Table of Contents

Foreword......................................................................................................................................... 1
SYLLABUS AREA A.............................................................................................................................. 12
The conceptual and regulatory framework for financial reporting .................................................. 12
1. IASB Conceptual Framework..................................................................................................... 13
2. Elements of the Financial Statements ...................................................................................... 18
SYLLABUS AREA B .............................................................................................................................. 24
Accounting for transactions in financial statements ........................................................................ 24
3. Tangible NCA ............................................................................................................................. 25
4. IAS 38 - Intangible Assets .......................................................................................................... 40
5. IAS 36 – Impairment of Assets ................................................................................................. 45
6. IFRS 5 Non-Current Assets Held For Sale & Discontinued Operations ..................................... 52
7. IFRS 16 Leases ........................................................................................................................... 53
8. Financial Instruments ................................................................................................................ 65
9. IAS 37 Provisions, Contingent Liabilities and Contingent Assets .............................................. 78
10. IAS 10 Events After Reporting Period...................................................................................... 85
11. IAS 2 Inventory and IAS 41 Agriculture .................................................................................. 86
12. IFRS 13 Fair Value Measurement ............................................................................................ 91
13. IFRS 15 – Revenue From Contracts With Customers .............................................................. 94
14. IAS 21 The Effects Of Changes In Foreign Exchange Rates ................................................... 107
15. IAS 12 Income Taxes.............................................................................................................. 111
16. IAS 33 – EPS ........................................................................................................................... 117
SYLLABUS AREA C ............................................................................................................................ 128
Preparation of financial statements(Group Accounts) ................................................................... 128
17. Consolidation of Financial Statements and Profit or Loss .................................................... 129
SYLLABUS AREA D............................................................................................................................ 162
Analysing and interpreting the financial of single entities and groups .......................................... 162
18. Ratio & Ratio Analysis ........................................................................................................... 163
SYLLABUS AREA E ............................................................................................................................ 175
Statement of Cashflows .................................................................................................................. 175
19. IAS 7 Statement of Cashflows ............................................................................................... 176
 Foreword 1

Foreword
‘By the ACCA, for the ACCA’

These notes are designed with a simple mission, to fill the gap for Indian students who don’t find
comfort in studying from notes that are framed in a complex manner. Our priority at Zell is to
improve the results our students achieve by providing all that they need, be it quality education,
state of the art infrastructure and techniques or the next step, the content that perfectly fits in
making the trifecta or the winning formula.

Here at Zell, we don’t worry about the background, prior knowledge or preferences someone has.
The aim is simple, by the time a student is done with a paper, they are on the same page as anyone
else and that for us, should be enough knowledge to be able to call them a professional truly.

Keeping all this in mind, we bring to you these notes, created by us, for you, to truly help make the
difference and turn your journey of ACCA into an even better one. This is just the beginning; there
is more in store.

Thank you

Credits:

Authored by:

Kush Shah

Aaisha Sayed

Designed by:

Mehak Sethi

Sana Patni

For June 2023 to March 2024 examination sittings

 Foreword 2

Best way to study

Planning how to study

Before starting the preparation for any paper, you should always make a macro level plan on how
to go about preparing for the exam. Understand what is expected of you to be able to clear the
exam with high scores. It is important to set targets and stick to them, to ensure that you stay on
track and progress in your ACCA journey.

Have a plan from the beginning about where you want to be at the end of the month or two
months, then work backwards and understand what you must do to stay on track. Then, at the
start of every week, make a brief plan about how much needs to be covered every day, resulting
in the timely completion of the exam.

Break your macro plan intro studying along with the professor/recordings, examination month
and final revision. Plan how many hours can you give every day and make a schedule accordingly.
Ensure that you can give quality hours without distractions. The quantity of hours doesn’t matter.

How to approach the exam

Knowing how much importance ACCA places on application-based learning is important. You must
understand that rote learning in any exam for any concept will mostly amount to zero marks being
scored.

Students leave minimal time to their core exam preparation and directly jump into mock exams
without finishing the exam kit. Leave the exam month for core practice of questions available to
you, ensure you finish the conceptual understanding before starting to do so.

The ideal approach is to watch/attend lectures and keep up with the pace, practising 40% of the
question bank alongside, to cement conceptual understanding. Once classes conclude, ensure the
remaining 60% of the question bank is solved, followed by at least three mock examinations
before attempting the main exam.

Exam month

 In the exam month, ensure that you finish the portion as soon as possible and shift all
focus to completing the question bank. Remember, completing the textbook alone is not
enough, whereas completing the question bank gives you a higher chance of clearing the
exam.
 If you are done with your question bank, repeat the question bank or key questions you
marked before the exam. Only 40% of your total time should be allocated to building a
conceptual understanding, the remaining 60% to solve questions.
 You must practice newly launched past exam questions available on the ACCA website at
the end to ensure you can solve questions of the rigour expected from you.
 Ensure you do not get into the habit of reading a question and then reading the answer.
This approach will make you seek answers in the exam and not seek solutions on your
own. Read a question, solve it on your own, check the answer. If it is incorrect, solve the
question again to get another answer, rather than reading the explanation to understand
what you did wrong. That should always be the last resort.
 Foreword 3

 For subjective questions, do not simply read the answer and make notes. Type the answer
or solve it on a spreadsheet before checking the solution. Practising on a computer for a
computer-based exam can make the difference for you in finishing the exam.
 Familiarise yourself with the scientific calculator, the CBE exam platform and other tools
to ensure you are comfortable with the same in the actual exam.
 Ensure you complete 100% of the portion. Do not skip anything as the exam will test you
on a range of interconnected topics, and leaving parts of the portion will guarantee you
are losing certain marks.

Exam strategy

There are certain things to be kept in mind before attempting the main exam.

1. Remain calm before the exam. Do not study at the last moment, as going into the exam
with a fresh mind will allow you to tackle the questions more easily.
2. There is no negative marketing in the exams. Ensure that you attempt 100% of the paper
to ensure that some of your educated guesses score some marks even in the worst case.
3. The examination is 3 hours 15 minutes long, which means you have 195 minutes for 100
marks, or simply 1.95 minutes per mark. Ensure you don’t get overboard with the time
you take to solve a question at hand.
4. Ensure you read the question very carefully. Don’t assume that you faced a similar
question in the past and jump to solving it as the requirements can vary even in small
concepts causing you to lose easy marks.
5. Read the requirements carefully. Pay attention to the verb used, Define, explain,
calculate, evaluate etc., to understand what the examiner is seeking to ensure you answer
on those lines.
6. Do not go for quantity when you are answering subjective questions. The examiner will
award one mark per valid statement and one mark only per valid point. Do not elaborate
on points to simply write more.
7. The options are set up so that even answers derived using the wrong steps are available
as options. Do not jump to the conclusion that your answer has to be correct because it is
available as an option.
8. If there is a tricky question that you can’t solve, make an educated guess by eliminating
the one’s you definitely know are wrong, flag the question and move ahead. If you finish
the paper and have remaining time, revisit the flag questions to score full marks.
9. Do not sit and recalculate the answer you got more than twice, as you are likely to
calculate it in the same way you did previously, by repeating the same mistake if any. This
is a massive waste of your crucial time. Rather move faster and revisit key questions at the
end, recalculating your answers at that point will possibly reveal mistakes and allow you
to rectify them, thus scoring more marks.
 Foreword 4

Elements

Syllabus wise study material

The study material is curated in a manner where the syllabus provided by ACCA has been covered
in vast depth, and the order is set in a way that the flow of concepts within the material suits a
student.

Apply Your Knowledge

Various AYK style questions test the student on their ability to remember and understand
concepts thoroughly before moving to analytical questions.

Quiz

Further, there are primarily application-based quiz questions, introducing the student to analytical
and evaluative questions to bring the student one step closer to actual exam-style questions.

Recap

After the end of every main chapter, there is a recap page summarising all the important topics,
formulae etc., to enable ease of revision for the student.

Mind Maps

Mind maps are flowcharts that summarise the information visually, making it more likely for a
student to retain the knowledge and build upon it. These are present at the end of the book to
enable last-minute revision by simply spending time on those pages.
 Foreword 5

Nimbus™ Preparation tools

Interactive notes with gamification

The articulated version of the notes is available on the platform, allowing students to get fully
immersed in their learning and complete more in less or equivalent time they spend reading the
book.

Case studies

Case studies are specifically tailored to address the audience commonly using these notes. Having
interesting case studies based on current affairs, covering key organisations etc., contribute to
further professional development.

Technical articles

ACCA’s technical articles are placed strategically in the material, allowing students to understand
when they are supposed to go through these all-important technical articles.

Exam experience

The system mimics the exam experience to ensure that the student has conceptually and
technically mastered the paper before appearing for the exam. This includes various objective
questions, live spreadsheets and word processors to practice typing, presentation and most
importantly, time management.

Question Bank & Test Series

The students have access to unit tests, half portion tests, progressive tests, mock tests and
unlimited practice tests with all performance data allowing them to know where they stand, the
improvements required before the exam day arrives.

Flashcards and Interactive mind maps for revision

Flashcards help students quiz themselves, which is more effective as a revision technique than
simply reading through pages. Interactive mind maps allow the student the power to take a
detailed glance through a whole chapter or large concept in minutes while revising at the same
time.

Check the last page of this book for more information on Nimbus™ LMS by Zell
 Foreword 6

ACCA support

Examining team guidance/Exam technique & reports

The examiners’ reports are an essential study resource. Read them to learn about mistakes that
students commonly make in exams and how to avoid them.

Practice tests

Practice Tests are an interactive study support resource that will replicate the format of all the
exams available as on-demand computer-based exams (CBEs). They will help you to identify your
strengths and weaknesses before you take an exam.

As well as giving you an insight into a live exam experience, Practice Tests will also provide
feedback on your performance. Once you complete the test, you will receive a personalised
feedback diagram showing how you have performed across the different areas of the syllabus.

Specimen exams

The specimen exam indicates how the exam will be assessed, structured and the likely style and
range of questions that could be asked. Any student preparing to take this exam should familiarise
themselves with the exam style.

Technical articles

There is a range of technical articles available on ACCAs website under ‘Study support resources’.
These include a range of simplified articles on complex topics, study support videos, articles on
exam technique etc. making it an important tool to be practised when nearing the exam.

FAQs

Various commonly asked questions about the style of the examination, the coverage, computer-
based exam setup etc., are covered here to allow a student to stay up to date and ensure their
understanding is aligned with that of the ACCA body.

Question practice – ACCA practice platform

Question practice is a vital part of exam preparation. Practising in the CBE environment provides a
fantastic opportunity to get fully prepared for the real exam.

