Liabilities
---------- Rs. in ‘000’ ----------
(i) As per Question 4,573 43,500 12,300
Dividend 200 200 -
Reversal of share of profit (330) (330) -
Loss on fair value adjustment of shares
40× (80–70) (400) (400) -
(ii) Transaction cost (120) (120)
Reversal of Amortization 12 12
Additional finance cost (W-1) (33) - 33
Revised amounts 4,022 42,862 12,213

Workings:
(i)

Dr. Cr.
Date Description
Rs. in ‘000’
31-12-21 Share of Profit (2.4 x 11/12 x 15%) = 0.33 330
Investment in JL 330
(Reversal of equity method)
31-12-21 Investment (40,000 x 5) 200
Dividend Income 200
(Reversal in Dividend Income in equity method)
31-12-21 Fair value loss (P&L) 400
Investment 400

(Remeasurement of investment of shares)

[40,000 x 80 = 3,200,000 – 2,800,000 (40,000 x 70)] = 400,000

----------( 411 )----------

(ii)

Date Description Dr. Cr.

Rs. in ‘000’
31-12-21 Financial Liability 120
Asset 120
31-12-21 Asset 12
Expense (120 ÷ 5 x 6/12) 12
(Reversal of Amortization)
31-12-21 Interest expense 33
Financial liability (363-330) 33
Table would be: Rs.’000’

Interest expense @13% Interest Paid @11% Balance

01-07-2021 5,700
(6,000 x 950)
30-6-2022 741 660
(6,000 x 11%)

Interest expense that would be recorded = 660 x 6/12 = 330

Table should be: Rs.’000’

Interest expense Interest paid Balance
@13% @11%
01-07-2021 5,580
(5,700 - 120)
30-6-2022 725 660
(5,580 x 13%)
Interest expense that should be recorded = 725 x 6/12 = 363

Answer-4
(i) Cost incurred on pilot plant should be recorded as intangible as it falls under development activities. As
criteria for capitalizing development cost has been met, all cost (i.e., designing, constructing and
operating) incurred on pilot plant should be capitalized as an intangible. Amortization will begin once
development activity ends and commercial production starts over the life of product.
(ii) This exchange has a commercial substance as future cash flows are expected to change as a result of this
exchange. Therefore, the exchange should be recognized at fair value. As fair value of both assets
exchanged is given, the exchange should be recorded at the fair value of equipment given. So, the patent
should be recorded at Rs. 60 million i.e., sum of fair value of equipment given up (Rs. 35 million) and cash
consideration (Rs. 25 million). Further, cost of transferring title of Rs. 2 million should be added to cost of
patent. No amortization will be charged on patent due to indefinite life. However, the patent will be tested
for impairment annually.
(iii) Grant of license by government should be treated as government grant. The license can be recorded as
intangible asset at its fair value of Rs. 50 million. Government grant so recognized should be amortized to
P&L over the life of license. Alternatively, intangible asset can be recorded at a nominal amount. AL should
select an accounting policy in this regard and apply it consistently.

Answer-5
List of errors and omissions
Long term loans and advances – secured
1. With regards to loans and advances to directors, the purposes for which loans or advances were
made shall be disclosed.
2. Reconciliation of the carrying amount at the beginning and end of the period, showing
disbursements and repayments shall be disclosed for directors only and not for Executives
and other employees;
3. The maximum aggregate amount outstanding at month end shall be disclosed for
Executives.
4. The particulars of collateral security held shall be disclosed when loans and advances are
secured.
5. The opening balance for year 2021 shall tie with closing balance for year 2020 i.e. Rs.87,600.
----------( 412 )----------
 Remuneration of chief executive, directors and executives
1. Comparative information for the year 2020 shall be provided.
2. Directors and Executives information shall be separately disclosed.
3. Number of persons shall be separately disclosed for directors and executives.
4. Other benefits e.g. vehicle, cellular phone, etc. in cash or in kind shall be disclosed stating
their nature and, where practicable, their approximate money values.

Answer-6:
(i) (b) IAS 20
(ii) (b) recommending accounting standards to the Securities and Exchange Commission
of Pakistan for notification.
(iii) (d) None is correct
(iv) (c) at the date when fair value was determined
(v) (a) Directors approved the plan to close down the major segment before year-end but
announcement to public was made after year-end.
(d) A change in income tax rate announced after year-end.
(vi) (a) Only (I) is correct
(vii) (d) None is correct
(viii) (a) Accounts receivable Contract liability
(ix) (a) It may be a reportable segment if quantitative threshold is met

Answer-7:
SURPRISE LIMITED
NOTES TO FINANCIAL STATEMENTS
FOR THE YEAR ENDED 2021

2021
Rs. in million
Current tax (W-1) (22)
Deferred tax (15.3)
(37.3)
Reconciliation between tax expense and accounting profit
Profit before tax 130.0
Tax @ 30% 39
Effect of low rate on dividend [4 x (30%-10%)] (0.8)
Effect of low rate on fair value gain on investment (10 × (30%-15%) (1.5)
Effect of disallowed donation 5×40%×30% 0.6
37.3

W-1: Current tax Rs. in million

Profit before tax 130.0
Tax depreciation exceeding accounting depreciation (9.0)
Interest income exceeding interest receipt (12.0)
Commission receipt exceeding commission income 15.0
Donation disallowed 5×40% 2.0
Dividend income taxable at different rate (4.0)
Development cost expensed out 25.0
Tax amortization of development cost 25×28% (7.0)
Borrowing cost allowed in tax (8.0)
Fair value adjustment not yet taxable (10.0)
Taxable profit 122.0
Unused tax losses (50.0)
72.0
Tax @ 30% 21.6
Tax on dividend 4×10% 0.4
22.0
----------( 413 )----------
Deffered Tax:
Description C.A T.B Diff %
Property plant & equipment 394 331 63 x 30% 18.9 DTL
Interest receivable 22 - 22 x 30% 6.6 DTL
(3/30% = 10 + 12(receivable is more))
Unearned Commission 45 - 45 x 30% (13.5) DTA
(9/30% = 30 + 15(unearned is more))
Capital work in progress 8 - 8 x 30% 2.4 DTL
Development Cost [25 - 7] - 18 18 x 30% (5.4) DTA
Investment in FL [70 + 10] 80 70 10 x 15% 1.5 DTL
D.T.L 10.5

PPE (Tax)
PPE (C.A) b/d 440 Dep 109
b/d Dep (500 – 60*)
500 100 *18/30%
(Assumed) [Link] 6

c/d 331

c/d 394

Un-earned commission
Interest receivable Income 35 b/d 30
b/d 10 cash 38 (9/30 x 100)
(3/30 x 100) Cash 50
(Assumed)
Income 50
(assumed) c/d 45
c/d 22

D.T.L / D.T.A [Link] 6

b/d 3 Asset 6
(50 x 30% - 12) D.T.E 15.3
[Link] 1.8 D.T.L 1.8
[Link] 1.8

c/d 10.5

----------( 414 )----------

Answer-8
Hapiness limited
Consolidated statement of profit or loss and other comprehensive income
For the year ended 31 December 2021
Rs. in million
Sales 4,100+2,250 6,350.0
Cost of sales 2,880+1,125+80 (4,085.0)
Gross profit 2,265.0
Operating expenses 800+550+45+210+42 (1,647)
Other income 414+216–90 540.0
Gain on re measurement of investments 195.0
Finance cost 50 + 76.3 (126.3)
Share of associate’s profit (123(W1) - 3) 120.0
Net Profit 1,346.7

Other Comprehensive Income

Loss on re-measurement of investment (80.0)
Share of associate’s OCI (20+100) ×30% 36.0
(44.0)
Total comprehensive income 1,302.7

Profit or loss attributable to:

Owner of the parent (Bal.) 1,192.7
Non-controlling interests (741 (W-3) -45 -80) x 25% 154.0
1,346.7

Total Comprehensive income attributable to:

Owner of the parent (Bal.) 1168.7
Non-controlling interests 154–20(80×25%) 134.0
1,302.7

Analysis of equity of Subsidiary

At Acquisition: 1.7.2020 P (75%) NCI (25%)
S.C 1,500
R.E 1,200
R.S (180+200) 380
3080 2,310 770
Cost of Investment(W-2) 2,590
Goodwill 280

(W-1.1)
Analysis of equity of Associate
Share of profit from Associate for the current year= 2,100 – 1,365 – 303 + 95 – 35 = 492 x 10/12 = 410
[Investment measured at FVOCI]
= 410 x 30% = 123
Investment 123
Share of profit 123

Workings:
(W-2)
Cost of investment = 1,700 + 843 (1 + 0.12)-3 = 2,300
Cost of investment 290
Payable (at FV) 290
[correct entry on acquisition]
Total = 2,300 + 290 = 2,590
Adjustment to be made in previous year:
Payable 210
Cost of investment 210

----------( 415 )----------

During the year,there is a change in estimate which should be measured as an expense in 2021.
Expense 210
Payable 290
Cash 500
(No effect on NCI)

Description Dr. Cr.

Rs. in million
Software 180
[Link] 180
(Additional cost is 20m which would have been
properly accounted for in SL books)
Amortization 45
[Link] 45
(180/4 x 1)
(From 1.1.2021 as the project is completed on
this date)

(NCI will affected)

Inventory 200
[Link] 200

50% inventory sold last year till 31.12.2020, 200 x 50% = 100
Opening CRE 75
Opening NCI 25
Stock 100
10% remains on 31.12.21 and 50% sold before start of period it means 40% sold this year.
200 x 40% = 80
COS 80
Stock 80
(NCI will be affected)

Other income (P) 90

Dividend (S) 90
(1500 x 8%) = 120 x 75%

Share of profit 3
Stock 3
(150 x 40% = 60/120 x 20 = 10 x 30% = 3)

Impairment loss 42
Goodwill 42
(280 x 15% = 42)
(No effect on NCI)

Finance cost 76.32

Payable 76.32
(No effect on NCI)
Unwinding of discount on deferred consideration
Last year: 843 x (1.12)-3 = 600 x 12% x 6/12 =36 (From July to Dec 2020)
Carrying amount at the end of last year = 600 + 36 = 636
636 x 12% = 76.32 (From Jan to Dec 2021)

W-3)
Profit of SL:
(2,250 – 1,125 – 550 + 216 - 50) = 741 (Investment measured at FVOCI)

----------( 416 )----------

Answer-9
(a)
Statement of financial position (extracts)
as at 31 December 2021
2021 2020
--- Rs. in million ---
Non-current assets
Right of use - Machinery 17.77 26.66
Current assets
Photocopy rent prepaid (2/6×4) 1.33 -
Non-current liabilities
Lease liability (W-2) 6.22 12.81
Current liabilities
lease liability 6.66 7.74
Interest payable 1.41 2.26

Statement of profit or loss (extracts)

for the year ended 31 December 2021
2021 2020
--- Rs. in million ---
Depreciation expense 8.89 8.89
Interest expense (W-2) 1.41 2.26
Photocopy rental 2×2/12×8 2.66 -
Notes to the financial statements (extracts)
for the year ended 31 December 2021
Schedule of property plant & equipement
2021 2020
--- Rs. in million ---
Right of use assets
Cost
Opening balance 35.55 -
Addition during the year (32.55 + 3) - 35.55
35.55 35.55
Accumulated depreciation
Opening balance (8.89) -
Depreciation for the year (35.55/4) (8.89) (8.89)
(17.78) (8.89)
Closing carrying amount 17.77 26.66
Maturity Analysis – Contractual
Undiscounted lease payment
2021 2020
less than one year 8 10
1 to 2 years 7 8
2 to 3 years - 7
15 25
W-1: Present value of lease payments
01-01-2020 12.00
01-01-2021 12-2=10 × (1.11)–1 9.01
01-01-2022 10-2=8 × (1.11)–2 6.49
01-01-2023 8-2=6 × (1.11)–3 4.39
31-12-2023 1 × (1.11)–4 0.66
32.55

----------( 417 )----------

 Journal Entries
For the year ended 31-12-2021

Date Description Debit Credit

01-01-2020 Right of use 32.55
Lease liability 32.55
01-01-2020 Right of use 3
Cash 3
(IDC of 3 million paid by lessee)
01-01-2020 Lease liability 12
Cash 12
31-12-2020 Depreciation 8.89
[Link] (32.55 + 3)/4 8.89
31-12-2020 Finance cost 2.26
Interest payable 2.26
01-01-2021 Interest payable 2.26
Lease liability 7.74
Cash 10
31-12-2021 Depreciation 8.89
[Link] - 8.89
31-12-2021 Finance cost 1.41
Interest payable 1.41

W-2: Lease schedule

Principal Interest Balance
Year Rental
repayment @11%
01-01-2020 - - - 32.55
01-01-2020 12 12 - 20.55
01-01-2021 10 7.74 2.26 12.81
01-01-2022 8 6.60 1.41 6.21
(ii)
As EL has Substantive Substitutive right to replace the machines therefore not a lease but a rent agreement,
So 2 million related to 1 May to 30 Oct 2021 should be expensed out while next 2 million related to [Link] to
30 April 2022 should be segregated as :
Expense = 2M/6 x 2 = 0.66
Advance = 2M/6 x 4 = 1.33

(b) Calculation of Un-Guaranteed residual Value

F.V + IDC = P.V of L.P + P.V of URV
Lets assume URV is x.
40 + 2 = 12 + 10 (1 + 0.11)-1 + 8(1 + 0.11)-2 + 6(1 + 0.11)-3 + 4(1 + 0.11)-4 + 2(1 + 0.11)-5 + X(1 + 0.11)-6
42 = 35.71 + X(1 + 0.11)-6
X = 42 – 35.71/0.53 = 11.87

----------( 418 )----------

 Autumn 2022
Q.1 On 1 July 2021, Nonagon Leasing (NL) leased a machine to Decagon Limited (DL). Details are as follows:
(i) The non-cancellable lease term is five years during which annual instalment of Rs. 6 million is
payable by DL in arrears.
(ii) DL has an option to extend the lease term by one year by paying Rs. 4 million at start of sixth year. It is
reasonably certain that DL will exercise this option.
(iii) NL estimates the residual value of the machine at the end of lease term to be Rs. 10 million
out of which DL has guaranteed Rs. 8 million. DL expects that the machine will have market value
of Rs. 5 million at the end of lease term.
(iv) NL incurred initial direct cost of Rs. 1 million.
(v) The rate of interest implicit in the lease is 11% per annum.
(vi) The useful life of the machine is eight years.