The ACCA Practice Platform contains a range of content that allows you to attempt questions to
time and then mark and debrief your answers. It also contains a blank workspace that allows you
to answer constructed response questions from other sources in the CBE environment.

Past Exam library

Past exams are made available to view and become familiar with the styles of questions that you
may face in your exam.

Make sure you log into the ACCA Practice Platform early in your studies - completing your practice
in the CBE environment is the only way to prepare for your exam fully.
 Foreword 7

CBE Support

Getting ready for your CBE includes getting familiar with the CBE functionality and how to use it to
your advantage in the exam. You should be thinking about your exam approach well before exam
day itself.

There are series of videos that will help you get ready for your exam. It includes what to think
about before your exam day, exam strategy, how to manage your CBE workspace effectively and
techniques you could use to plan and complete your answers.
 Foreword 8

Syllabus

Introduction to the syllabus

The aim of the syllabus is to develop knowledge and skills in understanding and applying IFRS
Standards and the theoretical framework in the preparation of financial statements of entities,
including groups and how to analyse and interpret those financial statements.

The financial reporting syllabus assumes knowledge acquired in Financial Accounting (FA), and
develops and applies this further and in greater depth.

The syllabus begins with the conceptual framework for financial reporting with reference to the
qualitative characteristics of useful information and the fundamental bases of accounting
introduced in the Financial Accounting (FA) syllabus within the Knowledge module. It then moves
into a detailed examination of the regulatory framework of accounting and how this informs the
standard setting process.

The main areas of the syllabus cover the reporting of financial information for single companies and
for groups in accordance with generally accepted accounting principles and relevant IFRS Standards.

The syllabus also covers the analysis and interpretation of information from financial reports.

Finally the syllabus contains outcomes relating to the demonstration of appropriate digital and
employability skills in preparing for and taking the FR examination. This includes being able to
interact with different question item types, manage information presented in digital format and
being able to use the relevant functionality and technology to prepare and present response options
in a professional manner. These skills are specifically developed by practicing and preparing for the
FR exam, using the learning support content for computer-based exams available via the practice
platform and the ACCA website and will need to be demonstrated during the live exam.

Main capabilities

On successful completion of this exam, candidates should be able to:

A. Discuss and apply a conceptual and regulatory frameworks for financial reporting
B. Account for transactions in accordance with International IFRS Standards
C. Analyse and interpret financial statements.
D. Prepare and present financial statements for single entities and business combinations in
accordance with International IFRS Standards
E. Demonstrate employability and technology skills
 Foreword 9

Performance Objectives

Objectives Chapter in Text

PO1 Ethics and professionalism IASB Conceptual Framework

PO2 Stakeholder relationship management Elements of Financial Statements

PO6 Record and process transactions and events IAS 33 - EPS

PO7 Prepare external financial reports Consolidation of Financial Statements and

Profit or Loss Statements

PO8 Analyse and interpret financial reports Ratio & Ratio Analysis
 Foreword 10

Exam Structure

The syllabus is assessed by a three-hour computer-based examination.

All questions are compulsory. The exam will contain both computational and discursive elements.

Some questions will adopt a scenario/case study approach.

Section A of the computer-based exam comprises 15 objective test questions of 2 marks each plus
additional content as per below.

Section B of the computer-based exam comprises three questions each containing five objective
test questions plus additional content as per below.

Section C of the exam comprises two 20 mark constructed response questions.

The 20-mark questions will examine the interpretation and preparation of financial statements for
either a single entity or a group. The section A questions and the other questions in section B can
cover any areas of the syllabus.
 Foreword 11

International accounting standards

It is appreciated when answering audit risk and response questions to mention the IAS applicable.

IAS 1 Presentation of financial statements

IAS 2 Inventories

IAS 7 Statement of cash flows

IAS 8 Accounting policies, changes in accounting

estimates and errors
IAS 10 Events after the reporting period

IAS 12 Income taxes

IAS 16 Property, plant and equipment

IAS 19 Employee benefits

IAS 20 Accounting for government grants and

disclosure of government assistance
IAS 21 The effects of changes in foreign exchange
rates
IAS 23 Borrowing costs

IAS 24 Related party disclosures

IAS 33 Earnings per share

IAS 36 Impairment of non-current assets

IAS 37 Provisions, contingent liabilities and
contingent assets
IAS 38 Intangible assets

IAS 40 Investment property

IAS 41 Agriculture

IFRS 5 Non-current assets held for sale and

discontinued operations
IFRS 15 Revenue from contracts with customers

IFRS 16 Leases
 Foreword 12

SYLLABUS AREA A:

The conceptual and regulatory framework for financial reporting

 1. IASB Conceptual Framework 13

1. IASB Conceptual Framework

Syllabus Area A1a-b-c-d-e-f-g

- Describe what is meant by a conceptual framework for financial reporting.

- Discuss whether a conceptual framework is necessary and what an alternative system
might be.
- Discuss what is meant by relevance and faithful representation and describe the
qualities that enhance these characteristics.
- Discuss whether faithful representation constitutes more than compliance with
accounting standards.
- Discuss what is meant by understandability and verifiability in relation to the provision
of financial information.
- Discuss the importance of comparability and timeliness to users of financial statements.
- Discuss the principle of comparability in accounting for changes in accounting policies.

Syllabus Area A3a-b-c-d-e

- Explain why a regulatory framework is needed including the advantages and

disadvantages of IFRS over a national regulatory framework.
- Explain why accounting standards on their own are not a complete regulatory
framework.
- Distinguish between a principles based and a rules based framework and discuss
whether they can be complementary.
- Describe the IASB’s Standard setting process, including revisions to and interpretations
of Standards.
- Explain the relationship of national standard setters to the IASB in respect of the
standard setting process.

Why the Need for IASB(regulatory) Framework?

The IASB Framework provides the underlying rules, conventions and definitions that underpin the
preparation of all financial statements prepared under International Financial Reporting Standards
(IFRS).

1. Ensures the standards are developed within a conceptual framework.

2. Provide guidance on areas in the absence of a standard.
3. Helps prevent creative accounting (cook-books approach)
4. Ensures financial statements contain relevant information that is useful to users while
making decisions.
5. Helps to improve existing standards
6. Improves harmonisation to bridge the gap between different standards used by different
companies for financial reporting.
 1. IASB Conceptual Framework 14

Principle based framework Rules based framework

Based upon Conceptual framework like IASB Accounting standards are a set of rules which
Framework.(used as a basis) companies must follow
E.g. In UK principles based framework in E.g. Cookbook
terms of Statement of Principles and Approach(manipulating/overstating revenue
Accounting Standards. and profit)
Used in Companies Acts, EU derivatives and
stock exchange rulings.

Objective of financial reporting is to:

‘Provide information that is useful to existing and potential investors, lenders and other creditors
in making decisions(investment, financing, voting) about providing resources to the entity.’

Qualitative Characteristics(which make information useful):

FUNDAMENTAL QUALITATIVE ENHANCING QUALITATIVE CHARACTERISTICS

CHARACTERISTICS (RF) ( U C TV)
(R)Relevance (U) Understandability
(F)Faithful Representation (C) Comparability
(T) Timeliness
(V) Verifiability

Fundamental qualitative characteristics:

Relevance:

Information is relevant if it has the ability to influence the economic decisions of the users and if
the information is timely for those decisions. If any information is omitted or misstated, which
could influence the economic decisions of the users taken on financial statements, then the
information is said to be material. Materiality has a direct impact on the relevance of information.
Qualities of Relevant information has predictive value(enables users to evaluate past, present or
future events) and/or confirmatory value(assists users to confirm past evaluations and
assessments.

Faithful Representation:

The information must be faithfully represented, which should be complete(contains all necessary
descriptions and explanations), neutral(free from biasness which would reflect in the financial
statements) and free from error( the FS must be free from error in boundaries of materiality)

Enhancing qualitative characteristics:

Understandability:

Users have a reasonable knowledge of business and economic activities and review and analyse
the information diligently.
 1. IASB Conceptual Framework 15

Comparability:

Users must be able to compare the financial statements of the company over the years to identify
trends in its financial position and performance and also compare the financial statements of
different entities ideally their competitors, to evaluate their relative financial performance and
financial position. This would only be possible if there is consistency in reporting and disclosure of
accounting policies to the financial statements to achieve comparability.

Verifiability

Direct Verification- Verifying an amount or other representation through direct observation, e.g.
manually counting inventory or counting cash. Indirect Verification- checking the inputs to a
model, formula or other technique and recalculating the outputs using the same methodology'
e.g. recalculating inventory amounts using the same cost flow assumption such as FIFO method.
(Framework, para QC27).

Timeliness

'Timeliness means having information available to decision makers in time to be capable of

influencing their decisions. Generally, the older the information is the less useful it becomes'
(Framework, para QC29).

¨ Apply Your Knowledge:

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Let’s try and solve a couple of exam standard questions:

1) The International Accounting Standards Board’s Conceptual Framework for Financial Reporting
identifies qualitative characteristics of financial statements.

Which TWO of the following characteristics are fundamental qualitative characteristics according
to the IASB’s The Conceptual Framework for Financial Reporting?

A. Relevance
B. Reliability
C. Comparability
D. Faithful representation

2) Which of the following explains the value that relevant information contains?

A. Fair value
B. Instructive value
C. Confirmatory value
D. Present value
 1. IASB Conceptual Framework 16

ANSWER KEY TO APPLY YOUR KNOWLEDGES

1. A and D

2. C
 1. IASB Conceptual Framework 17

PO1 – ETHICS AND PROFESSIONALISM

Description

The fundamental principles of ethical behaviour mean you should always act in the wider public
interest. You need to take into account all relevant information and use professional judgement,
your personal values and scepticism to evaluate data and make decisions. You should identify right
from wrong and escalate anything of concern. You also need to make sure that your skills,
knowledge and behaviour are up-to-date and allow you to be effective in your role.

Elements

a. Act diligently and honestly, following codes of conduct, taking into account – and keeping
up-to-date with – legislation.
b. Act with integrity, objectivity, professional competence and due care and confidentiality.
You should raise concerns about non-compliance.
c. Develop a commitment to your personal and professional knowledge and development.
You should become a life-long learner and continuous improver, seeking feedback and
reflect on your contribution and skills.
d. Identify, extract, interrogate and evaluate complex data to make reliable, informed
decisions.
e. Interrogate, critically analyse and assess data and other information with professional
scepticism. You should challenge opinion and facts through corroboration and robust
testing.

Example activities

 Applying legislation appropriately to client needs.

 Continually reviewing legislation and regulation that affects your working environment.
 Briefing a team on a new standard and how to apply it.
 Keeping sensitive information confidential and disclosing only to those who need it or when
disclosure is legally required.
 Recognising unethical behaviour and telling your line manager about what you have seen.
 Avoiding situations where there may be any threat to your professional independence.
 Deciding what information is important and reliable, using it to support your decision
making.
 Completing all the code of conduct and/or professional ethics training provided by your
organisation.
 Checking transactions and supporting documents to verify the accuracy of accounting
records.
 Use digital technology responsibly to analyse and evaluate data from a variety of sources,
ensuring the integrity and security of this data.
 2. Elements of the Financial Statements 18

2. Elements of the Financial Statements

Syllabus Area A2a-b-c-d-e-f

- Define what is meant by ‘recognition’ in financial statements and discuss the

recognition criteria.
- Apply the recognition criteria to:
(i) assets and liabilities
(ii) income and expenses
- Explain and compute amounts using the following measures:
(i) Historical cost
(ii) Current cost
(iii) Value in use
(iv) Fair value
- Discuss the advantages and disadvantages of historical cost accounting
- Discuss whether the use of current value accounting overcomes the problems of
historical cost accounting.
- Describe the concept of financial and physical capital maintenance and how this affects
the determination of profits.

1. ASSETS
2. LIABILITIES
3. EQUITY INTEREST
4. INCOME
5. EXPENSES

ASSETS

An asset is

 a resource controlled by the entity

 as a result of past events from which future economic benefits are expected to flow to
the entity' (Framework, para 4.4(a))

LIABILITIES

A liability is

 a present obligation of the entity

 arising from past events
 expected to result in an outflow from the entity of resources embodying economic
benefits' (Framework, para 4.4(b)).

EQUITY INTEREST

'Equity is the residual interest in the assets of the entity after deducting all its liabilities'
(Framework, para 4.4 (c))
 2. Elements of the Financial Statements 19

INCOME

Income is

 increases in economic benefits during the accounting period in the form of inflows
 enhancements of assets or decreases of liabilities that result in increases in equity, other
than those relating to contributions from equity participants' (Framework, para 4.25 (a))

EXPENSES

Expenses are

 decreases in economic benefits during the accounting period in the form of outflows
 depletions of assets or incurrences of liabilities that result in decreases in equity, other
than those relating to distributions to equity participants' (Framework, para 4.25 (b)).

Recognition and derecognition

Recognition – An item can only be included or recognised in the financial statements if it results in
a relevant and faithful representation of information.

Derecognition – the removal of complete or part of an asset if it loses control of the asset or has
no present obligation for the liability.

Measurement:

Historical cost Current Value

Assets in financial statements recognised at 1) Fair value - updated information or the
original cost and less written off. market value of the assets and liabilities.
(depreciation)
Advantages: 2) Value in use for assets(Present value of
Easy to understand, straightforward method, Future cash flows from the asset)
Free from bias(objective), Cost can be Fulfilment value for liabilities
confirmed with invoices of the cost, gains are
not recognised until realised.
Disadvantages: 3) Current cost- Based on deprival value of a
-Outdated method of measuring assets and business(deprival value= loss suffered if
liabilities where the true value of current deprived of the asset)
assets and liabilities are not reflected, and Non-monetary assets are adjusted (Inventory
they are misstated in the financial statements. and Non-current assets)
-CV of non-current assets < Current value Monetary assets(cash, receivables, payables,
-Overstatement of profits, understatement of loans) not adjusted.
assets therefore, ROCE is overstated
- Inventory is reflected at the date of purchase
rather than today’s date.
4) Replacement cost- cost to the firm for
replacing a particular asset.(after
depreciation)
Net realisable value-(Fair value less cost to
sell)
 2. Elements of the Financial Statements 20

Capital Maintenance: Theoretical concept which tries to ensure that in times of changing prices,
excessive dividends are not paid out to the shareholders.

Types of Capital Maintenance

Physical/(Operating) Capital Financial Capital Maintenance(FCM)

Maintenance(PCM)
According to this, profits are set aside to allow According to this, profits are set aside to
a business to continue to operate at current preserve the value of shareholder’s funds by
activity levels. monetary terms or constant purchasing
power.
Opening Capital is adjusted by Price Changes. Monetary terms: (Money Financial Capital)
Eg. Opening capital = $2000;Closing capital =
Opening capital = $2000;Closing capital = $2500
$2500 Profit = 2500-2000 = $500
Profit = 2500-2000 = $500
Price change is 10% Constant Purchasing Power:(Real financial
Thus, Increase in Opening capital = Capital)
$2000*10%= 200 Opening capital = $2000;Closing capital =
Opening capital = 2000+200=2200 $2500
Closing Capital = 2500 Profit = 2500-2000 = $500
Profit = 2500-2200 = $ 300 Inflation is 10%
Thus, Increase in Opening capital =
$2000*10%= 200
Opening capital = 2000+200=2200
Closing Capital = 2500
Profit = 2500-2200 = $ 300
 2. Elements of the Financial Statements 21

IFRS Foundation Supervisory body for the Board and is

responsible for governance issues and
ensuring each body is properly funded.
International Accounting Standards Solely responsible for issuing International
Board(IASB) Financial Reporting Standards (IFRS Standards)
International Financial Reporting This committee issues rapid guidance on
Interpretations Committee (IFRIC) accounting matters where divergent
interpretations of IFRS Standards have arisen,
and these must be approved by the Board.
They cover both areas where newly identified
financial reporting issues which are specifically
not dealt with in IFRS Standards and issues
where unsatisfactory or conflicting
interpretations have developed.
The IFRS Advisory Council (IFRSAC) The IFRS Advisory Council provides a forum for
the Board to consult a wide range of
interested parties affected by the Board's
work, with the objectives of:
1. Advising the Board on agenda
decisions and priorities in the Board's
work
2. Informing the Board of the views of
the organisations and individuals on
the Council on major standard-setting
projects
3. Giving other advice to the Board or to
the Trustees.

The procedure for the development of an IFRS Standard is as follows:

 The Board identifies a particular subject and appoints an advisory committee to advise on
the issues of the subject.
 The Board may then issue a discussion paper(DP) to encourage comment.
 The Board publishes an exposure draft(ED) for the public to comment on (which would be
a draft version of the standard to be made)
 The Board publishes the final text of the IFRS Standard taking into consideration of the
comments on the Exposure Draft(ED).
 The publication of an IFRS Standard, exposure draft(ED) or IFRIC Interpretation requires
the votes of at least 8/15 Board members.

¨ Apply Your Knowledge:

ư
E
□
(
Y
.
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J

3) The Body listed below is responsible for issuing International Financial Reporting Standards
and guidance on their application?

A. IFRS Interpretations Committee

B. IFRS Foundation
C. IFRS Advisory Council
D. International Accounting Standards Board
 2. Elements of the Financial Statements 22

4) Bodies listed below acts as the overall supervisory body?

A. IFRS Foundation
B. International Accounting Standards Board
C. IFRS Advisory
D. IFRS Interpretations Committee

QUESTION BANK
SECTION A: 1-27

ANSWER KEY TO APPLY YOUR KNOWLEDGES

3. D

4. A
 2. Elements of the Financial Statements 23

PO2 – STAKEHOLDER RELATIONSHIP MANAGEMENT

Description

You manage stakeholder expectations and needs, developing and maintaining productive business
relationships. You listen to and engage stakeholders effectively and communicate the right
information to them when they need it.

Elements

a. Display sensitivity, empathy and cultural awareness in all your communications. This allows
you to establish trust and credibility with a range of stakeholders and gain their confidence.
b. Use a range of mediums and make appropriate use of digital technology to communicate
clearly, concisely and persuasively in formal and informal situations.
c. Gain commitment from stakeholders by consulting and influencing them to solve problems,
meet objectives and maximise mutually beneficial opportunities.
d. Develop and build effective and ethical professional relationships and networks using face
to face and digital technology.
e. Deal calmly and efficiently with conflicting priorities, deadlines or opinions – both internally
and externally – by listening and negotiating.

Example activities

 Communicating in a way that suits the audience or audiences, using the right tone, style
and medium, including data visualisation techniques. This could include communicating
with clients from different cultures.
 Developing relationships in meetings that lead to positive outcomes.
 Discussing work problems with colleagues or clients to improve and maintain relationships.
 Planning for and engaging positively with the appraisal process.
 Using media and technology to contribute to business related discussions – for example,
contributing to intranet community conversations, hosting virtual meetings or making
online presentations.
 Presenting internally or externally.
 Participating effectively in interviews.
 Drafting reports effectively.
 Dealing well with conflicting deadlines or requirements.
 Acting responsibly and with maturity when there are disagreements.
 Addressing service level complaints.
 Engaging productively with internal and external stakeholders including business partners.
 Discussing expectations of your work with your supervisor.
 Working within your supervisor’s requirements and giving them regular progress updates.
Networking at conferences, internally or by joining business-related groups.
 2. Elements of the Financial Statements 24

SYLLABUS AREA B:

Accounting for transactions in financial statements

 3. Tangible NCA 25

3. Tangible NCA

Syllabus Area B1a-b-c-d-e

- Define and compute the initial measurement of a non-current asset (including
borrowing costs and an asset that has been self-constructed).
- Identify subsequent expenditure that may be capitalized, distinguishing between capital
and revenue items.
- Discuss the requirements of relevant accounting standards in relation to the revaluation
of non-current assets.
- Account for revaluation and disposal gains and losses for non-current assets.
- Compute depreciation based on the cost and revaluation models and on assets that
have two or more significant parts (complex assets).

IAS 16 Property, Plant and Equipment

A. Recognition:
An item of property, plant and equipment should be recognised as an asset when:
 It is probable that future economic benefits associated with the asset will flow to the
entity; and
 The cost of the asset can be measured reliably (IAS 16, para 7).

B. Measurement:
Initial:
 Cost of the asset
 Direct cost is involved in bringing the asset to its working condition and place.
e.g.: Delivery cost, installation, borrowing cost, site preparation etc.
 Dismantling cost at present value.
PV = FV X (1 + Rate/100)^n , Where n is the number of years.

Recording dismantling costs:

Dismantling cost in future is $4m, and the discount rate is 12%, and useful life is 5 years.
Hence we bring this value to present value terms today and capitalize it by adding it to the
initial recognition of the asset and then depreciating it further for the useful life.