Required:
Prepare note(s) for inclusion in the financial statements of NL for the year ended
30 June 2022. (09)

Q.2 The following transactions pertain to Sphere Limited (SL) for the year ended 30 June 2022:
(i) On 1 July 2021, SL acquired a license against cash consideration of Rs. 50 million. SL incurred cost of
Rs. 3 million which includes refundable taxes of Rs. 1 million for transferring the title to its name.
The license is valid for five years but is renewable every five years at a significant cost of Rs. 40 million.
SL intends to renew the license only once and then sell the license at the end of ten years.

SL estimates that residual value of the license would be Rs. 12 million and Rs. 9 million at the end of
five years and ten years respectively.

(ii) On 1 July 2021, SL decided to develop a website for advertising and promotion of its products. SL
believes that website would enhance the brand value of the products and would also be used for
providing general information about SL to the public.
On 1 September 2021, SL internally initiated development of the website which was completed on
31 January 2022. Directly attributable costs incurred by SL for developing website were as follows:
▪ Rs. 2 million for planning the website in September 2021.
▪ Rs. 7 million for acquisition of the web servers in October 2021.
▪ Rs. 3 million for content development equally in November and December 2021.
▪ Rs. 1 million for annual website hosting fees (valid till 31 January 2023) paid inJanuary 2022.

Required:
Discuss how the above transactions should be dealt with in the SL’s books for the year ended
30 June 2022, in accordance with the IFRSs. (08)

Q.3 Arrow Limited (AL) was incorporated on 1 January 2018 with an authorised capital of 90 million
ordinary shares of Rs. 10 each. Details of ordinary shares issued on different dates are as follows:

Issued in Shares Issue price Consideration

(in million) (Rs. per share)
January 2018 20 10 Cash
April 2019 15 12 Plant & machinery
October 2019 7 - Bonus issue
March 2020 5 18 Cash
February 2021 10 - Bonus issue
June 2021 8 25 Plant & machinery
November 2021 6 27 Cash

Required:
Prepare note(s) on ‘Share capital’ for inclusion in the financial statements of AL for the year
ended 31 December 2021. (Show comparative figures) (07)

----------( 419 )----------

 Q.4 For the purpose of this question, assume that the date today is 31 August 2022.
Financial statements of Cone Motors Limited (CML) for the year ended 31 July 2022 areunder
preparation. Following matters are under consideration:

(i) CML is concerned with the impact of rupee devaluation as its significant cost of production is
incurred in USD. Between 15 June 2022 to 31 July 2022, rupee devalued from Rs. 200 to Rs.
240 per USD. At year-end, CML has following foreign currency balances appearing in its
books:
▪ Trade payables to foreign suppliers amounting to Rs. 638 million (representing USD 3.1
million) which would be settled within next two months.
▪ Advances to other foreign suppliers amounting to Rs. 654 million (representing USD 3
million) against which the raw materials would be delivered within nextthree months.
CML’s management is of the view that above balances do not need retranslation at year-end
as loss of one will net off with gain of other. Further, rupee has started appreciating since
15 August 2022 and is trading at Rs. 208 per USD on31 August 2022.

(ii) At year-end, certain orders against which the customers have paid full amount in advance
are still undelivered. These orders were booked at old prices but production cost of these
vehicles have increased enormously due to fluctuation in exchange rates and inflation in local
market.
CML can cancel these orders by refunding the full amount alongwith additional penalty of
Rs. 85 million but would result in loss of reputation and goodwill in the market. Therefore,
CML is considering to fulfil these orders on their delivery dates in October 2022 which would
result in loss of Rs. 150 million.
CML’s management is of the view that loss on these orders is a future loss and does not
need to be accounted for at year-end.

Required:
Comment on the CML’s management view about the impact of above matters in the financial
statements for the year ended 31 July 2022, in accordance with the IFRSs. (08)

Q.5 While reviewing the draft financial statements of Hexagon Industries (HI) for the year ended 30 June
2022, following mistakes were identified:
(i) Investment in bonds of Oval Limited (OL) was accounted for as a financial asset subsequently
measured at fair value through profit or loss instead of measuring the investment at amortised
cost.
On 1 July 2021, HI purchased 1 million bonds of OL of Rs. 100 each at a discount of Rs. 5
each with maturity in three years. Transaction cost of Rs. 2 million was also incurred on
purchase of these bonds. The coupon interest rate is 12% per annum payable annually on
30 June while the approximate effective interest rate was 13.28% per annum. The fair value of
each bond of OL was Rs. 99 on 30 June 2022.

(ii) HI has accounted for investment in shares of Kite Limited (KL) as a financial asset
subsequently measured at fair value through other comprehensive income instead of applying its
policy of equity method for investment in associates.
On 1 September 2021, HI purchased 500,000 shares (par value at Rs. 10 each) of KL
representing 20% shareholdings at Rs. 60 per share. On 30 April 2022, KL paid interim cash
dividend of Rs. 3 per share. KL reported net profit of Rs. 15 million for the year ended 30 June
2022. The fair value of each share of KL was Rs. 67 on 30 June 2022.

Required:
Prepare correcting entries in the books of HI for the year ended 30 June 2022. (08)
Q.6
Select the most appropriate answer(s) from the options available for each of the following Multiple
Choice Questions.
(i) Which of the following accounting framework and schedule of the
Companies Act, 2017 applies to a non-listed public sector company?
(a) IFRS and Fifth schedule
(b) IFRS and Fourth schedule
(c) Revised AFRS for SSEs and Fifth schedule
(d) Revised AFRS for SSEs and Fourth schedule (01)
----------( 420 )----------
(ii) Which TWO of the following situations might create a self-interest threat?
(a) Profit/incentive based compensation
(b) Reviewing self-prepared reports
(c) Fear of losing job
(d) Accepting gift of significant value (01)

(iii) Which of the following statements are correct?

(I) Self-interest threat arise if a chartered accountant promotes a client’s position to the point
that the accountant’s objectivity is compromised.
(II) Professional behaviour means members should not allow bias, conflicts of interest or
undue influence of others to override their professional or business judgements.
(a) Only (I) is correct (b) Only (II) is correct
(c) Both are correct (d) None is correct (01)

(iv) Nasir is working as a director of Rectangle Limited (RL). He is aware of the profit in RL’s draft
financial statements which would increase share price of RL upon public announcement. He
has suggested his friend to purchase shares of RL.
Which of the following fundamental principles of ICAP’s code of ethics has been breached by
Nasir?
(a) Integrity
(b) Confidentiality
(c) Objectivity
(d) Professional competence and due care (01)

(v) Which of the following statements are correct in the context of IFRS 8?
(I) Two or more operating segments may be aggregated into a single operating
segment.
(II) An operating segment not fulfilling 10% quantitative threshold may still be a
reportable segment.
(a) Only (I) is correct (b) Only (II) is correct
(c) Both are correct (d) None is correct (01)

(vi) As per IFRS 8, which TWO of the following disclosures apply to all entities including those
entities that have a single reportable segment?
(a) Extent of reliance on major customers
(b) Extent of reliance on major suppliers where quantitative threshold is met
(c) All liabilities payable in Pakistan and in all foreign countries
(d) Non-current assets located in Pakistan and in all foreign countries (01)

(vii) Which of the following is NOT required to be measured at fair value less costs to selleven if
fair value is measurable?
(a) Biological assets at initial recognition
(b) Biological assets at the end of each reporting period
(c) Agricultural produce at the point of harvest
(d) Agricultural produce at the end of each reporting period (01)

(viii) Which of the following statements are correct in the context of IFRS 16?
(I) When the supplier has a substantive right of substitution, then the contract does not
constitute a lease.
(II) When consideration for use of an asset is paid in terms of goods and services (other
than cash), then the contract does not constitute a lease.
(a) Only (I) is correct (b) Only (II) is correct
(c) Both are correct (d) None is correct (01)

(ix) On 1 January 2021, a herd of 20 animals of 1-year old was recorded at Rs. 800,000. On 1
July 2021, 10 animals of 1.5 years old were purchased for Rs. 50,000 each. On 31
December 2021, the fair value less costs to sell of 1-year and 2-year animals were Rs.
60,000 and Rs. 70,000 respectively. Calculate the amount that will be taken to profit or loss for
the year ended 31 December 2021.
(a) Rs. 500,000 (b) Rs. 1,000,000 (c) Rs. 1,300,000 (d) Rs. 800,000 (02)

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Q.8 Rhombus Limited (RL), a supplier of high quality office equipment, has entered into
following two contracts during the year ended 31 August 2022:
(i) On 1 July 2022, RL entered into a contract with Trapezoid Limited (TL) to sell 50
laptops at a total consideration of Rs. 10 million. 50% laptops would be delivered on 20
July 2022 and balance on 15 August 2022. RL was unconditionally entitled toreceive full
payment upon delivery of first lot of 25 laptops, however, TL paid full amount on 31
July 2022.

On 7 August 2022, the contract was modified as TL ordered additional 30 laptops of Rs.
190,000 each for delivery on 25 August 2022. These 30 laptops are distinct but do not
reflect the stand-alone selling price. It was agreed that TL would pay for 29 laptops only
instead of 30 laptops. This discount has been given in compensation of minor defects
identified in 25 laptops, delivered on 20 July 2022. TL settled the balance in September
2022 as per the terms of the contract.
All laptops were delivered as agreed. (07)

(ii) On 1 January 2022, RL entered into a contract with Crescent Limited (CL) for sale of
10 units of its state of the art 3D printers. The cost and stand-alone price of
goods/services included in each unit of printer are as follows:

Unit cost Unit price

Rs. In 000
Hardware 1,800
Printing software 720 3,600
Software upgrade to next version 350 500
Maintenance support for 1 year 210 N/A

RL sells 3D printer hardware along with the software as hardware cannot be used
without the printing software. The 3D printer remains functional without the software
upgrade and the maintenance support. RL sells software upgrade upon release to all of its
customers. However, RL does not provide maintenance support but went against its
policy to provide it to CL.

Each unit of printer was sold to CL at an overall discounted price of Rs. 4 million. As per
payment terms, CL paid 30% on 1 January 2022 while 50% was paid at the time of
delivery of printers (hardware plus printing software) on 1 March 2022 and remaining
20% will be paid in February 2023.

At year-end, 80% work has been completed on the new version of the printing software
which is expected to be released in October 2022. (09)

Required:
Prepare necessary accounting entries for the year ended 31 August 2022 in accordance with
the IFRSs. (No marks will be awarded on entries without dates)

Q.9 Following information has been gathered for preparing the disclosures related to taxation of
Prism Limited (PL) for the year ended 31 December 2021:
(i) Accounting profit before tax for the year after making all necessary adjustments was Rs.
105 million.

(ii) On 1 July 2020, PL acquired an investment property for Rs. 50 million. The fair values of
property as on 31 December 2020 and 2021 were Rs. 55 million and Rs. 65 million
respectively. PL follows fair value model for accounting purposes.

Under tax laws, depreciation is allowed at 10% per annum on cost. Further, full year’s tax
depreciation is allowed in the year of purchase.

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(iii) On 1 January 2021, PL purchased a license having indefinite life from a foreign
company at a cost of Rs. 116 million. Upon payment, PL recorded foreign exchange
gain of Rs. 16 million.

Under tax laws, foreign exchange differences arising on payment are added
to/deducted from the cost of asset while amortisation is allowed at 10% per annum.

(iv) PL commissioned a new plant at a cost of Rs. 210 million which became operationalon 1
January 2021. PL is also obliged to incur decommissioning cost of Rs. 40 million at the
end of useful life of eight years. Applicable discount rate is 12% per annum.
Under tax laws, decommissioning cost is allowable deduction at the time of payment
while depreciation on plant is allowed at 10% per annum.

(v) On 1 May 2021, PL acquired 5% equity investment for Rs. 75 million. In October
2021, dividend of Rs. 8 million was received on this investment. As at 31
December 2021, PL recorded Rs. 15 million as gain for change in fair value which was
taken to other comprehensive income.

Under tax laws, gain on investment is taxable at the time of sale while dividend income is
exempt from tax.

(vi) As on 31 December 2021, taxable temporary differences on other items amounted to Rs.
30 million (2020: Rs. 39 million). These differences have arisen due to items taken to profit
or loss.

(vii) The tax rate for the year is 35% (2020: 32%).

Required:
(a) Prepare a note on taxation for inclusion in PL’s financial statements for the year ended 31
December 2021 and a reconciliation to explain the relationship between the tax (08)
expense and accounting profit.

(b) Compute deferred tax liability/asset in respect of each temporary difference as at

31 December 2021 and 2020. (08)

(THE END)

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 Suggested Answers
Answer # 1:

Nonagon Limited
Notes to Financial Statements
For the year ended 30-06-2022
It is a finance lease as lease term (5 + 1) = 6 covers major part of economic life; i.e., 8 years.

Maturity analysis - contractual undiscounted lease payment:

Less than one year 6.00
One to two years 6.00
Two to three years 6.00
Three to four years 6.00
Four to five years (4 + 8) 12.00
Total undiscounted cash flows 36.00
Reconciliation:
Undiscounted lease payments 36.00
Add: Un-guaranteed residual value (10 – 8) 2.00
Gross investment in lease 38.00

Unearned finance income (1 4 .1 – 3 . 2 8 ) (10.82)

Net investment (W-1) 27.18
Current portion of Net Investment (W-1) (3.01)
Non-current portion of Net Investment (W-1) 24.17

Nonagon Limited (NL) leased a machine to Decagon Limited (DL). Lease term consists of non-cancellable
periodof 5 years with an option to extend for one year. Implicit rate is 11% per annum and initial direct cost is
1 million with an annual installment of 6 million per annum in arrears.

(W-1) Finance Charge Allocation Table:

Date Rental Principal Interest Balance

01-07-2021 - - - 29.90(W-2)
30-06-2022 6 2.72 3.28 27.18
30-06-2023 6 3.01 2.99 24.17
30-06-2024 6
30-06-2025 6
30-06-2026 6
01-07-2026 4
30-06-2027 10
[8(GRV) + 2(URV)]
Gross Investment 44 29.90 14.1 (44-29.90)

(W-2) Net Investment: (PV of Lease Payments + PV of URV) = 28.83 + 1.07 =

29.90PV of LP: 6[1 - (1.11)-5/0.11] + 4(1.11)-5 + 8(1.11)-6 = 28.83
PV of URV: 2(1.11)-6 = 1.07

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Answer #2:

Ans: (i).
Sphere Limited
The license should be recognized as an intangible asset at an initial cost of Rs. 52 million (50+2). The
transfer fee being directly attributable cost should be included while a refundable tax of Rs. 1 million should
not be included inthe cost.

The useful life of the license will be restricted to the original five years as the renewal cost of Rs. 40 million is
significant and should be considered a separate intangible at the time of renewal. The residual value of the
licenseat the end of five years is zero because there is no commitment by 3rd party to purchase the license
and there is no active market for the license. The amortization for the year should be Rs. 10.4 million (52/5).
(4Marks)

(ii).
As per IAS 38, Rs. 5 million (2+3) for planning and content development should be expensed out.

The website is developed primarily for promoting and advertising SL’s products and services. So, SL will not
be able to demonstrate how it will generate probable future economic benefits. Rs. 7 million incurred for the
acquisition of the web servers should be capitalized under property, plant and equipment and depreciated
overthe useful life.

Since Webhosting fees are paid for one year, Rs. 0.42 (1/12×5) million will be expensed out while Rs. 0.58
million will be recorded as prepayment. (4 Marks)

Answer # 3:

Arrow Limited
Notes to the financial statements
For the year ended 31 December 2021

Share Capital:

Authorized share capital

2021 2020 2021 2020

Shares in million Rs. in million
90 90 Ordinary shares of Rs. 10 each 900 900

Issued, subscribed and paid-up capital:

2021 2020 2021 2020
Shares in million Rs. in million
31 25 Ordinary shares of Rs. 10 each Fully paid in 310 250
cash.
(25 + 6) (20 + 5)
Ordinary shares of Rs. 10 each Issued for
23 15 consideration other than cash. 230 150
(15 + 8)
17 7 Ordinary shares of Rs. 10 each Issued as fully 170 70
paid bonus shares.
(7 + 10)
71 47 710 470

Shares issued for consideration other than cash were issued against plant and machinery.
All ordinary shares rank equally with regard to the AL’s residual assets. Holders of theshares are entitled to
dividends from time to time and are entitled to one vote per share at the general meetings of the AL.

----------( 425 )----------

Answer # 4:

Cone Motors Limited

(i) CML’s management view is incorrect as per IAS 21. Foreign currency trade payables are a monetary item, which
needs to be retranslated at a closing rate of Rs. 240 per USD i.e., Rs. 744 million which should result in an
exchange loss of Rs. 106 million to be taken to profit or loss. However, advance to other foreign suppliers being
a non-monetary item should not be retranslated at the closing rate. The appreciation in exchange rate
on 31 August 2022 shouldbe a non-adjusting event as no condition existed on 31 July 2022.

(ii) CML’s management view is incorrect as per IAS 37. This is an onerous contract because the unavoidable costs of
meeting the obligations under the contract exceed the economic benefits expected to be received under it.
The unavoidable costs under the contract reflect the least net cost of exiting from the contract which is the
lower of the cost of fulfilling it. i.e., Rs. 150 million and any penalties arising from failure to fulfill it i.e., Rs. 85
million. So, CL should recognize a provision of Rs. 85 million irrespective of the management’s decision
of fulfilling the contract.

Answer # 5:
Hexagon Industries
Correcting entries

I. FVTPL to Amortized Cost:

Dr. Cr.
Sr No. Description Rs in '000'
1 Financial Asset 2,000
Transaction Cost Expense (P/L) 2,000
(Transaction Cost to be reversed)
2 Financial Asset 882
Interest Income (W-1) 882
3 FV Gain (P/L) (W-2) 4,000
Financial Asset 4,000

W-1: Adjustment of Interest Income:

Interest Income would be recorded (100,000 x 12%) = 12,000
Interest Income should be recorded (97,000* x 13.28%) = 12,882
Increase in Interest Income = 882
*[95 x 1,000 = 95,000 + 2,000(transaction cost) = 97,000]

W-2: Gain to be reversed:

Carrying Amount (1,000 x 95) = 95,000
FV at 30-6-2022 (1,000 x 99) = 99,000

FV Gain to be reversed = 4,000

[Note: The entry of cash received would have been recorded correctly which is same in both methods)

II. FV through OCI to Equity Method:

Sr No. Description Dr. Cr.

Rs in '000'
1 Dividend Income (P/L) (500 x 3) 1,500
Investment in A 1,500
2 Investment in A (15,000 x 20% x 10/12) 2,500
Share of Profit (P/L) 2,500
3 FV Gain (OCI) (W-1) 3,500
Investment in A 3,500

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 W-1: FV Gain to be reversed:

Carrying Amount (500,000 shares x 60/share) = 30,000

Fair Value (500,000 shares x 67/share) = 33,500

FV Gain in OCI to be reversed = 3,500

Answer # 6:

(i) (a) IFRS and Fifth schedule

(ii) (a) Profit/incentive- based compensation
(d) Accepting gift of significant value
(iii) (d) None is correct
(iv) (b) Confidentiality
(v) (c) Both are correct
(vi) (a) Extent of reliance on major customers
(d) Non-current assets located in Pakistan and in all foreign countries
(vii) (d) Agricultural produce at the end of each reporting period
(viii) (a) Only (I) is correct
(ix) (d) Rs. 800,000

Answer # 8:

Rhombus Limited

I. Contract with Trapezoid Limited (TL):

Date Description Dr. Cr.

20-7-2022 Receivable 10,000

Revenue (10,000 x 50%) 5,000
Contract Liability(bal.) 5,000
31-7-2022 Cash 10,000
Receivable 10,000
7-8-2022 Revenue 190
Payable to TL/Contract Liability 190
(Revenue reversed due to minor defects in 25 items
delivered on 20-7-2022)
15-8-2022 Contract Liability 4,864
Revenue(W-1) 4,864
25-8-2022 Receivable (190 x 29) 5,510
Contract Liability (5,000 + 190 – 4,864) 326
Revenue (194.55(W-1) x 30) 5,836

W-1) Modification of Contract:

30 x 190 = 5,700.
(5,000 + 5,700)/55 = 194.55/unit.
194.55 x 25 = 4,864 (Revenue to be recorded on 15-8-2022)

(Laptops are considered distinct but price does not reflects standard alone price, therefore termination of
contract and creation of new contract using average price)

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 II. Contract with Crescent Limited (CL):

Date Description Dr. Cr.

1-1-2022 Cash (40,000 x 30%) 12,000

Contract Liability 12,000
1-3-2022 Cash (40,000 x 50%) 10,000
Contract Liability 12,000
Receivable (bal.) 730
Revenue (3,273(W-1) x 10) 32,730
31-8-2022 Receivable (273 x 10 x 6/12)[March to August] 1,365
Revenue (Maintenance) 1,365

No revenue will be recorded for software upgrade, as RL sell software upgrade upon release to
customer.

W-1) Allocation of transaction price:

Description Stand-alone price Transaction price allocation

3D Printer and Software 3,600 3,273*
Software upgrade 500 454
Maintenance 300(W-1) 273
4,400 4,000
*3,600/4,400 x 4,000 = 3,273

W-1) Standalone sale price of maintenance service is estimated by using cost plus approach.

Margin: [ 3,600 – 1,800 – 720]/ 3,600 x 100 = 30% or by using figures of software upgrade.

Answer # 9:
Prism Limited
(a)
Tax expense Rs. in million
Current tax (W-1) (25.97)
Deferred tax (7.98 + 1.47) (b) (9.45)
(35.42)

Reconciliation between tax expense and accounting profit

Profit before tax 105.0
Tax @ 35% 36.75
Effect of change in tax rate 15.68 ÷ 32 × 3 1.47
Decrease in tax due to exempt dividend income 8 × 35% (2.80)
35.42

W-1: Current tax Rs. in million

Profit before tax 105.00
Fair value gain on investment property 65 - 55 (10.00)
Tax depreciation on investment property 50 × 10% (5.00)
Exchange gain deducted from cost in tax (16.00)
Tax depreciation on license 100(116 – 16) × 10% (10.00)
Interest on decommissioning cost 16.16[40 × (1.12)–8] × 12% 1.94
Accounting depreciation 226.16(210 + 16.16) /8 28.27
Tax depreciation on plant 210 × 10% (21.00)
Exempt dividend income (8.00)
Other taxable items 39 – 30 9.00
(Add because taxable temporary differences decreased in 2021 means taxable profit will
increase in the current year)
Taxable profit 74.21
Tax @ 35% 25.97
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(b) Deferred tax liability / (assets) as at 31 December 2021:

Carrying value Tax base Difference

-----------------------------Rs. In millions----------------------------
Investment property 65.00 40.00 25.00 TTD
(45 – 5)
License 116.00 90.00 26.00 TTD
(116 - 16 -10)
Plant 197.89 189 8.89 TTD
(226.16*–28.27) (210–21)
(*210+16.16)
Provision for decommissioning 18.1 - 18.1 DTD
(16.16+1.94)
Investment in shares (Gain in OCI) 90 75 15 TTD
(75+15)
Other taxable items 30 TTD
86.79 TTD
Tax rate 35%
Deferred Tax Liability 30.38 DTL

Deferred tax liability / (assets) as at 31 December 2020:

Carrying value Tax base Difference

---------------- Rs. in million ----------------
Investment property 55 45 10 TTD
(50–5)
Other taxable items 39 TTD
49 TTD
Tax Rate 32%
Deferred Tax Liability 15.68 DTL

D.T.L
b/d 15.68
D.T. E 1.47*
FV Gain OCI 5.25**
D.T.E (bal.) 7.98

c/d 30.38

15.68
∗______ 𝑋 3 = 1.47
32

**Note:

Sr no. Description Dr. Cr.