PV = 4m X (1 + 12/100)^5 = 2.27m
 3. Tangible NCA 26

Balance sheet adjustment:

(+) PV of dismantling cost to asset Dr 2.27m

(+) Liability (provision) Cr 2.27m

P/L figures for Y1

(+) Finance Cost (liability at start of the year * Interest rate) (P/L) Dr 0.272m
(+) Liability (provision)(B/S) Cr 0.272m

(+) Depreciation (P/L) Dr 0.454m

(-) Asset (B/S) Cr 0.454m

Subsequent:

Subsequent Expenditure on PPE is capitalized only if:

 Enhances the economic benefits from the asset, i.e. increasing productivity of life of the
asset.
 Overhaul or major inspection of the asset.
 Replacing component of a complex asset. (Complex assets are made up of further smaller
assets having a life of their own. E.g. Airplane has an engine, cushioned seats, exterior
body etc., each having different useful lives.)

Illustration 1

A part of machinery has an annual service cost of $23,000. During the recent servicing, it was
decided to replace part of the engineering meaning that it will work faster and produce more
units of product per hour. The cost of the replacement part is $45,000.

Would this be treated as capital or revenue expenditure?

Solution:

 The servicing cost is revenue expenditure, hence should be expensed off to P&L.
 The replacement part enhances future economic benefits and so is capital expenditure and
increases the cost of non-current assets in the statement of financial position

Apply Your Knowledge 1:

Ravi purchased a cruise ship that has a useful economic life of 20 years with no scrap value. The
cruise ship will require a substantial overhaul at the end of year 5, and it’s multiple 5 years except
 3. Tangible NCA 27

year 20. The aircraft has a cost of $50 million, and $10 million of this amount is estimated to be
attributable to the economic benefits that are restored by overhauls. In 6th year the overhaul cost
is estimated to be $12 million. What will be the annual depreciation charge for the years 1–5 and
years 6–10.

Illustration 2

Fincorp LLP revalues its land and buildings and decides to incorporate the revaluation into
financial statements:

Extract from statement of financial position as on 31/3/20X8 is:

Buildings: $000
Cost 1,500
Depreciation (150)

1,350
The building was revalued on 1/4/20X8 and was valued at $1,600,000. Its useful life was estimated
to be 40 years from that date.

Show relevant extracts from the financial statements as at 31/3/20X8.

Solution:

Extract from SPOL:

$000
Depreciation (WN1) (40)
Other Comprehensive Income:
Gain on Revaluation (WN1) 250

Extract from SOFP:

$000
Non-Current Assets
Land and Buildings (WN1) 1,560

Equity
Revaluation Surplus 250

Extract from SOCIE:

 3. Tangible NCA 28

Revaluation Surplus
$000
1/4/20X7 B/f -
Revaluation Gain (WN1) 250

31/3/20X8 C/f 250

WN-1 L&B Note

Land and Buildings $000

1/4/20X8 1,350
Revaluation 250

1,600
Depreciation (1,600/40 years) (40)
31/3/20X8 1,560

1. An asset costing $20m is revalued for the first time to $10m. The next time the asset has been
revalued, there has been a gain of $25m on the revaluation of the asset. What amount should go
in the OCI as Revaluation Gain:

1)$10m
2)$12m
3)$15m
4)$25m

Depreciation:
'Depreciation is the systematic allocation of the depreciable amount of an asset over its useful
life'.
Depreciation can be calculated using two methods:
1) Straight line method
2) Reducing balance method

Transfer of excess depreciation on Revaluation:

On revaluation, depreciation is calculated on the revalued amount of asset. This leads to excess
depreciation. The brunt of this excess depreciation would be borne by shareholders as it will lead
to lesser Retained Earnings which is a distributable reserve. As a result, the company could opt to
follow a policy of transferring excess depreciation from revaluation surplus to retained earnings
yearly.

DR Revaluation surplus
CR Retained Earnings

Asset cost 12m, life of 6 years. Asset revalued at 16m after 2 years
 3. Tangible NCA 29

Old depreciation: 12/6=2m

New depreciation: 16/4=4m

Excess depreciation of 2m (4m-2m) is transferred from the Revaluation surplus to Retained

earnings if the company follows the excess depreciation transfer policy.

If the asset is carried under the revaluation model, the following must be applied:
 Review periodically and keep revaluations of the assets up to date
 Consistent policy for each class of asset.
 Depreciate the revalued asset over its remaining useful life.
 3. Tangible NCA 30

2. A firm purchased a machinery 10 years ago at a cost of $50,000 and have been depreciating it
at a rate of 5% per annum, on the straight line basis. The entity have had the property
professionally revalued at $400,000. What is the revaluation surplus that will be recorded in the
financial statements in respect of this machinery?

A. $300,000
B. $375,000
C. $220,000
D. $330,000

Disposal of Non-Current Assets:

1. Profit or loss on the disposal of a non-current asset should be calculated as the difference
between the net sale proceeds and the carrying amount of the asset at the time of disposal.

2. Gain or Loss is accounted for in the statement of P/L of the period in which the disposal occurs.

3. If the disposed asset is a revalued asset, then any balance remaining on the revaluation surplus
relating to this asset should now be transferred to retained earnings.

3. An entity purchased the property for $8 million on 1 July 20X5. The land element of the
purchase was $2 million. The expected life of the building was 10 years, and its residual value nil.
On 30 June 20X7, the property was revalued to $10 million, of which the land element was $2.5
million and the buildings $7.5 million. On 30 June 20X9, the property was sold for $9 million. What
is the gain on disposal of the property that would be reported in the statement of profit or loss for
the year to 30 June 20X9?

A. Gain $875,000
B. Loss $700,000
C. Gain $1,000,000
D. Gain $1,240,000

QUESTION BANK SUMS :

SECTION A: 29,32,33,37,43,44
 3. Tangible NCA 31

IAS 23 BORROWING COSTS

 IAS 23 Borrowing Costs gives regulations as to how much of the borrowing costs should be
capitalized, which were incurred on money borrowed to finance the acquisition of
qualifying assets. Qualifying asset is one which necessarily takes a substantial period of
time to get ready for its intended use or sale. (Under construction)

 Commencement of Capitalisation of borrowing costs should occur when the expenditure

of asset is being incurred, borrowing costs are being incurred, and activities necessary to
prepare asset for use is in progress.

 Cessation of borrowing costs when all activities for assets intended use are complete or
the construction is suspended (e.g. due to industrial disputes, workers strike)
 Interest Rate used for borrowing costs

Single Rate of Interest: Weighted Average Interest rate :

When money is borrowed specifically for the When money is being used from a pool of funds
construction or preparation of an asset. which were borrowed at different rates of
interest. In this case, a weighted average
interest rate needs to be found. Which is
(Interest on first rate + Interest on Second
Rate)/ Total borrowed funds.
Eg $15m @ 4% and $10m @ 2%. Interest rate
to be used for capitalising is
((15*4%)+(10*2%))/(15+10)=3.2%

 If construction stops, interest should stop getting capitalized and should be expensed.

 If all funds were not being put to immediate use and some of them were invested, then
the interest earned on the invested funds should be deducted from the borrowing costs
giving a net interest cost to be capitalized. However, if construction had not begun or had
stopped for a substantial period, then the interest earned can be treated as investment
income in Profit and Loss.
 3. Tangible NCA 32

4. Manchester United took out a $20 million 8% loan on 1 January 20X3 to build a new football
stadium. Not all funds were immediately required, so $4 million was invested in 4% bonds till 30
June 20X3. Construction of the stadium began on 1 February 20X3 and was completed on 31
December 20X3. Calculate the amount of interest to be capitalised in respect of the football
stadium as at 31 December 20X3?

QUESTION BANK SUMS:

SECTION A : 31,38,39,42
IAS 40 INVESTMENT PROPERTIES

Syllabus area B1f-g

- Discuss why the treatment of investment properties should differ from other properties.
- Apply the requirements of relevant accounting standards to an investment property.

A. Recognition
Investment property is land or a building ‘held to earn rentals or for capital appreciation or both’
(IAS 40, para 5), rather than for use by the entity or for sale in the ordinary course of business.
If a floor is rented out in a building where the building was being carried as per IAS 16 Property,
Plant and equipment, then the floor rented out would be classed as IAS 40 Investment Properties.
Owner occupied properties should be excluded from terming it under Investment Properties.

B. Measurement
Initial:
Investment Properties should initially be measured at cost plus the directly attributable costs.

Subsequent:

Measured at either cost model or fair value model:

Cost model Fair Value Model

Recognised at Cost plus directly attributable  Investment Properties are revalued to
costs and then depreciated further using Fair Value at each reporting date.
either of the two depreciation methods.  There is no depreciation to be charged
under this model.
 Any Gains or losses on revaluation are
recognised in Profit & Loss.
 3. Tangible NCA 33

Illustration 3

Soya Ltd purchased a property for $2 million on 1/1/20X8 for its investment potential. The land
element of the cost is estimated to be $600,000, and the buildings element is expected to have
useful life of 40 years. At 31/12/20X8, local authorities suggest the fair value of the property had
risen to $2.3 million.

Show how the property would be presented in the financial statements as at 31 December 20X8
if Soya Ltd adopts:

(a) The cost model

(b) The fair value model

Solution:

A) Cost Model:

Depreciation for the year = $1,400,000 / 40 = $35,000

Therefore:

 In the statement of profit or loss, there will be a depreciation charge of $35,000

 In the statement of financial position, the property will be shown at a carrying amount of
$2,000,000 – $35,000 = $1,965,000.

B) Fair Value Model

 In the statement of financial position, the property will be shown at its fair value of $2.3
million.
 In the statement of profit or loss, there will be a gain of $0.3 million representing the fair
value adjustment.
 No depreciation is charged.
 3. Tangible NCA 34

CHANGE OF USE OF PROPERTY:

IAS 16 PPE  IAS 40 INVESTMENT PROPERTY IAS 40 INVESTMENT PROPERTY IAS 16 PPE

Check the model at which Investment Property is being carried.

COST MODEL: COST MODEL:

Transfer the asset at date of change of the Transfer the asset at date of change of the
asset from PPE to Investment Property at asset from Investment Property to PPE at
current Carrying value and continue to current Carrying value and continue to
depreciate the asset as under IAS 40 depreciate the asset as under IAS 16 Property,
Investment Property. Plant and Equipment

REVALUATION MODEL: REVALUATION MODEL:

1) At date of change, get the asset 1) At date of change, get the asset
revalued. (as per IAS 16 revaluation revalued(as per IAS 40 revaluation
rule) rule)
2) Transfer the asset at Revaluation 2) Transfer property to PPE at Fair Value
Amount to Investment Property. Do and should depreciate further after
not depreciate the asset further. the transfer has been done.
3) Before date of change: Gain on 3) Before date of change : Gain/loss on
Revaluation should be taken to OCI. Revaluation should be taken to P/L.
4) After date of change: Revaluation 4) After date of change: Revaluation
gain/loss on Investment Property to gain/loss on PPE according to the IAS
be credited in P/L 16 PPE.