1 Investment 15
FV Gain (OCI) 15
2 FV Gain (OCI) 5.25
Deferred Tax Liability (15 x 35%) 5.25

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 Certificate in Accounting and Finance Stage Examination
The Institute of 6 March 2023
Chartered Accountants 3 hours – 100 marks
of Pakistan Additional reading time – 15 minutes

Financial Accounting and Reporting-II

Instructions to examinees:
(i) Answer all NINE questions.
(ii) Answer in black pen only.
(iii) Multiple Choice Questions must be answered in answer script only.

Section A

Q.1 Zinc Limited (ZL) has entered into the following transactions:

(i) On 1 January 2022, ZL purchased 1.5 million bonds of Copper Limited having face
value of Rs. 100 each at a premium of Rs. 5 each with maturity of five years. The
transaction cost associated with the purchase of these bonds was Rs. 2 each. The
coupon interest rate is 13% per annum payable annually on 31 December while the
effective interest rate was approximately 11.1% per annum. The investment was
classified at fair value through other comprehensive income. At 31 December 2022,
the bonds were quoted at Rs. 103 each on stock exchange.

(ii) On 1 July 2022, ZL issued 2 million 10% redeemable preference shares having face
value of Rs. 100 each at a discount of Rs. 10 each. The transaction cost associated
with the issuance of these shares was Rs. 3 million. ZL measured preference shares
at fair value through profit or loss. At 31 December 2022, the shares were quoted at
Rs. 80 each on stock exchange and ZL has estimated that 70% reduction in the fair
value is due to drop in ZL’s credit rating. No dividend was declared during 2022 in
respect of these shares.

Required:
Prepare journal entries in the books of ZL for the year ended 31 December 2022 in
accordance with IFRSs. (08)

Q.2 You have recently joined as Finance Manager of Mercury Limited (ML) and have been
asked by the CFO to prepare a power point presentation on ML’s financial statements for
the half-year ended 31 December 2022 for the board of directors’ meeting. These financial
statements were finalised by the CFO who is a chartered accountant.

While preparing the presentation, you have noted that a five storey building purchased in
July 2022 by ML was entirely classified as an investment property. ML uses the ground and
first floors for its administrative purposes while remaining three floors were rented out to
different tenants and will be sold in future. Further, on 31 December 2022, the fair value
increase of Rs. 150 million for the entire building has been taken to the statement of profit or
loss which has ensured that the required interest cover as per bank loan covenants has
been met.

The CFO is of the view that IFRSs allow such application as ML only uses less than 50% of
the building for its own use. He further explained that non-compliance of loan covenants
should be avoided at any cost as the bank loan would become immediately payable upon
non-compliance. This would create significant financial difficulties for ML which may even
result in closure of business.

Required:
Briefly explain how CFO may be in breach of the fundamental principles of ICAP’s Code of
Ethics for Chartered Accountants. Also state the potential threats that you may face in the
above circumstances and how you should respond. (08)

----------( 430 )----------

Q.3 Fluorine Limited (FL), a manufacturer of ships, has entered into the following contracts during
the year ended 31 December 2022:
(i) On 1 January 2022, FL entered into a contract with Alpha Limited (AL) to construct a
cruise ship for Rs. 400 million to be delivered on 31 December 2023 i.e. the date on
which control of the ship would be transferred to AL. As per the contract, 90% of agreed
amount was paid immediately by AL and the balance will be paid on delivery.
Till 31 December 2022, only 40% of the construction of the ship was completed at a cost of
Rs. 150 million.
(ii) On 1 April 2022, FL entered into a contract with Beta Limited (BL) to sell three fishing boats
for Rs. 50 million per boat. The amount was received on 1 April 2022 but the boats were
delivered on 1 May 2022. As per the contract, if BL purchases more than six boats
before 31 December 2022, FL will retrospectively reduce the price to Rs. 48 million
per boat. At the inception of the contract, FL expected that BL would meet the threshold
for the discount.
On 1 November 2022, BL purchased two additional boats on the same price of Rs.
50 million per boat for which the payment was made in January 2023.
Despite FL’s expectation, no further order was placed by BL till 31 December 2022.
(iii) On 1 November 2022, FL sold a luxury yacht to Gamma Limited (GL) for Rs.
100 million on cash. FL also provided GL with a Rs. 5 million discount voucher for any
interior design work on yacht within six months. There is 80% likelihood that GL will award
the work of interior design within six months and will avail the discount. However, no
interior design work was awarded till 31 December 2022. FL normally sells such luxury
yachts for Rs. 100 million without any discount voucher for interior design work.
Discount rate of 15% per annum may be used wherever required.
Required:
Prepare journal entries in FL’s books to record the above information for the year ended 31
December 2022 in accordance with IFRSs. (No marks will be awarded on entries without (09)
dates)
Q.4 On 1 January 2020, Uranium Limited (UL) completed installation of a manufacturing plant which
will be required to be dismantled at the end of its eight years’ useful life. UL paid Rs. 3,000
million for the plant. On 1 January 2020, it was estimated that the cost of dismantling would
amount to Rs. 500 million. Applicable discount rate at the time of initial estimate of dismantling
cost was 10% per annum.
Estimates of dismantling cost and applicable discount rate were reviewed as at 31
December 2021 and were revised to Rs. 475 million and 15% per annum respectively.
The fair value of the plant including dismantling cost as at 31 December 2022 was assessed at
Rs. 1,900 million.
UL has a policy to subsequently measure plant using the revaluation model and provide depreciation
on straight line basis.
Required:
Prepare relevant extracts from UL’s statement of profit or loss and other comprehensive income
for the year ended 31 December 2022 and statement of financial position on that date. (Show
comparative figures) (09)
Q.5 Ahmed, a foreign qualified accountant, has recently returned to Pakistan and has joined a newly
incorporated company Radium Limited (RL), a subsidiary of a listed company. Ahmed has been
entrusted with preparing the notes on ‘Property, plant and equipment’ in the financial statements
of RL for the year ended 28 February 2023. While preparing the notes, Ahmed has complied
with all the disclosure requirements of IAS 16, however, he is unaware of additional disclosures
required by the Companies Act, 2017.
Required:
List down the disclosure requirements related to ‘Fixed Assets’ as provided in the fourth
schedule of the Companies Act, 2017. (06)

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Q.6 Select the most appropriate answer(s) from the options available for each of the following
Multiple Choice Questions.
(i) As per IFRS 8, an operating segment is identified as newly reportable segment in the
current year that was not required to be reported separately in prior years. Which of
the following is the correct way of reporting this newly reportable segment?
(a) It shall be reported separately in current year and comparative information shall be
restated
(b) It shall be reported separately in current year and comparative information shall not
be restated
(c) It shall not be reported separately in current year to ensure consistency with
comparative information
(d) It shall be reported only when the criteria is met for two consecutive years (01)
(ii) According to Companies Act, 2017, analysis of expenses in the statement of profit or
loss require to be presented using:
(a) nature of expenses only
(b) function of expenses only
(c) function of expenses with additional information on nature
(d) nature of expenses with additional information on function (01)
(iii) Which of the following statements under the Companies Act, 2017 is/are correct?
(I) The classification of a company shall be based on the current year’s audited
financial statements.
(II) The classification of a company can be changed where it does not fall under the
previous criteria for two consecutive years.
(a) Only (I) is correct (b) Only (II) is correct
(c) Both are correct (d) None is correct (01)
(iv) Two or more contracts with the same customer can be combined as a single contract if
it meets certain criteria. Which of the following is NOT the criteria as specified in IFRS
15?
(a) The contracts are negotiated as a package with a single commercial objective
(b) The amount of consideration to be paid in one contract depends on the price of the
other contract
(c) The goods are regularly sold separately and the customers generally can benefit
from the goods on its own
(d) The goods promised in the contracts are a single performance obligation (01)
(v) A company exchanged an intangible asset having fair value and carrying value of Rs.
15 million and Rs. 13.6 million respectively with a new intangible asset having a fair
value of Rs. 18 million. An amount of Rs. 3.2 million was also paid in cash. If this
transaction lacks commercial substance, the cost of intangible asset acquired would
be measured at:
(a) Rs. 15.0 million (b) Rs. 16.8 million
(c) Rs. 18.0 million (d) Rs. 18.2 million (01)
(vi) Which of the following statements is/are correct under IAS 21?
(I) An entity can have only one presentation currency.
(II) Any currency other than functional currency of the entity is foreign currency.
(a) Only (I) is correct (b) Only (II) is correct (01)
(c) Both are correct (d) None is correct

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 (vii) Government grant related to a biological asset measured at its cost less
any accumulated depreciation is accounted for under:

(a) IAS 20 (b) IAS 16

(c) IAS 41 (d) IAS 41 and IAS 20 (01)

(viii) Which TWO of the following elements are NOT included within the definition of
control?

(a) Power to participate in the financial and operating policies of the investee
(b) Power over the investee to affect the amount of the investor’s returns
(c) Exposure or rights to variable returns from its involvement with the investee
(d) Holding the majority of shares in investee’s share capital (01)

(ix) Which TWO of the following costs related to development of a website may be
capitalized?

(a) Defining hardware and software specifications

(b) Stress testing
(c) Evaluating alternative products and suppliers
(d) Graphical design development (01)

(x) Which TWO of the following are the adjusting events?

(a) A company made an out of court settlement with a customer after reporting
date, for a case that was lodged before the reporting date
(b) A decline in the fair value of investments between the end of the reporting
period and the date when the financial statements are authorized for issue
(c) A company made a provision for damages in respect of a pending suit, which
was decided by the court after the reporting date with the same amount of
damages
(d) Directors approved the plan to close down the major segment before the
reporting date but the announcement to public was made after the reporting date (01)

Section B

Q.7 Gold Limited (GL) is a dealer of specialized engines. GL acquires each engine from a
manufacturer at a cost of Rs. 58 million and sells it for Rs. 71 million on cash. The estimated
economic life of an engine is five years.

On 1 January 2022, Lead Limited (LL) leased an engine from GL on four years lease term.
The first annual instalment of Rs. 16 million was paid on 1 January 2022 and all subsequent
annual instalments are payable on 1 January subject to increase of Rs. 2 million in each
year. LL incurred initial direct cost of Rs. 4 million, out of which GL reimbursed Rs. 1.5
million. GL estimates the residual value of the engine at the end of lease term to be Rs. 5
million. However, LL has guaranteed an additional amount of Rs. 3 million at the end of
lease term.

Market rate for similar transaction is 15% per annum. As an incentive to LL for entering into the
lease, GL has incorporated an implicit rate of 10% per annum which is known to LL.

LL is also obliged to incur decommissioning cost of Rs. 9 million at the end of the lease term.

Discount rate of 12% per annum may be assumed wherever required but not given.

Required:
In accordance with IFRSs:
(a) prepare journal entries in the books of GL for the year ended 31 December 2022. (07)
(b) prepare relevant extracts from LL’s statement of profit or loss for the year ended
30 September 2022 and statement of financial position on that date. (10)
----------( 433 )----------
Q.8 Following are the summarized statements of financial position of Aluminium Limited (AL)
and Silver Limited (SL) as at 31 December 2022:

AL SL
----- Rs. in million -----
Property, plant and equipment 1,160 960
Investment property 440 290
Investments - at cost 1,000 -
Inventories 365 190
Other current assets 295 270
3,260 1,710

Share capital (Rs. 10 per share) 1,400 800

Share premium 550 -
Revaluation surplus - 150
Retained earnings 618 445
Liabilities 692 315
3,260 1,710
Additional information:
(i) On 1 January 2022, AL acquired a 70% shareholding in SL for the following
consideration:
▪ Issuance of 20 million shares of AL after one month of acquisition. The market
price of AL’s shares at the date of acquisition was Rs. 25 each. However,
market price increased to Rs. 27 each when shares were issued. The
issuance of shares has been recorded in AL’s books at Rs. 27 per share.
▪ Cash payment of Rs. 304 million after three years. The amount payable has
been recorded in full i.e. at Rs. 304 million in AL’s books.
(ii) At acquisition date, SL’s retained earnings and revaluation surplus were
Rs. 515 million and Rs. 105 million respectively. Further, carrying values of SL’s net
assets were equal to their fair values except an investment property whose fair
value exceeded the carrying value by Rs. 160 million. The property had a remaining
useful life of eight years. Both AL and SL subsequently measure investment
properties using the cost model.
(iii) AL follows the cost model whereas SL follows the revaluation model for subsequent
measurement of property, plant and equipment. If SL had adopted the cost model,
SL would not have recorded revaluation surplus of Rs. 45 million on 31 December
2022.
(iv) During the year, SL made sales of Rs. 150 million to AL at 20% mark-up. 40% of these
goods are included in AL’s closing inventories.
(v) On 1 July 2022, AL acquired 5 million shares representing 25% shareholdings in
Platinum Limited (PL) for Rs. 91 million. On acquisition date, the fair value of PL’s
share was Rs. 17 each. AL has nominated 1 director out of 5 directors on the board
of PL.
(vi) During the six months ended 31 December 2022, PL reported net profit of
Rs. 52 million. AL has recorded its share of dividend from PL amounting to
Rs. 5 million as other income.
(vii) On 1 September 2022, AL sold a machine having carrying value of Rs. 60 million to
PL for Rs. 108 million. The remaining useful life of the machine at the time of disposal
was four years.
(viii) A fair value loss of Rs. 22 million needs to be recorded in respect of AL’s remaining
investments.
(ix) Discount rate of 15% per annum may be used wherever required.
(x) AL measures non-controlling interest at the proportionate share of SL’s identifiable
net assets.