5. Kohl Co acquired an investment property a few years ago and carries it under the fair value
model. At 1 January 20X7, the property had a fair value in Kohl Co's financial statements of $14
million. On 1 July 20X7, Kyle Co decided to move into the property and use it for its own business.
At this date, the asset had a fair value of $16 million and a remaining useful life of 16 years. What
amount should be recorded in Kohl Co's statement of profit or loss for the year ended 31
December 20X7?
 3. Tangible NCA 35

QUESTION BANKS SUMS:

SECTION A : 35,36,40,41
IAS 20 ACCOUNTING FOR GOVERNMENT GRANTS & DISCLOSURE OF GOVERNMENT ASSISTANCE

Syllabus area B2a

- Apply the provisions of relevant accounting standards in relation to accounting for
government grants.

 Government grants is money or incentives provided by the government to companies in

return for fulfilling certain conditions, e.g.: Employing workers, purchase of machinery etc.

 Grants should not be recognised until the conditions for receipt have been complied with,
and there is reasonable assurance the grant will be received. The grants also need to be
matched with the expenditure towards which they are intended to contribute.

 The grants should be spread over the period in which the related expenditure is
recognised.

 If the grant is used to buy depreciating assets, then the grant must be spread over the
same life and use the same method.

TYPES OF GRANTS:

REVENUE GRANTS (contribution towards CAPITAL GRANTS (contribution towards the

payroll costs) purchase of NCA)
Method 1: Deferred income method Method 1: Deferred income method
Presented as credit in statement of P/L. Presented as credit in statement of P/L.
and put in Non- current liabilities and Current and put in Non -current liabilities and Current
liabilities as deferred income. liabilities as deferred income.

Method 2: Netting off method Method 2: Netting off method

Reduce the grant income from the expense Reduce Government Grant from the cost of
line item in P/L. Remaining grant should be the asset as a result a reduced depreciation is
split between Current and non -current recorded in Profit & Loss which gives the same
liabilities as deferred income. net impact on Profit as per Method 1.
 3. Tangible NCA 36

Apply Your Knowledge 2:

Revenue Grant
Method 1:

Admin expense is $1m and grant received is 4m for keeping employees for 10 years then:
Journal entry for Y1 end
Cash DR 4m
Government grant Income CR 0.4m (4/10=0.4)
Deferred Income CR 3.6m (0.4m in CL and 3.2m in NCL)

P/L B/S
Grant Income 0.4m NCL Deferred Income: 3.2m (4m-0.4m-0.4m)
Admin expense 1m CL: Deferred Income:0.4m(for next year

Method 2:

Admin expense is $1m and grant received is 4m for keeping employees for 10 years then:

P/L B/S
Admin expense : 1m Non-current liability:
Less: Grant Income: (0.4m) Deferred Income: 3.2m (4m-0.4m(P/L)-0.4m(CL))
Net: 0.6m Current Liability
Deferred Income: 0.4m (for next year

Capital Grant

Method 1:

NCA cost 100000 for 5 years. Grant Income 15000 for 3 years (5000 each year)

P/L B/S
Grant Income: 3000 NCA: 80000 (100000-20000)
Depn: (20000) NCL: Deferred Income: 12000 (15000-3000(P/L)-
3000(CL)) CL: Deferred Income : 3000 (for next year)

Method 2:

NCA cost 100000 for 5 years. Grant Income 15000 for 3 years (5000 each year)

P/L B/S
Depn: 17000 NCA: 100000
Grant Income: (15000)
Carrying Value: 85000
Depn: (85000/5): 17000
Carrying value: 68000
 3. Tangible NCA 37

Repayment of Grants:

 Grant could become repayable if the conditions are not satisfied, which were necessary to
be able to deserve the grant. The repayment amount will depend on the terms of the
conditions of the grant.

 If the deferred income method has been used, then the remaining grant would be repaid
to the government. Any amounts released to profit or loss may also need to be reversed,
if the terms mentioned full repayment.

 If the netting-off method for capital grants has been used, then the cost of the asset must
be increased to recognise the full cost of the asset without the grant. A liability will be set
up for the grant repayment.

QUESTION BANK SUMS:

SECTION A : 30,34,134,136,138

ANSWER KEY TO APPLY YOUR KNOWLEDGES

Apply Your Knowledge 1 Ans:
The cruise ship is treated as two separate components for depreciation purposes:

Years 1–5
$m
Initial overhaul value 10m
depreciated over 5 years 2m
Balance of $40m depreciated over 20 years 2m
Depreciation charge per annum 4m

When the first overhaul is completed at the end of year 5 at a cost of, say, $6 million, then this
cost is capitalised and depreciated to the date of the next overhaul:

Years 6–10

$m
Overhaul 12m
depreciated over 5 years 2.4m
Aircraft depreciation 2m
Depreciation charge per annum 4.4m
Subsequently, PPE can be measured using two models:

1) Cost model
 3. Tangible NCA 38

2) Revaluation Model

1) Cost Model:

The asset is carried at cost less accumulated depreciation less impairment losses.

2) Revaluation Model:

The asset is carried at Revalued Amount less further depreciation.

1st time Revaluation

 If Gain then take it to OCI as Revaluation Gain
 If loss, then take it to P/L as impairment expense.

2nd time Revaluation

 If there is a gain, then take the gain to PL up to the amount of any previous losses, if
further any gain remains, then record in OCI.
If there is a loss, then take the loss amount to OCI up to the amount of previous gain, if further
any loss remains then take it to PL.

Apply Your Knowledge 2 Ans:

Revenue Grant

Method 1:
Journal entry for Y1 end

Cash DR 4m
Government grant Income CR 0.4m (4/10=0.4)
Deferred Income CR 3.6m (0.4m in CL and 3.2m in NCL)

P/L B/S
Grant Income 0.4m NCL Deferred Income: 3.2m (4m-0.4m-0.4m)
Admin expense 1m CL: Deferred Income:0.4m(for next year

Method 2:

P/L B/S
Admin expense : 1m Non-current liability:
Less: Grant Income: (0.4m) Deferred Income: 3.2m (4m-0.4m(P/L)-0.4m(CL))
Net: 0.6m Current Liability
Deferred Income: 0.4m (for next year
 3. Tangible NCA 39

Capital Grant

Method 1:

P/L B/S
Grant Income: 3000 NCA: 80000 (100000-20000)
Depn: (20000) NCL: Deferred Income: 12000 (15000-3000(P/L)-
3000(CL)) CL: Deferred Income : 3000 (for next year)

Method 2:

NCA cost 100000 for 5 years. Grant Income 15000 for 3 years (5000 each year)

P/L B/S
Depn: 17000 NCA: 100000
Grant Income: (15000)
Carrying Value: 85000
Depn: (85000/5): 17000
Carrying value: 68000

ANSWER KEY TO QUIZ

1. 3

2. B

3. A

4. Expense:

Expensed in P/L = (20m * 8% * 1/12)=0.133m( as not in construction months)

Capitalised = (20m * 8% * 11/12) = 1.466m (as in construction months)

Income
Income in P/L= (4m*4%*1/12) = 0.0266m
Income allowed to be capitalised = (4m*4%*5/12) = 0.133m

Net Interest Cost:

A] 1.466m
B] 0.133m
Answer: Net interest cost to be capitalised = (1.466m-0.133m) =1.333m

5. On the date of 1st July 20X7 that Kohl Co moves into the property, it should be classed as
property, plant and equipment as under IAS 16. As Kohl Co uses the fair value model for
investment properties, this should be revalued to fair value at the date of reclassification,
resulting in a fair value gain of $2 million being recorded in the statement of profit or loss.
Following this, the asset should then be depreciated over its remaining useful life of 16 years.
Therefore Kohl Co will also have a depreciation expense of $500,000, being $16m/16 years, for
the last six months of the year.
 4. IAS 38 - Intangible Assets 40

4. IAS 38 - Intangible Assets

Syllabus Area B3a-b-c-d-e-f

- Discuss the nature and accounting treatment of internally generated and purchased
intangibles.
- Distinguish between goodwill and other intangible assets
- Discuss the criteria for the initial recognition and measurement of intangible assets.
- Describe the subsequent accounting treatment, including the principle of impairment tests in
relation to goodwill.
- Indicate why the value of purchase consideration for an investment may be less than the
value of the acquired identifiable net assets and how the difference should be accounted for.
- Describe and apply the requirements of relevant accounting standards to research and
development expenditure.

'An intangible asset is an identifiable non-monetary asset without physical substance'(IAS 38,
para 8)
E.g. Licenses and quotas, trademarks, intellectual property (patents, copyrights)

A. Recognition

For an asset to be classed as under IAS 38 Intangible Assets, the 3 factors need to be considered:

1) Identifiability: The asset is separable from the rest of the business and could be bought and
sold separately.
2) Control: The asset should arise from legal/contractual rights, which could be a part of
purchasing an entire company. As a result, the asset should be controlled by the entity as a result
of past events.
3) Recognition(Framework criteria for asset):
i.e. It is probable that future economic benefits attributable to asset will flow to the entity, and
the cost of the asset can be measured reliably.
 4. IAS 38 - Intangible Assets 41

If all these 3 factors meet, then the intangible assets should be initially recognised at cost.

B. Measurement

INITIAL
Cost + directly attributable costs(legal fees, testing cost) should be capitalised.

6. Which TWO of the following items below could potentially not be classified as intangible
assets?
A. Internally generated brand
B. Licenses and quotas
C. Purchased brand name
D. Training of staff

SUBSEQUENT:

COST MODEL REVALUATION MODEL

Intangible asset carried at cost less Intangible asset revalued to a carrying amount
amortisation and impairment losses. of fair value less amortisation and impairment
losses.
Fair value is determined with reference to an
active market. (market with identical
products, price available to public)
Assets which are prohibited from being
revalued are patents, brand names,
trademarks and publishing rights.
 4. IAS 38 - Intangible Assets 42

The intangible should be amortised over the useful life of the asset, starting only when it is
available for use.

FINITE USEFUL LIFE INDEFINITE USEFUL LIFE

Amortised over the life of the asset, straight There should be no amortisation for this type
line method with no residual value of asset.
Asset should be checked for impairment
annually.

QUESTION BANK SUMS:

SECTION A: 46,48,50
INTERNALLY GENERATED INTANGIBLE ASSETS:

These type of intangible assets cannot be capitalised as the costs associated with them cannot be
identified separately from the costs of running the business.
E.g. Brands, mastheads, customer lists, publishing titles, inherent goodwill.