Required:
In accordance with IFRSs, prepare AL’s consolidated statement of financial position as at
31 December 2022. (18)

----------( 434 )----------

Q.9 The first year’s financial statements of Titanium Limited (TL) for the year ended 31
December 2022 are under preparation. The following matters have been identified which may
have implications of deferred tax:
(i) TL acquired an equity investment for Rs. 85 million which was subsequently measured at
fair value through profit or loss. On 31 December 2022, TL recorded Rs. 20 million as
gain for change in the fair value. Under the tax laws, gain on investment is taxable at the
time of sale.
(ii) TL purchased factory building for Rs. 1,200 million in 2022 which was depreciated by
Rs. 80 million. On 31 December 2022, the factory building was revalued at Rs.
1,260 million. Under the tax laws, depreciation at the rate of 10% per annum is allowed
as a tax expense while revaluation does not affect taxable profit.
(iii) Development cost of Rs. 20 million incurred in 2022 has been expensed out. Under the
tax laws, development cost is amortized over ten years.
(iv) TL received government grant of Rs 12 million related to an equipment. The grant is
recognised as income over three years. Under the tax laws, the government grant is
exempt from tax.
(v) TL incurred a tax loss of Rs. 260 million for the year ended 31 December 2022. Under the
tax laws, all unused tax losses are adjustable from future profits within next six
years.
Applicable tax rate is 35%.
Required:
Discuss how the deferred tax related to each of the above matters should be dealt with in TL’s
financial statements for the year ended 31 December 2022. (15)

(THE END)

----------( 435 )----------

 A.1 Zinc Limited
General Journal
i.

Date Description Debit Credit

----- Rs. in million ----
1-Jan-22 Investment / Financial asset 157.50
Bank 157.50
[1.5 × (100 + 5)]
1-Jan-22 Investment / Financial asset 3.00
Bank 3.00
[1.5 X 2]
31-Dec-22 Investment / Financial asset 17.82
Interest income (P&L) 17.82
[160.5(157.5 + 3) × 11.1%]
31-Dec-22 Bank 19.50
Investment / Financial asset 19.50
[150 × 13%]
31-Dec-22 Fair Value loss (OCI) 4.32
Investment/Financial Asset 4.32
[154.5(1.5 x 103) – 158.82]
Workings:
Effective [email protected]% Coupon rate Balance
@13%
1-Jan-22 160.5
(157.5+3)
31-Dec-22 17.82 19.5 158.82
(1.5 x 100 x13%)
ii.

S. No. Description Debit Credit

---- Rs. in million ----
1-Jul-22 Bank 180.00
Financial liability / Redeemable pref. Shares 180.00
[2× (100–10)]
1-Jul-22 Transaction cost Expense (P&L) 3.00
Bank 3.00
31-Dec-22 Interest expense (P&L) 10.00
Financial liability 10.00
[200×10%×6/12]
31-Dec-22 Financial liability 30.00
[190(180+10)– 160(80×2)]
Fair value gain (OCI) 21.00
[30×70%]
Fair value gain (P&L) bal. 9.00

A.2 In the given situation, CFO might be in breach of the following fundamental principles of theCode of
Ethics for Chartered Accountants:
(i) Professional competence and due care:
A chartered accountant (CA) should act diligently and in accordance with the applicable
technical and professional standards. Applying incorrect application of standard raises
questions on his professional competence and due care. Under IAS 40, each portion that can be
sold separately should be accounted for separately. Therefore, ground and first floors should be
recorded as ‘Property, plant and equipment’ and remaining floors should be recorded as
‘Investment property’.
(ii) Objectivity:
CA should not compromise professional or business judgements because of bias, conflict of
interest or undue influence of others. Incorrect application of IFRSs by CFO to avoid the non-
compliance of loan covenant is affecting the objectivity of CFO.
----------( 436 )----------
 (iii) Professional behavior:
CA should comply with the relevant laws and regulations and avoid any conduct that might
discredit the profession. Pressurizing or threatening subordinates with an intention to
influence them is the non-compliance of ICAP’s code of ethics and is reflective of non-
professional behavior of CFO.

In the given situation, following threats to compliance with the fundamental principles arises for me:
(i) Intimidation threat:
CA will be deterred from acting objectively because of pressures or exercise of undueinfluence
over him. I may feel intimidation threat due to perceived pressure exerted by the CFO on raising
objection over his finalized financial statements.
(ii) Self-interest threat:
CA’s judgement or behavior may be inappropriately influenced by financial or other interest. I
may feel self-interest threat due to fear of losing job in case of financial difficulties of ML.

In order to reduce the threat to an acceptable level, one or more of the following safeguards should be
applied:
(i) Discuss and persuade CFO to follow the correct application of standard and adjust thefinancial
statements.
(ii) If CFO refuses to adjust the financial statements, consider informing appropriate authorities
such as CEO or the audit committee.
(iii) Consult the policies or procedures (i.e. ethics or whistleblowing policies) of ML.
(iv) Refuse to present or disassociate with the presentation of misleading financial
statements.
(v) Resign from the job.

Answer- 3: Fluorine Limited

General Journal:
[Link]. Date Description Debit Credit
----- Rs. in million -----
1- 1 Jan 22 Cash 360
(400×90%)
Contract liability - AL 360

31 Dec 22 Interest expense 54

(360×15%)
Contract liability - AL 54

Inventory 150
Cash 150

2- 1 Apr 22 Cash (50 x 3) 150

Contract Liability (48 x 3) 144
Refund Liability 6
[At the Inception, it is expected that the threshold will be met]

1-May-22 Contract Liability 144

Revenue 144

1-Nov-22 Receivable - BL (50×2) 100

Revenue (48×2) 96
Refund liability - BL 4

31-Dec-22 Refund liability - BL [6(150–144)+4] 10

Revenue 10
(As the threshold is not met)

3- 1-Nov-22 Cash 100

Contract Liability-GL (W-1) 3.8
Revenue (W-1) 96.2
----------( 437 )----------
W-1: Price Allocation
Standalone Price Price
----- Rs. in million -----
Luxury Yacht 100 96.2
(100 x 100)/104)
Discount 4.0 3.8
(5 x 80%) (4 x 100/104)
104.0 100

A.4 Uranium Limited

Statement of financial position as at 31 December 2022
2022 2021
--- Rs. in million ---
Non-current assets
Property, plant and equipment 1,900.0 2424.93
[3000+233.25-
(404.16x2)]
Non-current liabilities
Provision for dismantling (205.36+30.8) ; 236.16 205.36
(475×1.15–6)

Equity
Revaluation surplus - 76.9

Statement of profit or loss and other comprehensive income for the year
ended 31 December 2022

2022 2021
Profit or loss: --- Rs. in million ---
Depreciation expense (3,000+233.25)/8 (404.16) (404.16)
Unwinding of interest on dismantling (205.36×15%) ; (W-1) (30.8) (25.66)
Revaluation loss (56.7) -

Other comprehensive income:

Revaluation surplus / (loss) (64.07) 76.88

W-1: Dismantling cost before revision Rs. in

million
01/01/20 PV of dismantling cost 500×1.10–8 233.25
31/12/20 Unwinding of interest @10% 233.25×10% 23.33
256.58
31/12/21 Unwinding of interest @10% 256.58×10% 25.66

31/12/21 OR 500×1.10–6 282.24

W-2: Revaluation loss on 31 December 2022

Carrying value of plant (3,000+233.25)- 2,020.77
(404.16x3)
Revalued amount (1,900.0)
Revaluation loss 120.77

----------( 438 )----------

 1-1-2020 Plant 3,000
cash 3,000
1-1-2020 Plant 233.25
Provision [500x(1.1)-8 233.25
31-12-2020 Dep. 404.16
Acc. Dep. (3000+233.25)/8 404.16
31-12-2020 Finance cost 23.33
Provision (233.25x10%) 23.33
31-12-2021 Dep. 404.16
Acc. Dep. 404.16
31-12-2021 Finance Cost 25.66
Provision [233.25+23.33]x10% 25.66

31-12-2021
Provision as per books 282.24
[233.25 + 23.33 + 25.66]
Provision should be 205.36
[475 x (1.15)-6
Decrease in provision 76.88

31-12-2021 Provision 76.88

R. surplus(O.C.I) 76.88
31-12-2022 Dep. 404.16
Acc. Dep. 404.16
[3000+233.25]/8 or [(3000+233.25)-
(404.16x2)]/6
31-12-2022 [Link] 12.81
Retained Earnings 12.81
[76.88/6]
31-12-2022 [Link] (O.C.I) [76.88-12.81] 64.07
[Link] (P/L) 56.7 120.77
Plant
31-12-2022 Finance Cost 30.80
Provision 30.80
[205.36x15%]

Answer # 5:
Following are the disclosure requirements related to ‘Fixed Assets’ as provided in the fourth schedule of
Companies Act, 2017.
1. Where any property is acquired by RL which is not held in the name of RL or is not in
the possession or control of RL, following shall be disclosed:
such fact along with the reason for property not being held in the name of RL,
description and value of such property, and
the person in whose name and possession or control such property is held.
2. Land and building shall be distinguished between free-hold and leasehold.
3. Forced sale value shall be disclosed separately in case of revaluation of property, plant
and equipment.
4. In case of sale of fixed assets, if the aggregate book value of assets exceeds Rs. 5 million,following
particulars of each asset, which has book value of Rs. 500,000 or more shall be
disclosed:
cost or revalued amount,
the book value,
the sale price and the mode of disposal (e.g. by tender or negotiation),
the particulars of the purchaser,
gain or loss, and
relationship, if any of purchaser with RL or any of its directors.
5. Geographical location and address of all business units including mills/plant.
6. Particulars of company’s immovable fixed assets, including location and area of land.
7. The capacity of an industrial unit, actual production and the reasons of the shortfall.
----------( 439 )----------
Answer # 6:
i. (a) It shall be reported separately in current year and comparative information shall be
restated
ii. (c) function of expenses with additional information on nature
iii. (b) Only (II) is correct
iv. (c) The goods are regularly sold separately and the customers generally can benefit
from the goods on its own
v. (b) Rs. 16.8 million (13.6 + 3.2)
vi. (b) Only (II) is correct
vii. (a) IAS 20
viii. (a) Power to participate in the financial and operating policies of the investee
(d) Holding the majority of shares in investee’s share capital
ix. (b) Stress testing
(d) Graphical design development
x. (a) A company made an out of court settlement with a customer after reporting date,
for a case that was lodged before the reporting date
(c) A company made a provision for damages in respect of a pending suit, which was
decided by the court after the reporting date with the same amount of damages.