BRANDS:
Expenditure on internally-generated brands cannot be distinguished from the cost of developing
the business as a whole, so it should be written off as incurred.
Where a brand name is separately acquired and can be measured reliably, then it should be
separately recognised as an intangible non-current asset, and accounted for in accordance with
the general rules of IAS 38.

QUESTION BANK SUMS:

SECTION A: 47
RESEARCH AND DEVELOPMENT:

RESEARCH:
'Research is original and planned investigation undertaken with the prospect of gaining new
scientific knowledge and understanding' (IAS 38, para 8).
Research is written off as incurred to statement of P/L.
 4. IAS 38 - Intangible Assets 43

DEVELOPMENT:
'Development is the application of research findings or other knowledge to a plan or design for
the production of new or substantially improved materials, devices, products, processes, systems
or services before the start of commercial production or use' (IAS 38, para 8).

Development expenditure can be recognised as an intangible asset (hence capitalised) only if a

certain criteria is met else it is expensed.

Criteria – ‘PIRATE’
P Probable flow of future economic benefits from the asset
I Intention to complete the intangible asset and use or sell it
R Reliable measure of development cost
A Adequate resources to complete the asset
T Technical feasibility to complete the asset
E Expenditure measured reliably attributable to the intangible asset during
development

If development expenditure is recognised as an expense in P/L, then it cannot be recognised as an

asset later. If any asset used in the development process then the depreciation of this asset should
be added to the development costs in an intangible asset.
Development expenditure should be amortised over its useful life as soon as commercial
production begins.

Illustration 1

Modern Ltd has incurred following expenditure in the current year:

1. $250,000 spent on the initial design work of a new product – it is anticipated that this design
will be taken forward over the next 2-year period to be developed and tested with a view to
production in 4 years' time.
2. $770,000 spent on the testing of a new production system which has been designed internally
and which will be in operation during the following accounting year. This new system should
reduce the costs of production by 18%.

Solution:

1. These are research costs as they are only in the early design stage and therefore should be
written off to the statement of profit or loss in the period.
2. These would appear to be development stage costs as the new production system is due to be
in place fairly soon and will produce economic benefits in the shape of reduced costs.
Therefore, these should be capitalised as development costs.
 4. IAS 38 - Intangible Assets 44

7. To make the product successful, the entity incurred 500,000 in its initial research to study the
market niche in which it plans to launch the product, which was from 1st Jan 20X5 till the year end.
During the year to 31st December 20X6, Cric Co. incurred $200,000 of development costs for a
new product. In addition, Cric Co spent $60,000 on 1st January 20X6 on machinery specifically used
to help develop the new product and $40,000 on building the brand identity. Commercial
production is expected to start from 1st Jan 20X7. The machinery is expected to last 4 years with
no residual value. What value should be included within Intangible Assets in respect of the above
in Cric Co’s Statement of Financial Position as at 31 December 20X6?

A. 215000
B. 260000
C. 275000
D. 800000
QUESTION BANKS SUMS:
SECTION A: 45,49,51

ANSWER KEY TO QUIZ

6. A and D
7.

Research phase Development phase Commercial production begins

1/1/15 to 31/12/15 1/1/16 to 31/12/16 1/1/17 to 31/12/20 ( 4 years)
Expense in P/L Capitalise in BS Start Amortisation now
Amount: 500,000 Amount: 200,000
Depn: 60000/4 =15000
Total amount to be capitalised : 215000

40000 will be ignored as it is for building brand identity, and hence it is an internally generated
intangible asset and not capitalised
 5. IAS 36 – Impairment of Assets 45

5. IAS 36 – Impairment of Assets

Syllabus Area B4a-b-c-d-e

- Define, calculate and account for an impairment loss
- account for the reversal of an impairment loss on an individual asset.
- Identify the circumstances that may indicate impairments to assets.
- Describe what is meant by a cash generating unit.
- State the basis on which impairment losses should be allocated, and allocate an impairment
loss to the assets of a cash generating unit.

The aim of this standard is to ensure that assets of the entity ‘are carried at no more than their
recoverable amount’ (IAS 36, para 1)

Exceptions to IAS 36 IMPAIRMENT OF ASSETS:

 Inventories (IAS 2)
 Construction contracts (IAS 11)
 Deferred tax assets (IAS 12)
 Financial assets included in the scope of IFRS 9
 Investment property measured at fair value (IAS 40)
 Non-current assets are classified as held for sale (IFRS 5).

INDICATORS OF IMPAIRMENT:

INTERNAL INDICATORS EXTERNAL INDICATORS

Evidence of assets economic performance Changes in the technological, economical,
worse than expected. market, legal environment having an adverse
impact on the company.
Evidence of obsolescence or damage to the Interest rates increasing which would increase
asset. the discount rate, and hence the present value
of the asset’s value in use would reduce.
Change in the way the asset is used. Significant decline in the asset’s Market Value
which is more than expected over the period
of time. (Carrying Value>Market Value of
asset)
Loss of Key employees.
Operating losses or net cash outflow relating
to the asset.
 5. IAS 36 – Impairment of Assets 46

ANNUAL IMPAIRMENT REVIEW WOULD BE MANDATORY FOR THE FOLLOWING IRRESPECTIVE OF

ANY IMPAIRMENT INDICATION OR NO:

1)Goodwill acquired in a business combination

2)Intangible assets unavailable to use.
3)Intangible asset having an indefinite useful life (no depreciation charged on it)

Illustration 1

The following amounts were recorded in the books of Indicate LLP prior to impairment review on
1/1/20X9:

$M
Goodwill 20
Land 45
Buildings 30
Technology 7

The recoverable amount of the unit is expected to be $65 million and it is estimated that the
technology is now worthless.

Show the impact of the impairment as on 1/1/20X9.

Solution:

Carrying amount = $102 million

Recoverable amount = $65 million

Total impairment = $102 - $65 = $37 million.

As the technology is worthless, it should first be written down to $NIL:

Dr Impairment Expense (P&L) $7 million

Cr Technology $7 million

The impairment loss attributable to remaining CGUs is $(37-7) = $30 million:

Dr Impairment Expense (P&L) $30 million

Cr CGUs (WN-1) $30 million
 5. IAS 36 – Impairment of Assets 47

WN-1

CGUs Carrying Amount ($M) Impairment ($M) Post-Impairment Amount ($M)

Goodwill 20 20 NIL
Land 45 6 39
Buildings 30 4 26
Total 95 30 65

WN-2

Impairment Loss remaining after allocation to goodwill = $(30-20) = $10 million

Pro-rate based on carrying amount:

Land: 10 * 45 / (45+30) = $6 million

Buildings: 10 * 30 / (45+30) = $4 million

8. Which TWO of the following is an internal indication that an asset is impaired according to IAS
36 Impairment of Assets?

A. Decrease in market interest rates

B. Increase in market values for the asset
C. Damage caused to the asset
D. Evidence of assets economic performance worse than expected.

QUESTION BANK SUMS:

SECTION A: 61

IMPAIRMENT

Asset is said to be impaired if its Carrying value Is greater than the Recoverable amount.
The recoverable amount is said to be the higher of Fair value less costs to sell (NRV) or Value in
use
 5. IAS 36 – Impairment of Assets 48

Value in use is defined as the present value of future cash flows to be derived from the use of the
asset until its final disposal.

The following information relates to four assets held by the entity:

(All in $m) A B C D
Carrying amount 100 70 95 70
Value in use 80 60 80 10
Fair value less costs to sell 70 40 70 20

Impairment 20 10 15 50

What is the total impairment loss? $ 95 m

Recognition of Impairment:

Impairment losses are recognised as an expense in P/L as Impairment Losses unless related to a
revalued asset, in which case it is taken to the Revaluation surplus first.
The only exception to this is if the impairment reverses a previous gain taken to the revaluation
surplus. In this case, the impairment will be taken first to the revaluation surplus (and so disclosed
as other comprehensive income) until the revaluation gain is fully exhausted, then any excess is
taken to the statement of profit or loss.

Reversal Of Impairment Loss:

The impaired assets should always be reviewed for impairment each year to check if any
impairment needs reversal.

Reversal Effects:
 5. IAS 36 – Impairment of Assets 49

Impairment Through P/L:

If the impairment was through P/L, then the asset value should be increased by the reversal
amount, and the reversal amount should be credited to P/L.
Asset DR xx
Reversal of Impairment(P/L) CR xx

Impairment through Revaluation surplus:

If Impairment was charged through revaluation surplus, then the amount of reversal should
increase the value of the asset and then the OCI should be credited. This amount credited in the
OCI would then, in turn go to the Revaluation surplus.

Asset DR xx
Reversal of Impairment(OCI) CR xx

The maximum reversal allowed is not to be above the value of the asset above its depreciated
historical cost, i.e. the amount it would have been if the original impairment had never been
recorded. The depreciation that would have been charged in the meantime must be taken into
account.

For future years the asset should be depreciated on the changed carrying amount.

Maximum Reversal allowed is: ( Easier proforma for calculation)

Historical Cost X
(less) Depreciation (X)
Historical cost without impairment X
(less) Impaired Carrying amount with Impairment (X)
Maximum Loss which can be reversed XX

An impairment loss recognised for goodwill cannot be reversed in a subsequent period. The
reason for this is that once purchased goodwill has become impaired, any subsequent increase in
its recoverable amount is likely to be an increase in internally generated goodwill, rather than a
reversal of the impairment loss recognised for the original purchased goodwill. Internally
generated goodwill cannot be recognised.

Indicators of Impairment Reversal is the situation in the external and internal impairment factors
reversing in favour of the company.
 5. IAS 36 – Impairment of Assets 50

9. Apple purchased a non-current asset on 1 January 20X5 at a cost of $30,000. At that date, the
asset had a useful life of ten years. Apple doesn’t revalue this type of asset but accounts for it on
the basis of depreciated historical cost. At 31 December 20X6, the asset was subject to an
impairment review and had a recoverable amount of $16,000. At 31 December 20Y0, the asset
has been performing better than expected, and an impairment reversal needs to be done, with
the result that the recoverable amount is now $40,000. What is the maximum the impairment loss
can be reversed too?

A. 10000
B. 15000
C. 16000
D. 5000

QUESTION BANK SUMS

SECTION A: 52-60

CASH GENERATING UNIT(CGU’s)

A CGU is defined as 'the smallest identifiable group of assets that generates cash inflows that are
largely independent of the cash inflows from other assets' (IAS 36, para 6).

The Carrying Value of CGU is compared to that of its recoverable amount.