Answer # 7 (a):
Gold Limited (Dealer Lessor)
General Journal
Lease is a finance lease as the lease term covers a major part (4/5 x 100 = 80%) of economic life
“Rs. In millions”
Date Description Debit Credit
1 Jan 22 Lease Receivable 65.82
Sales (lower of 62.96 or 71) (W-1) 62.96
Cost of Sales (58 - 2.86) 55.14
Inventory 58
1 Jan 22 Selling Expenses /Direct cost (P/L) 1.50
Bank 1.50
1 Jan 22 Bank 16.00
Lease Receivable 16.00
31 Dec 22 Interest Receivable 7.47
Finance Income (65.82 - 16) x 15% 7.47

W-1: Revenue
Gross Investment = LP + URV
= [16 + 18 + 20 + 22 + 3] + 5
= 79 + 5 = 84
Net Investment = [16 + 18(1.15)-1 + 20(1.15)-2 + 22(1.15)-3 + 3(1.15)-4 + 5(1.15)-4
= 62.96 + 2.86 = 65.82

(b) Lead Limited

Statement of Financial Position as at 30 September 2022
“Rs. In millions”
Non-Current Assets
Right of use - Engine (W-1) 61.50

Non-Current liabilities
Lease Liability (W-2) 38.62
Provision for Decommissioning (5.72 + 0.52) 6.24

Current liabilities
Current Portion of lease liability 12.85
Interest Payable 3.86

----------( 440 )----------

Statement of Profit or loss for the year ended 30 September 2022
[Link] millions
Depreciation expense 14.19
Interest on lease liability (5.15 x 9/12) 3.86
Unwinding of interest on decommissioning cost (5.72 x 12% x 9/12) 0.52

W-1: Right of use asset

Rs. in millions
Present value of lease payments@10%
2022 16
2023 18 x 1.1 -1 16.36
2024 20 x 1.1 -2 16.53
2025 22 x 1.1 -3 16.53
Guaranteed Residual value 3 x 1.1-4 2.05
67.47
Initial direct cost (4 - 1.5) 2.5
Decommissioning Cost 9 x 1.12-4 5.72
75.69
Depreciation for the year 75.69/4 x 9/12 (14.19)
61.50
*(As there is no information of transfer of ownership so shorter of lease term and useful life)

W-2:
Date Rentals Principal Interest Balance
1-1-2022 67.47
1-1-2022 16 16 - 51.47
1-1-2023 18 12.85 5.15 38.62

A.8
Aluminium Limited
Consolidated statement of financial position as on 31 December 2022
Non-current assets: Rs. in million
Property, plant and equipment 1,160 + 960 – 45 2075
Investment property 440 + 290 + 160 – 20 870
Investments (1,000 – 40 – 104.12 – 699.88 – 91 - 22) 43
Investment in associate (W-3) 88
Inventories 365 + 190 – 10 545
Other current assets 295 + 270 565
4,186
Equity & liabilities:
Share capital (Rs. 10 each) 1,400
Share premium 550 – 40 510
Consolidated retained earnings (W-4) 899.14
Non-controlling interest (W-5) 444
Liabilities (692 + 315 – 104.12 + 29.98) 932.86
4,186

----------( 441 )----------

Workings:
(W-1) Analysis of equity of SL (subsidiary)

At acquisition: P(70%) NCI(30%)

Share capital 800
Share premium -
Rev. Surplus 105
Retained earnings 515
1420
Rev. Surplus 160
1106 474
1580
Cost of Investment
(20 x 27 + 304 = 844 – 40 – 104.12) 699.88
NCI (At Proportionate Method) -
Gain in bargain purchase (CRE) 406.12
Since Acquisition till Cons. date: Retained earnings
(70) (49) (21)
(445 - 515)
Change in Rev. surplus is reversed in
working to make uniform accounting policies.

(W-2) Analysis of Equity of PL (Associate)

No information of PL’s Net assets on acquisition to identify any goodwill or gain.

Since Acquisition till Consolidation date: P (25%)

Profit of six months 52 13*

*Investment in PL 13
Share of Profit (CRE) 13

(W-3) Investment in Associate (PL)

Cost 91
Share of Net Profit (W-2) 13
Dividend income (5)
Unrealized gain on machinery-AL (11)
Total 88
(W-4) Consolidated Retained earnings:

[618 – 49 + 13(Share of Profit from Associate) -29.98(Unwinding of discount) -14 – 7 – 5 – 11 – 22 +

406.12(Gain on bargain purchase)] = 899.14

(W-5) Non-Controlling Interest:

(474 – 21 – 6 - 3) = 444
Accounting entries:
i. Share Premium 40
Investment (20 x 2) 40
(Investment in shares should be recorded at market value on the date of acquisition)
ii. Payable 104.12
Investment 104.12
(304 x (1.15)-3 = 199.88 - 304 = 104.12)
(Deferred consideration recorded without present value)
iii. Finance Cost (CRE) 29.98
Payable 29.98
(199.88 x 15% = 29.98)
(Effect of unwinding of discount)
----------( 442 )----------
 iv. At Acq:
Investment Property 160
Rev. Surplus 160
(It is fair value adjustment according to consolidation standards at acquisition)
CRE (70%) 14
NCI (30%) 6
Investment Property 20
(160/8 = 20)
v. Rev. Surplus 45
PPE 45
(Uniform accounting policies should be adopted by Group, therefore reversal of revaluation surplus in the
post-acquisition period).
vi. S P
150 x 40% = 60/120 x 20 =10
CRE (70%) 7
NCI (30%) 3
Stock 10
vii. Dividend Income (CRE) 5
Investment in PL 5
viii. P to A
Gain to be reversed 48 Dr.
Depreciation to be reversed (48/4 x 4/12) 4 Cr.
Net gain to be reversed 44 Dr.
X 25% = 11
Gain (CRE) 11
Investment in Associate 11
ix. FV loss (CRE) 22
Investments 22

Answer # 9:

i) The carrying value of the investment is Rs. 105 million [85+20] while its tax base is Rs. 85 million as at
31 December 2022 i.e., the amount that will be deductible for tax purpose upon sale. This should result
in taxable temporary difference of Rs. 20 million on which deferred tax liability/expense of Rs. 7 million
[20×35%] shall be recognized. Since the fair value gain is reported in profit or loss, the related deferred tax
expense is also recognized in profit or loss.

ii) The carrying value of the factory building is Rs. 1,260 million while its tax base is Rs. 1,080 million
[1,200×90%] as at 31 December 2022 i.e., the amount that will be deductible for tax purpose in future
years. This should result in taxable temporary difference of Rs. 180 million on which deferred tax
liability/expense of Rs. 63 million [180×35%] shall be recognized. The effect arising due to the difference
in depreciation. i.e., Rs. 14 million [40 (120 – 80) ×35%], would be taken to profit or loss. While the
remaining effect of liability arising due to revaluation adjustment i.e., Rs. 49 million [140 (180 – 40) ×
35%], would be taken to other comprehensive income.

Working

C.A T. B Difference
2022 cost 1200 1200
Dep. (80) (120)
Rev. surplus 140 -
31-12-2022 1260 1080 180 x 35% = 63 D.T. L

----------( 443 )----------

 [Link] Deferred Tax Liability

D.T.L 49 b/d - b/d -

Building 140 31-12

[Link] 49
(140 x 35%)
c/d 91
c/d 63 DTE 14

iii) The carrying value of development cost is Nil (being expensed out) while its tax base is Rs. 18 million [20×90%]
as at 31 December 2022 i.e., the amount that will be deductible for tax purpose in future years. This
should result in the deductible temporary difference of Rs. 18 million on which deferred tax asset / income of Rs.
6.3 million [18×35%] shall be recognized. Since the development cost is takento profit or loss, the corresponding
effects should also be credited to profit or loss.

iv) At 31 December 2022, the carrying value of the government grant is Rs. 8 million [12–4(12÷3)] while its
tax base is the same as the carrying value as benefit of government grant is not taxable. Therefore, no
deferred tax shall arise.

v) The tax loss of Rs. 260 million for the year 2022 shall result in deferred tax asset of Rs. 91 million
[260×35%]. The deferred tax asset shall be recognized to the extent that TL is probable that taxable profit
will be available against which unused tax losses can be utilized. If TL will earn sufficient profits within
next six years, then deferred tax asset should be recognized and corresponding effect should be
credited to statement of profit or loss. However, if TL is not expected to earn sufficient profit in future
than deferred tax asset would not be recognized and will be reassessed for recognition at each year
end.

----------( 444 )----------

Q.1 The following balances have been extracted from the statement of financial position of Uchhali
Limited (UL) as on 31 December 2022:

2022 2021
---- Rs. in million ----
Investment property 420 -
Inventories 840 780
Interest receivable 65 80
Accumulated losses 460 390
Accrued expenses 232 250

Additional information:
(i) UL has only one investment property, which was purchased during 2022 at a cost of Rs. 450
million. The fair value of the property as on 31 December 2022 amounted to Rs. 610 million.
UL follows cost model for accounting purposes.
Under tax laws, capital gain on investment property is taxable at the time of sale, while
depreciation is not allowed.
(ii) Inventories imported during the year 2022 amounted to Rs. 660 million, of which 40%
remained unsold as on 31 December 2022. Payment of imported inventories resulted in a
foreign exchange loss of Rs. 100 million.
Under tax laws, the foreign exchange loss is considered as the part of cost of inventories.
(iii) Interest income for the year 2022 amounted to Rs. 120 million, of which Rs. 65
million was receivable as on 31 December 2022.
Under tax laws, interest income was taxable on an accrual basis in 2021. However, with
effect from 1 January 2022, interest is taxable on a receipt basis.
(iv) Accrued expenses include payables for penalties of Rs. 42 million
(2021: Rs. 6 million). During the year, UL also paid penalties of Rs. 56 million. Under tax
laws, penalties are not deductible; however, other expenses are allowed on payment basis.
(v) UL has unused tax losses amounting to Rs. 550 million as on 31 December 2022.
(vi) It is expected that, after three years, sufficient taxable profits will be earned to utilise the benefit
of unused losses and deductible temporary differences.
(vii) The applicable tax rates are as follows:

*2023 and onwards 2022 and before

Interest income 20% 15%
All other incomes 30% 25%
*Enacted before 31 December 2022
Required:
Compute the deferred tax liability or asset that should be recognized in UL‘s statement of financial
position as on 31 December 2022. (10)

Q.2 Drigh Limited (DL), a listed company, has seven components. The following information is available
about the components:

Revenues Profit/(loss) Total

Components External Inter- Total assets
segment
--------------------------------- Rs. in million ------------------------------
---
A 2,600 200 2,800 (300) 700
B - 600 600 (45) 135
C 1,600 - 1,600 (580) 150
D 1,550 113 1,663 475 613
E 575 - 575 58 162
F 500 75 575 60 300
G 125 - 125 13 150
6,950 988 7,938 (319) 2,210

----------( 445 )----------

 Additional information:
(i) Operating results of all the above components are reviewed by DL’s CEO. He is of the view that
all components need to be presented separately in the DL’s financial statements as per
IFRS 8.
(ii) Components A and G exhibit similar long-term financial performance because they have
similar economic characteristics while other components do not have similar economic
characteristics.
(iii) Component F earns revenues that are only incidental to the activities of DL and supports
components C and D.

Required:
Keeping in view the CEO’s point of view, discuss how the above components should be presented
in the note of ‘Operating Segments’ in accordance with IFRS 8.
(Preparation of note is not required) (08)

Q.3 The following information pertains to three independent contracts:

(i) Alpha entered into a contract with Beta to provide administrative support services to Beta for a
period of one year. These services encompass data entry, scheduling departmental
meetings and tasks, and so on, to help Beta focus on its core operations. Alpha is not entitled to
any amount if the one year period is not completed.

(ii) Gamma is developing a residential society comprising identical villas. Delta entered into
contract with Gamma to buy one of the villas. The control of the villa will be transferred to
Delta once the entire society is complete.

The contract specifically mentions that no customized modification will be made during the
construction by Gamma. Delta is required to make payments in proportion to the work done. In
case of termination by Delta, Gamma is liable to return the amount paid by Delta once the
villa is sold to another party.

(iii) Eta entered into a contract with Theta to develop a software for Theta. The software will be
designed specifically to meet Theta's operational needs and will not be usable for any other
customer. The contract states that Theta will pay 50% of the total contract price upfront and the
remaining 50% upon completion of work. Theta does not have the right to terminate the
contract unless Eta fails to perform.

Required:
Analyze whether the revenue should be recognized over time in each of the above contracts
in accordance with IFRS 15. (08)

Q.4 You have been working as an accountant at Satpara Limited (SL), a listed company. SL is
considering to grant interest free long term loans to few directors for the purpose of building houses,
which will be recovered in instalments from salaries over five years. Further, a Pakistan-based
related party has also requested a long term loan from SL for business expansion, with
repayment expected after three years. You have pointed out that providing such loans would require
additional disclosures as per Fourth schedule to the Companies Act, 2017. CFO has asked you
to prepare an illustrative note disclosing the above, which would be included in the upcoming
annual financial statements of SL if these loans are granted.

Required:
Prepare the note as required by the CFO. (06)
(You may assume necessary details or numbers)

----------( 446 )----------

Q.5 On 1 January 2022, Namal Leasing Limited (NLL) leased a manufacturing plant to Haleji Limited
(HL). Details are as follows:
(i) The non-cancellable lease term is five years during which annual instalment of Rs. 60
million is payable by HL in arrears.
(ii) The interest rate implicit in the lease is 16% per annum.
(iii) NLL incurred an initial direct cost of Rs. 4 million for arranging the lease.
(iv) The estimated residual value of the plant at the end of the lease is Rs. 125 million, of which
Rs. 90 million has been guaranteed by HL.

The following information is also available:

(i) NLL’s profit before tax for the year after all adjustments was Rs. 350 million.
(ii) Applicable tax rate is 30%
(iii) Tax authorities treat each lease as an operating lease.