Just like normal impairment, if CV of asset>Recoverable amount of asset, then it is said to be

impaired. Similarly, in a CGU, if the carrying amount of all assets in a CGU>Recoverable amount of
all assets in a CGU, then the CGU is said to be impaired.
 5. IAS 36 – Impairment of Assets 51

ALLOCATION OF CGU IMPAIRMENT IN THIS ORDER:

1. Any specific asset mentioned is worthless.
2. Purchased goodwill
3. Pro rata any remaining impairment among other assets which are already carried at a
recoverable amount based on the carrying amount of each asset in the CGU.
Note:
 Do not pro rata to cash, trade receivables, inventory or other net assets.
 No individual asset should be written down below its recoverable amount.

10. Berry LLP has a cash generating unit (CGU) suffers a huge decline in income due to reduced
demand for its products. An impairment review was carried out, and the recoverable amount of
the cash generating unit was determined at $150m. The assets of the CGU had the following
carrying amounts immediately prior to the impairment:
Goodwill 20
Intangibles 80
Property, plant and equipment 40
Inventory 40
Trade receivables 20
Total 200

The inventory and receivables are considered to be included at their recoverable amounts.
What is the carrying amount of the intangibles once the impairment loss has been allocated?

A. 60
B. 10
C. 50
D. 40

ANSWER KEY TO QUIZ

8. C and D

9. D

Asset historical cost at 1 January 20X5 30,000

Historical cost depreciation to 31 December 20X6 (5 /10) (15,000)
Historical carrying amount at 31 December 20X6 15,000
Impaired carrying amount(W1) 10,000
Reversal of impairment loss 5,000

10. A

Total CV = 200, Recoverable amount=150 hence impairment of 50

First goes to the goodwill of full goodwill amount of 20 and then the remaining balance
impairment to intangibles and PPE pro rated based on their Carrying Value hence
Impairment to Intangibles are : 80/120*30=20
Therefore CV of Intangibles is 80-20=60
 6. IFRS 5 Non-Current Assets Held For Sale & Discontinued Operations 52

6. IFRS 5 Non-Current Assets Held For Sale & Discontinued Operations

Syllabus area B5a-b-c

- Discuss the importance of identifying and reporting the results of discontinued operations.
- Define and account for non-current assets held for sale and discontinued operations.
- Indicate the circumstances where separate disclosure of material items of income and
expense is required.

OBJECTIVES OF IFRS 5 are:

1. NON CURRENT ASSETS HELD FOR SALE (NCAHFS) should be presented separately on the face
of the statement of the financial position, which would improve the reader’s ability to
interpret results and make meaningful decisions.
2. Discontinued Operations should be presented on the statement of profit or loss, which would
require entities disclose information about operations discontinued in the accounting period.

NON CURRENT ASSETS HELD FOR SALE(NCAHFS)

'An entity shall classify a non-current asset as held for sale if its carrying amount will be recovered
principally through a sale transaction rather than through continuing use' (IFRS 5, para 6).

CRITERIA FOR NCAHFS:

The following criteria should be met for it to be classified as under IFRS 5 NCAHFS: PICWOMB
P - Sale of the asset must be highly PROBABLE
I - INTENTION to sell the asset
C - COMMITTED to sell the asset.
W - plan of WITHDRAWAL to sell the asset are unlikely.
O - sale is expected to be completed within ONE YEAR of classification as held for sale.
M - asset is actively MARKETED at a reasonable price.
B - BUYER of the asset is found.
 6. IFRS 5 Non-Current Assets Held For Sale & Discontinued Operations 53

MEASUREMENT OF NCAHFS:

LOWER OF:

CARRYING FAIR VALUE LESS

AMOUNT COSTS TO SELL

PRESENTATION OF NCAHFS:
1. Separately under current assets.
2. Stop depreciation when the asset is classified as NCAHFS as under IFRS 5.
3. If asset used cost model, Gain or loss to be taken to P/L.
4. If asset used Revaluation Model, then before reclassifying, asset should be revalued with any
gain(FV – CV) to be taken to OCI.
5. If on date of reclassification the asset’s CV > FV less costs to sell amount, then this difference
should be written down as impairment to P/L, and the asset should be carried at the FV less
costs to sell as this is the lower amount.

11. According to IFRS 5 Non-current Assets Held for Sale and Discontinued Operations which TWO
of the following relate to the criteria for an asset held for sale?

A. The management have the intention to sell the asset.

B. The item must be a major line of operations or geographical area
C. The sale is expected to be completed within the next six months
D. The asset has been marketed at a reasonable price.
 6. IFRS 5 Non-Current Assets Held For Sale & Discontinued Operations 54

12. On 1 January 20X5, Rachel Co bought a printing machine for $40,000. It has an expected useful
life of 10 years and no residual value. On 30 September 20X7, Rachel Co decides to sell the
machine and has located a buyer. Its market value at 30 September 20X7 is $18,500, and it will
cost $500 to dismantle the machine and make it available to the buyer. The machine has not been
sold at the year end.

At what value should the machine be stated in Rachel Co’s statement of financial position at 31
December 20X7?

A. 18,000
B. 29,000
C. 11,000
D. 40,000

QUESTION BANK SUMS:

SECTION A: 62,63,64
DISCONTINUED OPERATIONS
A discontinued operation is a 'component of an entity that has either been disposed of, or is
classified as held for sale, and:
 represents a separate major line of business or geographical area of operations
 is part of a single co-ordinated plan to dispose of a separate major line of business or
geographical area of operations, or
 is a subsidiary acquired exclusively with a view to resale' (IFRS 5, para 32)

An entity must disclose a single amount on the face of the statement of profit or loss, 'comprising
the total of:
 the post-tax profit or loss of discontinued operations, and
 the post-tax gain or loss recognised on the measurement to fair value less costs to sell or on
the disposal of the assets constituting the discontinued operation' (IFRS 5, para 33(a))
Distinguishing the performance of current operations and discontinued operations, the users of
the financial statements can predict and forecast future performance more correctly.

This single amount must be disclosed either in the notes to the financial statements or on the face
of the financial statements.
THE SINGLE AMOUNT must include:
 'the revenue, expenses and pre-tax profit or loss of discontinued operations
 the related income tax expense
 the gain or loss recognised on the measurement to fair value less costs to sell or on the
disposal of the assets constituting the discontinued operation' (IFRS 5, para 33(b)).

PROFORMA: (do not refer to this proforma for making Statement of P/L) just for Apply Your
Knowledge purpose
 6. IFRS 5 Non-Current Assets Held For Sale & Discontinued Operations 55

STATEMENT OF P/L PRESENTATION(including discontinued operations)

Continuing operations:
Revenue X
COGS (X)
Gross Profit X
Total Expenses +Finance cost+ tax (X)
Profit for period from continuing operations X
Discontinued operations:
Profit for period from discontinued operationsX Total
Profit for the period:
XX

13. Under which scenario should it be classed as under discontinued operations?

A. Represents major line of business.

B. Subsidiary acquired exclusively for the purpose of resale.
C. Management committed to sell the asset.
D. Buyer of the asset has been located.

14. St. Valentine produced cards and sold roses. However, half way through the year ended 31
March 20X6, the rose business was closed and the assets sold off, incurring losses on the disposal
of non-current assets of $76,000 and redundancy costs of $37,000. The directors reorganised the
continuing business at a cost of $98,000.
Trading results may be summarised as follows:
Cards Roses
$000 $000
Revenue 650 320
Cost of sales 320 150
Distribution 60 90
Administration 120 110
Other trading information (to be allocated to continuing operations) is as
follows:
$000
Finance costs 17
Tax 31
Required:
(a) Draft the statement of profit or loss for the year ended 31 March 20X6.
(b) Explain how an IFRS 5 Discontinued Operations presentation can make information more
useful to the users of financial statements.

QUESTION BANK SUMS

SECTION A: 65
 6. IFRS 5 Non-Current Assets Held For Sale & Discontinued Operations 56

ANSWER KEY TO QUIZ

11. A and D

12. A

Carrying amount at 30 September 20X7:

Cost 40,000
Depreciation year 1 (40,000/10 years) (4,000)
Depreciation year 2 (4,000)
Depreciation year 3 (40,000/10 years × 9 /12) (3,000)
Carrying value at date of classification 29000

Fair value less costs to sell = $18,500 – $500 = $18,000

The machine qualifies as ‘held for sale’ on 30 September 20X7, so it should be stated at the lower
of $29,000 and $18,000. The difference of $11,000 incurred in writing down the machine to fair
value less costs to sell will be charged to the statement of profit or loss as an impairment loss. The
machine will no longer be depreciated once it is reclassified as IFRS 5.

13. A and B

14. Statement of profit or loss for St Valentine for the year ended 31 March 20X6

$000
Continuing operations:
Revenue 650
Cost of sales (320)
––––
Gross profit 330
Administration costs (120)
Distribution costs (60)
––––
Operating profit 150
Reorganisation costs (98)
––––
52
Finance costs (17)
––––
Profit before tax 35
Income tax expense (31)
––––
Profit for the year from continuing operations 4
Discontinued operations:
Loss for the year from discontinued operations (143)
––––
Total loss for the year (139)
 6. IFRS 5 Non-Current Assets Held For Sale & Discontinued Operations 57

In the notes to the accounts disclose analysis of the discontinued

operations figure:
$000
Revenue 320
Cost of sales (150)
––––
Gross profit 170
Administration costs (110)
Distribution costs (90)
––––
Operating loss (30)
Loss on disposal (76)
Redundancy costs (37)
––––
Overall loss (143)
––––

(b) IFRS 5 presentation

When a business segment or geographical area has been classified as a discontinued
operation, IFRS 5 requires a separate presentation be made on the face of the
statement of profit or [Link] separate presentation enables users to immediately
identify that the performance relating to the discontinued segment or area will not
continue in the future, hence making the information more relevant to users’ decision-
[Link] user can choose to include the information when evaluating the past
performance of the company or ignore it when forecasting future outcomes.
 53

7. IFRS 16 Leases

Syllabus Area B6a-b-c

- Account for right of use assets and lease liabilities in the records of the lessee.
- Explain the exemption from the recognition criteria for leases in the records of the lessee.
- Account for sale and leaseback agreements.

DEFINITIONS: (IFRS 16, APPENDIX A)

LEASE: 'A lease is a contract, or part of a contract, that conveys the right to use an asset (the
underlying asset) for a period of time in exchange for consideration.

LESSOR: ' The lessor is the 'entity that provides the right to use an underlying asset in exchange for
consideration.

LESSEE: ' The lessee is the 'entity that obtains the right to use an underlying asset in exchange for
consideration.

RIGHT OF USE OF ASSET: ' A right-of-use asset 'represents the lessee's rights to use an underlying
asset for the lease term.'