Required:
Prepare the relevant extracts from NLL’s statement of profit or loss for the year ended 31
December 2022, and the statement of financial position as on that date. (08)

Q.6 Select the most appropriate answer(s) from the options available for each of the following Multiple
Choice Questions.
(i) Which of the following statements is/are correct?
(I) All public interest companies must follow the requirements of the Fourth
schedule to the Companies Act, 2017.
(II) IAS 1 requires entities to show an analysis of expenses based on both nature as well
as functions within the entity.
(a) Only (I) is correct (b) Only (II) is correct
(c) Both are correct (d) None is correct (01)

(ii) Siri Limited (SL) purchased 1 million ordinary shares of another company at the fair value of
Rs. 23 per share. SL also incurred transaction cost of Rs. 0.5 million. SL considers this
investment as a strategic equity investment and not held for trading.
Which of the following statements is/are correct in this regard?
(I) On initial recognition, the investment can be recognised at Rs. 23 million or Rs. 23.5
million depending on classification.
(II) On subsequent measurement, the investment must be carried at fair value only.
(a) Only (I) is correct (b) Only (II) is correct
(c) Both are correct (d) None is correct (01)

(iii) On 1 July 2022, a company issued 5% debentures with a par value of Rs. 15 million for Rs.
20 million, incurring issue costs of Rs. 0.5 million. The debentures are redeemable at a
premium, giving them an effective interest rate of 8% per annum.
What expense should be recorded in relation to the debentures for the year ended 30 June
2023?
(a) Rs. 2,400,000 (b) Rs. 1,600,000 (c) Rs. 975,000 (d) Rs. 1,560,000 (01)

(iv) Which of the following statements is/are correct?

(I) In case of sale of goods by parent to associate, the unrealised profit is eliminated in full.
(II) In case of sale of goods by associate to parent, amount payable to associate would
be presented in the consolidated statement of financial position.
(a) Only (I) is correct (b) Only (II) is correct
(c) Both are correct (d) None is correct (01)

(v) Which of the following statements is/are correct?

(I) Acceptance of a significant gift would result in familiarity threat to fundamental principles.
(II) Commercial pressure from outside the employing organization would result in self-review
threat to fundamental principles.
(a) Only (I) is correct (b) Only (II) is correct
(c) Both are correct (d) None is correct
----------( 447 )---------- (01)
 (vi) A Pakistan based company purchased a piece of land in Saudi Arabia for SAR 10
million on 1 August 2022. Details of payments on various dates are as follows:

Date Amount Exchange rate

1 May 2022 SAR 3 million 1 SAR = Rs. 65
1 August 2022 SAR 5 million 1 SAR = Rs. 74
1 October 2022 SAR 2 million 1 SAR = Rs. 78
At what amount, should this piece of land be recognised?
(a) Rs. 713 million (b) Rs. 721 million
(c) Rs. 740 million (d) Rs. 780 million (01)

(vii) Which of the following statements is correct in the light of IAS 21?
(a) ‘Investment in debt securities’ is a monetary item while ‘Refund liability’ is a non-
monetary item
(b) ‘Advance from customers’ is a monetary item while ‘Biological assets’ is a non-
monetary item

(c) ‘Deferred government grant’ is a monetary item while ‘Deferred tax asset’ is a non-
monetary item
(d) ‘Lease liability’ is a monetary item while ‘Right-of-use asset’ is a non-monetaryitem (01)

(viii) Ansoo Limited (AL) owns a property that has been rented to its subsidiary which uses it as sales
office. How should the above property be classified by AL in separate and consolidated
financial statements?
Separate Consolidated
(a) Property, plant and equipment Property, plant and equipment
(b) Investment property Property, plant and equipment
(c) Property, plant and equipment Investment property
(d) Investment property Investment property
(01)

(ix) Asghar Limited (AL) is currently negotiating the acquisition of Basker Limited (BL). Mr.
Karim ACA, besides being CFO of AL, is part of the team negotiating the acquisition
of BL. After becoming aware of the potential acquisition, Karim purchased 2 million
shares of BL in the name of his son.
Which TWO of the following fundamental principles of ICAP’s code of ethics is Mr. Karim
is in breach of?
(a) Confidentiality (b) Objectivity
(c) Professional behaviour (d) Professional competence (01)

(x) Which TWO of the following assets require the application of IAS 41?
(a) Animals kept by zoo for earning ticket revenue
(b) Parrots kept by a restaurant to attract more customers
(c) Birds kept for sale by a pet shop
(d) Hens kept by a poultry farm (01)

----------( 448 )----------

 Section B

Q.7 For the purpose of this question, assume that the date today is 1 September 2023.
Jahlar Cosmetics Limited (JCL) is currently in the process of finalising its financial
statements for the year ended 30 June 2023.
In May 2023, JCL was on the verge of launching an innovative line of beauty products.
However, the launch was cancelled due to alarming reports that employees involved in
internal testing of the new cosmetics experienced adverse skin reactions, ranging from minor
irritations to serious allergic responses. The situation worsened as news of these reactions
spread through media outlets, highlighting potential risks, damaging JCL's reputation, and
causing public doubt.
As a result of the above, JCL has incurred a net loss for the first time. Additionally, JCL has
encountered the following matters:
(i) In July 2023, affected employees filed a lawsuit against JCL for damages. Legal
advisors anticipate that these suits could result in potential liability of Rs. 120 million.
However, due to legal complexities, the actual payout remains uncertain. The legal
advisors estimate a 70% likelihood of incurring the full liability and a 30% likelihood of
incurring only half the amount.
(ii) In June 2023, the JCL’s board of directors approved a detailed restructuring plan
involving the reduction of operations in two cities due to high cost and low profitability.
The plan was announced and communicated to the employees in the same month. The
implementation of this plan will span over a six-months period, resulting in employee
redundancies, lease termination charges, and retraining cost amounting to Rs. 150 million,
Rs. 24 million and Rs. 18 million, respectively. Further, an expected disposal of assets is
projected to generate a gain of Rs. 18 million.
(iii) As of 30 June 2023, JCL was in breach of one of the loan covenants related to revenue
target, which would have led to the entire long term loan becoming payable
immediately. However, JCL contacted the banks and obtained a waiver from them for
compliance with the given covenant on 26 July 2023.
(iv) JCL plans to raise finance from the issuance of bonds in October 2023. Due to the
challenges, it is estimated that the bond issuance will yield Rs. 100 million less than the
original estimates. Further, the interest rates would need to be increased by 2% per annum
to make the issue possible. This additional interest would result in an annual loss of Rs.
14 million, which has a present value of Rs. 70 million.

Required:
Discuss the effect of the above matters on JCL’s financial statements for the year ended (13)
30 June 2023.

Q.8 Following balances have been extracted from the records of Baghsar Limited (BL), Rawal Limited
(RL), and Tarbela Limited (TL) for the year ended 30 June 2023:

BL RL TL
-------- Rs. in million --------
Sales 3,900 2,480 1,900
Cost of sales 1,980 1,660 810
Operating expenses 500 620 415
Other income 420 100 90
Finance cost 150 60 95
Revaluation surplus arising during the year 120 300 90

Additional information:
(i) Details of BL’s investments are as follows:

Share Retained Revaluation

Date of Holding Investee capital (Rs. earnings of surplus
investment % 10 each) investee
of investee
-------------- Rs. in million --------------
1 Oct 2022 75% RL 6,000 (1,650) 450
1 Jul 2022 30% TL 1,000 1,400 270
----------( 449 )----------
 (ii) BL acquired the shareholding in RL at the following consideration:
▪ Immediate cash payment of Rs. 2,600 million. This amount was recorded as
investment in BL’s books, and includes Rs. 120 million incurred as a valuation fee.
▪ Further cash payments of Rs. 2 per share and Rs. 1.5 per share to be paid on 30
September 2024 and 30 September 2025, respectively. This has not been recorded in
BL’s books.
(iii) At the date of acquisition, carrying values of RL’s net assets were equal to their fair values,
with the following exceptions:
▪ The brand, an intangible asset, had a carrying value of Rs. 160 million and a fair value of
Rs. 256 million. The remaining useful life of the brand on acquisition date is estimated at
four years. The recoverable amount of the brand as on 30 June 2023 was
estimated at Rs. 178 million.
▪ A building with a carrying value of Rs. 900 million had a fair value of Rs. 1,200
million. The building is depreciated using a 5% straight-line method. RL revalued the
building to its fair value on 2 October 2022 in its books.
(iv) The fair value of RL’s share was Rs. 8.5 per share on the acquisition date.
(v) Subsequent to the acquisition date, BL sold goods to RL at a sale price of Rs. 500
million, generating a profit of Rs. 160 million. 80% of these goods were sold by RL to its
customers at a profit of Rs. 150 million before 30 June 2023.
(vi) BL acquired the shareholding in TL by transferring BL's land having a carrying value of Rs. 690
million and a fair value of Rs. 932 million on that date. The investment in TL was recorded at
the carrying value of land.
(vii) TL paid a dividend of Rs. 5 per share on 1 June 2023. BL recorded the dividend as other
income.
(viii) BL measures non-controlling interest at the acquisition date at its fair value.
(ix) Income and expenses of all companies accrued evenly during the year unless stated
otherwise.
(x) A discount rate of 17% per annum may be used wherever required.

Required:
Prepare BL’s consolidated statement of profit or loss and other comprehensive income for
the year ended 30 June 2023. (18)

Q.9 The following information pertains to the intangible assets of Hadero Limited (HL):
(i) On 1 May 2022, HL acquired an eight year license at a cost of Rs. 174 million. HL plans to
use the license for six years. Licenses are traded in an active market. As on
31 December 2022, the fair value of a new license valid for eight years is Rs.
192 million, while older licenses sell at a fair value of new license value less Rs. 2 million
for each month the license has already been used.

(ii) On 1 July 2022, HL acquired operation management software at a cost of Rs. 410
million. HL also incurred a cost of Rs. 20 million for consulting charges to select and
evaluate the appropriate software in alignment with HL’s needs.
HL expects that indefinite life can be achieved if HL incurs future expenditures to enhance
its performance standards by integrating ‘artificial intelligence’ into this software. Without
such expenditures, the software is projected to become technologically obsolete in five
years.

After the acquisition of the new software, the existing software would henceforth serve limited
purposes. The existing software was acquired for Rs. 240 million, and as on 31 December
2021, Rs. 126 million had been amortized, based on a useful life of ten years.
On 31 December 2022, HL has estimated the value in use of the existing software to be Rs.
58 million. This valuation has been computed using cash flows projected over the revised
remaining useful life of two years.

(iii) During the year 2022, it was discovered that the entire cost of Rs. 1,050 million incurred on
‘product development’ has been recorded as intangible asset without considering the
following pertinent facts:
The product development was commenced on 1 August 2021. Up till the launch date of
1 October 2022, the following directly attributable costs were incurred:

----------( 450 )----------

 Rs. in million
Staff salary 150
Equipment (having useful life of five years) 420
Consumables 160
Consultant fee 320
Total 1,050

The recognition criteria for capitalization of internally generated intangible assets was met
on 1 February 2022. All costs have been incurred evenly during the period except the
equipment which was purchased specifically for this product development on 1
September 2021. The useful life of the developed product is estimated at eight years.

(iv) HL uses the revaluation model for the subsequent measurement of its intangible assets,
wherever possible, and accounts for revaluation using the net replacement value method.
Depreciation and amortisation are charged using the straight line basis.

Required:
Prepare the notes on ‘Intangible assets’ and ‘Correction of error’ for inclusion in HL’s financial
statements for the year ended 31 December 2022, in accordance with the requirements of
IFRSs. (19)
(THE END)

----------( 451 )----------

A.1 Computation of deferred tax liability / (asset) as on 31 December 2022:

Carrying Tax base Difference Liability/

Description value Tax (Asset)
---------- Rs. in million ---------- rate Rs. in million
Investment property 420 450 30 D.T. D 30% 9 D.T.A
Inventories:
- Imported 264 304 40 D.T. D 30% 12 D.T. A
(660×0.4) (660+100) ×40%
- Other (840-264) 576 576 Assumed as no difference -

Interest receivable 65 - 65 T.T. D 20% 13 D.T. L

Accrued expenses
- penalties 42 42 Permanent difference -
- others 190 (232–42) - 190 D.T. D 30% 57 D.T. A
Unused tax losses 550×30% 165 D.T. A

230 D.T. A

Ans-02
Quantitative thresholds for reportable segments:
Total 10%
----- Rs. in million -----
Revenue 7,938 793.8
Absolute profit *925 92.5
Assets 2,210 221
*Higher of total profit i.e. 606(475+58+60+13) or total loss i.e. 925(300+45+580)
Contrary to the CEO’s point of view, DL’s components should be presented in the note of ‘operating segments’
in the following manner:
• A & G may be presented as an aggregated segment because they have similar economic
characteristics and, when combined, meet all the quantitative thresholds.
• C will be presented as a separate segment because its loss of Rs. 580 million is greater than Rs. 92.5
million. Further, its revenue of Rs. 1,600 million is also greater than Rs. 793.8 million.
• D will be presented as a separate segment because it meets all the quantitative thresholds.
• Components B, E, and F will be presented as a combined category of ‘All other segments’ for the
following reasons:
➢ More than 75% i.e. 84.5%[(2600+1600+1550+125)/6950)] of the revenue is reported by
operating segments so additional reportable segments need not be identified.
➢ Segment B is an operating segment but fails to meet any quantitative threshold.
➢ Segment E is an operating segment but fails to meet any quantitative threshold.
➢ Segment F, despite having assets of Rs. 300 million which are greater than Rs. 221 million,
fails to meet the definition of operating segment. This is because its revenues are merely
incidental to the activities of the entity, and as a result, it does not meet the definition of an
operating segment.

----------( 452 )----------

Ans-03
As per para 35 of IFRS 15, an entity transfers control of a good or service over time and, therefore, satisfies
a performance obligation and recognises revenue over time, if one of the following criteria is met:
(a) The customer simultaneously receives and consumes the benefits provided by the entity’s performance
as the entity performs.
(b) The entity’s performance creates or enhances an asset that the customer controls as the asset is created
or enhanced.
(c) The entity’s performance does not create an asset with an alternative use to the entity and the entity has
an enforceable right to payment for performance completed to date.
(i) Beta would be simultaneously receiving and consuming the benefits of Alpha’s performance of
administrative support services so Alpha should recognize the revenue over time. The fact that
another entity would not need to re-perform the administrative support services already provided to
date by Alpha also demonstrates that Beta simultaneously receives and consumes the benefits of
the services performed by Alpha. As criterion (a) is fulfilled, payment terms have no effect on revenue
recognition.
(ii) As control of villa will be transferred to Delta upon completion of entire society, criteria (a) or (b) have
not met. The villas do seem to have an alternative use for Gamma as they can be sold to another
customer in case of termination of contract. Hence, the revenue shall not be recognized by Gamma
over time as criterion (c) above is also not met. Revenue would be recognized when control is
transferred to Delta.
(iii) Theta will be able to consume the benefits of the software upon completion, so criteria (a) or (b) have
not been met. As per criterion (c) above, the development of software does not create an asset with
an alternative use for Theta, as the software will be designed specifically for Theta’s needs and will
not be applicable for other customers. Eta also has a right to payment for performance completed to
date, as Theta cannot terminate the contract. Therefore, Eta should recognize revenue over time in
accordance with criterion (c).

Ans-04
Long term loans

Note Rupees
Loans to:
- Directors 1.1 xxx
- Related party 1.2 xxx

Current portion of long-term loans to directors (xxx)

xxx

1.1 Long term loans to directors

These are interest-free loans that have been granted for the purpose of house building. The reconciliation of
the carrying amount at the beginning and end of the period is as under:

Rupees
Opening balance Nil
Disbursements xxx
Receipts (Nil)
Closing balance xxx

1.2 Long term loan to related party

This represents an unsecured loan to a related party, ABC Limited, and bears interest at 16% per annum. The
repayment of full balance is due on 30 June 2026. There is no default in respect of this loan to date. No
provision has been recorded in respect of this loan to date. No amount in respect of this loan is written off
during the year 30 June 2023. The maximum amount due as at the end of any month during the year was Rs.
xxx.

----------( 453 )----------

Ans-05
Namal Leasing Limited
Statement of profit or loss for the year ended 31 December 2022
[Link] Million
Interest Income (W-1) 40.95

Taxation:
Current (W-2) (102.86)
Deferred (W-3) or (350 – 342.85) x 30% (2.14)

Namal Leasing Limited

Statement of financial position as on 31 December 2022
[Link] Million
Non-Current Assets
Lease Receivable (W-1) 214.80

Current-Assets
Lease Receivable (W-1) 22.10

Non-Current Liabilities:
Deferred tax liability 2.14

W-1)
Gross Investment=LP + URV
=(60 + 90) + 35
=150 + 35
= 185
Net Investment=PV of LP + PV of URV
= 60[1 - (1 + 0.16)-5/0.16] + 90(1 + 0.16)-5 + 35(1 + 0.16)-5
= 255.96
Rentals Principal Interest Balance
01.01.2022 255.6
31.12.2022 60 19.05 40.95 236.9
31.12.2023 60 22.1 37.90 214.8

W-2: Current Tax [Link] Million

Profit as per accounting records 350.00
Interest income (40.95)
Rent Income 60.00
Depreciation expense (255.96 (Note-1) – 125) ÷ 5 (26.19)
Taxable income 342.86
Current tax @ 30% 102.86
Note-01 This should be equal to FV + IDC and in question it is mentioned that tax authorities treat lease as
an operating lease. Therefore, IDC should be capitalized.

W-3)
C.A T.B Difference
Plant - 229.77(255.96 – 26.19) 229.77 DTD
Lease Receivable 236.9 - 236.9 TTD
7.12 TTD
x 30% 2.14 D.T.L

D.T.L
b/d -
D.T.E 2.14
c/d 2.14

----------( 454 )----------

Ans-06
(i) (d) None is correct
(ii) (c) Both are correct
(iii) (d) Rs. 1,560,000 01.07.2022 [20 – 0.5 = 19.5 x 8% = 1.56]
(iv) (b) Only (II) is correct
(v) (a) Only (I) is correct
(vi) (a) Rs. 713 million (3 x 65 + (5 + 2) x 74)
(vii) (d) ‘Lease liability’ is a monetary item while ‘Right-of-use asset’ is a non-monetary item
(viii) (b) Investment property Property, plant and equipment
(ix) (a) Confidentiality
(c) Professional behavior
(x) (c) Birds kept for sale by a pet shop
(d) Hens kept by a poultry farm

A.7
(i) JCL has a present obligation as a result of a past event i.e., skin reactions due to testing. It is probable
that an outflow of resources would be required as both possibilities would result in payment of damages.
A reliable estimate can be made. As it is a single instance, the most likely outcome of 70% should be
considered. So, JCL should make a provision forRs. 120 million.

(ii) A constructive obligation for restructuring has arisen as the formal plan has been approved by the Board,
and has been communicated to all concerned before the end of reporting period. Therefore, a provision
of Rs. 174 (150+24) million should be recognized comprising of redundancy costs and lease termination
charges. Retraining cost would not beincluded in the provision for restructuring, as it relates to future
conduct of the business. Gains on the expected disposal of assets are not taken into account in
measuring a restructuring provision, even if the sale of assets is envisaged as part of the restructuring
process.

(iii) JCL shall classify the bank loan as current since JCL does not have an unconditional right to defer
settlement of the loan for at least twelve months after the reporting period. Obtaining the waiver after the
year-end is a non-adjusting event and will not change the classification of loan from current to non-current
liabilities. However, the fact of obtainingwaiver may be disclosed in the notes.

(iv) The issuance of bond at a lower amount and increase in finance cost represents future operating losses
for which provision shall not be recognized in the financial statements for the year ended 30 June 2023.

----------( 455 )----------

Answer # 8: Baghsar Limited
Consolidated Statement of Profit or loss and other comprehensive income
For the year ended 30 June 2023
Rs. In million
Sale 3,900 + 1,860 (2480 x 9/12) - 5,260.0
500
Cost of Sales 1,980 + 1,245(1,660 x 9/12) – 500 + 32 (2,757.0)
Gross Profit 2,503.0
Operating Expense (500 + 620 x 9/12 + 120 + 18 + 30) (1,133.0)
Other Income (420 + 100 x 9/12 + 362.1(w-1) + 242 - 150) 949.1
Finance Cost (150 + 60 x 9/12 + 137.56) (332.56)
Share of Associate’s Profit (w-2) 201.0
Net Profit 2,187.54
Other Comprehensive Income:
Revaluation Surplus arising during the year 120.0
Share of Associates OCI 90 x 27.0
30%
147.0
Total comprehensive income 2,334.54
Profit or Loss attributable to:
Owner of the parent (Bal.) 2,154.54
Non-Controlling interests 33.0
(2,480 - 1,600 – 620 + 100 - 60) = (240 x 9/12 – 18 - 30) x 25%
2,187.54
Comprehensive income attributable to:
Owner of the parent (Bal.) 2,301.54
Non-Controlling interests 33.0
(Same as above as no post-acquisition surplus of subsidiary)
2,334.54

W-1) Analysis of Equity of S(RL):

At Acq: P 75% NCI 25%
Share capital 6,000
Retained earnings (1,650)
Revaluation surplus 450
4,800
Rev Surplus (Brand) 96
Rev Surplus (Building) 300
5,196 3,897 1,299 5,196
Cost of Investment (2,600 - 120 + 1,078.91) 3,558.9 3,558.9
Fair Value of NCI 1,275 1,275
Gain on Bargain Purchase 338.1 24 362.1
Since Acq. Till the end of last year:
Not relevant as acquisition is in current year

W-2) Analysis of equity of A(TL):

Since Acq. Till the end of the last year
Not relevant as acquisition is in current year
Share of Profit of A in current year:
(1900 – 810 – 415 + 90 - 95) = 670 x 30% =201
Investment in A (TL) 201
Share of Profit (P.L) 201
Accounting Entries:
2) Expense 120
Investment in BL 120

Investment 1,078.91
Payable 1,078.91
[(6,000/10 x 75% = 450 x 2(1 + 0.17)-2+
[(6,000/10 x 75% = 450 x 1.5(1 + 0.17)-3]
----------( 456 )----------
 Finance cost 137.56
Payable 137.56
(1,078.91 x 17% x 9/12)
3) At Acq: 96
Brand
[Link] 96
(256-160)
Amortization 18
[Link] 18
(96/4 x 9/12)
(NCI will be affected)
Impairment. Loss 30
[Link] loss 30
(NCI will be affected)
C.A = 256-48[(160/4 +18) or (256/4 x 9/12)] =208
Recoverable Amount =178
Impairment Loss
30
At Acq:
Building 300
[Link] 300
(No depreciation adjustment as building is also revalued in post-acquisition
period, however revaluation in post acq. period should be reversed)
[Link] 300
Building 300

4) Fair Value of NCI: (6,000/10 x 25% x 8.5) =1275

5) P to S:
Profit percentage: 160/500 x 100 = 32% on sale
500 x 20% = 100/100 x 32 = 32
Cost of Sale 32
Stock 32
Or 160 x 20% = 32
(No affect on NCI)
6) Investment in Associate 242
Gain on disposal 242
(Gain of Parent, No share of NCI)
(932-690)
7) Dividend Income 150
Investment 150
(1,000/10 x 30% x 5)
(Dividend income of parent, so no share of NCI)

----------( 457 )----------

A.9
Hamal Limited
Notes to the Financial Statements
for the year ended 31 December 2022
Software Product License
Development
[Link] Million
Gross Carrying Amount 240 - -
Accumulated amortisation and (126) - -
impairment losses
Opening Carrying Amount 114 - -
Addition
-Separate Acquisition 410 - 174
-Development - (w-1) 416 -
Amortisation expense (79) (13) (14)
41(410 ÷ 5 × 6 ÷ 12) + (416 ÷ 8 x 3÷12) (174 – 48 w-2)
38(114 ÷ 3) ÷ 6 x 8÷12
Revaluation 16
[176(192-16(2m × 8))-160(174-14)]
Impairment losses (18) - -
[58 - 76(114 – 38)]
Closing Carrying Amount 427 403 176
Gross Carrying Amount 650 416 176
Accumulated amortisation and (223) (13) -
impairment losses
Closing Carrying Amount 427 403 176

Basis of Measurement Cost Cost Revaluation

Useful Life (in years) 5 8 6
Amortization method Straight Line Straight Line Straight Line

1.2: The last revaluation of license was performed on 31 December 2022. The revalued amount was
determined with reference to active market for such licenses.

2. Correction of Error:
It is identified during the year that the amount capitalized as product development in 2021 was incorrect. The
effects of correction of the amounts reported in 2021 are as follows:

Effect on Profit or Loss: [Link]

Million
Increase in research expenses (1,050 – 420) x 5 ÷ 14 (225)
Increase in depreciation on equipment (420 ÷ 5) x 4 ÷ 12 (28)
(253)
Effect on Statement of Financial Position:
Decrease in intangible assets (225 + 420) (645)
Increase in Property, plant and equipment (420 – 28) 392
(253)

Correct Balance of Product Development [Link]

Million
Cost Other than Equipment (1050 – 420 – 270) 360
Depreciation on Equipment (420/5 x 8/12) 56
416

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Workings:
W-1)

01.09.2021 Equipment 420

Intangible Asset 420
31.12.2021 Depreciation 28
(Retained Earnings)
Acc. Depreciation 28
(420 ÷ 5) x 4 ÷ 12 (Sep 2021 to Dec 2021)
31.12.2021 Research Expense 225
(Retained Earnings)
Intangible Asset 225
(150 + 160 + 320) ÷ 14 x 5(Aug to Dec 2021)
31.12.2022 Research Expense 45
(P.L)
Intangible Asset 45
(150 + 160 + 320) ÷
14 x 1 (Jan 2022)
31.12.2022 Depreciation (P.L) 28
(420 ÷ 5 x (1 + 3)/12) (Jan & Oct to Dec 2022)
Intangible Asset 56
(420 ÷ 5 x 8/12)
Acc. Depreciation 84

W-2) Residual Value:

= [192(fair value of 8 years license) – (2 x 12 months x 6 years of useful life)]
= 48

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