WE SHALL USE ONLY LESSEE ACCOUNTING FOR FR Examination purpose:

INITIAL RECOGNITION:
At the start of the lease, the lessee should recognise a lease liability and a right to use of the asset.

LEASE LIABILITY:
‘The lease liability is initially measured at the present value of the lease payments that have not yet
been paid.

Lease payments should include the following (IFRS 16, para 27):

 Fixed payments
 Amounts expected to be payable under residual value guarantees(value of the asset won’t
be less than the guaranteed amount at the start of the lease contract)
 Options to purchase the asset that are reasonably certain to be exercised
 Termination penalties, if the lease term reflects the expectation that these will be incurred.’
 7. IFRS 16 Leases 54

RIGHT OF USE OF ASSET:

‘The right-of-use asset is initially recognised at cost. The initial cost of the right-of-use asset
comprises (IFRS 16, para 24):

 The amount of the initial measurement of the lease liability

 Lease payments made at or before the commencement date
 Any initial direct costs
 The estimated costs of removing or dismantling the underlying asset as per the conditions of
the lease.’

LEASE TERM:

‘The lease term is used to calculate the initial value of the liability and right-of-use asset. The lessee
must consider the length of the lease term. The lease term comprises (IFRS 16, Appendix A):
 Non-cancellable periods
 Periods covered by an option to extend the lease if reasonably certain to be exercised
 Periods covered by an option to terminate the lease if these are reasonably certain not to be
exercised.’

Illustration 1

Ryan enters into an agreement to lease an asset. The terms of the lease are as follows:

1. Primary period is for four years from 1 January 20X2 with a rental of $2,000 pa payable on 31
December each year.
2. The present value of the lease payments is $5,710.
3. The interest rate implicit in the lease is 15%.

What figures will be shown in the financial statements for the year ended 31 December 20X2?

Solution:

A non-current right-of-use asset is recorded at an initial value of $5,710.

Annual depreciation charge = 1/4 × $5,710 = $1,428.

A liability is initially recorded at $5,710.

The total finance charge for the lease is calculated as the difference between the total payments of
$8,000 and the initial value of $5,710 = $2,290. The allocation of this to each rental period is
calculated using the implicit interest rate on a lease liability table as follows:

Period Liability b/f Interest @15% Lease Payment Liability c/f

20X2 5,710 857 (2,000) 4,567
20X3 4,567 685 (2,000) 3,252
20X4 3,252 488 (2,000) 1,740
20X5 1,740 260 (2,000) NIL
The format above will be used whenever the payments under a lease are made in arrears. If the
payments are due in advance, the rental paid is deducted from the capital sum at the start of the
period before the interest is calculated.
 7. IFRS 16 Leases 55

Extracts from Financial Statements

SOPL

$M
Depreciation (1,428)
Finance Cost (857)

SOFP

$M
Non-Current Assets
Right of use of asset ($5,710 - $1,428) 4,282

Non-Current Liabilities
Lease Liability 3,252

Current Liabilities
Lease Liability 1,315

1. On 1 January 20X5, Tendulkar entered into a two year lease for a Ferrari car. The contract contains
an option to extend the lease term for a further year. Tendulkar believes that it is reasonably certain
to exercise this option. Ferrari cars have a useful economic life of ten years. Lease payments are
$20,000 per year for the initial term and $30,000 per year for the option period. All payments are
expected to be paid at the end of the year. To get the lease, Tendulkar incurs initial direct costs of
$6,000. Tendulkar’s incremental rate of borrowing is 5%.

What are the Journal entries to be passed?

 7. IFRS 16 Leases 56

SUBSEQUENT MEASUREMENT:

WITH RESPECT TO LEASE LIABILITY ADJUSTMENTS:

The interest cost as a measure of the outstanding liability*interest rate is added to the lease liability
and recorded as an expense in the P/L, and any cash repayments are subtracted from the
calculation, and the lease liability is reduced by this repayment amount.
For:
Interest component Cash repayment
Finance cost (P/L) DR XX Lease liability(BS fig) DR XX
Lease liability(BS fig) CR XX Cash CR XX

Two methods for calculating payment and lease liability calculation:

1. PAYMENT IN ARREARS
2. PAYMENT IN ADVANCE

PAYMENT IN ARREARS

b/f= PV of lease payments ; FC=b/f*Interest rate

NCL is what is left after payment next year. CL is Year-end liability less NCL
(Shortcut Method: Lease liability split between NCL & CL at y/e (NCL=c/f Y2 and CL=c/f Y1-c/f Y2)

Year 1 b/f + Finance cost(P/L) - Payments = c/f

Year 2 c/f for Y1 + Finance cost(P/L) - Payments = c/f

Eg PV of lease payment is 10000 and repayments is 2000 and interest rate is 10%
Therefore
b/f + FC - Payment = c/f
Y1 10000 + 1000 -2000 = 9000
Y2 9000 + 900 – 2000 = 7900

Thus NCL = 7900 (What is left after payment in next year = 7900)
CL = 1100 (9000(year end liability) – 7900(NCL)
 7. IFRS 16 Leases 57

PAYMENT IN ADVANCE

b/f= PV of lease payments ; FC=(b/f - payments)*Interest rate

NCL is what is left after payment in next year. CL is Year end liability less NCL.
(Shortcut method: Lease liability split between NCL & CL at y/e (NCL=(b/f Y2 – Payments)and
CL=every year payment)

Year 1 b/f - Payments + Finance cost(P/L) = c/f

Year 2 c/f for Y1 - Payments + Finance cost(P/L) = c/f

E.g. PV of lease payment is 10000 and repayments is 2000, and interest rate is 10%
Therefore
Y1 10000 - 2000 + 800 = 8800
Y2 8800 - 2000 +680 = 7480

Thus NCL = 6800 ( What is left after payment in next year(Y2) (8800-2000 = 6800))
CL = 2000 (8800(Year end liability) – 6800(NCL)

WITH RESPECT TO RIGHT TO USE OF ASSETS:

Right of use of an asset is measured using the cost model where the asset is measured at initial cost
less accumulated depreciation and impairment losses.

Depreciation on RTA:
Ownership of asset t/f to the lessee at end of Ownership of asset not t/f to the lessee at end
lease term of lease term
Depreciated over asset’s useful life Depreciated over the shorter of:
Useful life or
Lease term

QUESTION BANK SUMS

SECTION A: 66,68-78,81,82
 7. IFRS 16 Leases 58

MID YEAR ENTRY INTO THE LEASE

If an entity enters into a lease part-way through the year, then the depreciation and interest will
need to be pro rata.
HINT: Add extra columns to split the table between pre and post payment.

Apply Your Knowledge 1:

Rohit entered into an agreement to lease a machinery on 1st October 20X2. This lease requires five
annual payments of $100,000 each starting on 1st October 20X2. The plant has a useful economic life
of five years and is to be of no use and at the end of this period. The present value of the lease
payments is $500,000. The interest rate in the lease is 10%.
What will be the adjustments to the financial statements in respect of the leased machinery for the
year ended 31st March 20X3.

SHORT LIFE OR LOW VALUE ASSETS:

Recognition:
IFRS 16 LEASES considers certain assets as short life or low value assets if:
 Lease is short term ( less than 12 months from the date of start)
 Asset having a monetary value of less than $5,000. Assessment of the asset has to be
assessed based on its value when it is new.
 Examples of Low Value assets are tablets, small personal computers, small items of furniture
and telephones.
Also, NO depreciation is to be charged on short life or low value assets.

Measurement:
Annual lease rental expense = Total rental payable
Total lease period
Charge this rental expense in P/L for relevant months only (pro rata) it.

If Payment<expense then record a payable/accruals in Current liability in BS

If Payment>expense then record a prepaid expense in BS
 7. IFRS 16 Leases 59

2. On 1 April 20X9, Bluestone buys tablets for its sales team under a two year lease agreement. The
term of this lease requires an initial payment of $4,000 followed by two payments of $12,000 each
on 31 March 20Y0 and 31 March 20Y1.

Total rent payable for 31st December 20X9 to be recorded in P/L is :

A. 9000
B. 16000
C. 4000
D. 10500

QUESTION BANK SUMS

SECTION A: 67
 7. IFRS 16 Leases 60

SALE & LEASEBACK

In a Sale and lease back transaction, the seller (lessee) transfers an asset to another entity(lessor)
and then leases the asset back from the buyer.

Case 1: Transfer is not a sale (REFER Q86 from Exam Kit)

Hint: Life of the machine and the lease are of the same years.
The seller will continue to recognise this asset and will recognise a liability equal to the transfer of
proceeds(treated as a loan)

Journal entries to be passed:

1. Cash DR XX
Loan( in NCL) CR XX

2. Finance cost(P/L) DR XX
Non-Current Liability CR XX

3. Depreciation DR XX
Right to use of asset CR XX

Illustration 2

On 1/1/20X8, Lantern Co sold an item of machinery to a university for its fair value of $3.5 million.
The asset had a carrying amount of $1.5 million. This sale represents the satisfaction of a
performance obligation, in accordance with IFRS 15 Revenue from Contracts with Customers.
Lantern Co entered into a contract with the university for the right of use of the asset for next 5
years. Annual payments of $500,000 are due at the end of each year. The interest rate implicit in the
lease is 10%.

The present value of lease payments is $2.1 million. The remaining useful life of the machine is much
greater than the lease term.

Explain how Lantern Co will account for the lease transaction as on 1/1/20X8.

Solution:

Lantern Co must remove the carrying amount of the machine from its statement of financial
position. It should instead recognise a right-of-use asset. This right-of-use asset will be measured as
the proportion of the previous carrying amount that relates to the rights retained by Lantern Co:

$2.1 / 3.5 * 1.5 = $0.9 million

 7. IFRS 16 Leases 61

The accounting entry required is:

$M $M
Dr Cash 3.5

Dr Right of use of asset 0.9

Cr Machinery 1.5

Cr Lease Liability 2.1

Cr P&L (Bal Fig) 0.8

The right-of-use asset and the lease liability will then be accounted for using normal lessee
accounting rules.

3. On 1 January 20X6, Hulk entered into a sale and leaseback of its machinery. When it was sold, the
machinery had a carrying value of $8 million and a remaining life of 10 years. Stark sold the asset for
$9 million and leased it back on a 10 year lease paying $2 million on the last day of December each
year. The lease carried an interest rate of 5%. What is the total expense that should be recorded in
the P/L statement for the year ended 31 December 20X6?

A. 1m
B. 1.25m
C. 0.8m
D. 0.45m

4. On 1 January 20X1, Superman sells an asset to Batman for its fair value of $5 million. The asset
had a carrying amount of $4 million before the sale was done. The transfer is considered to be a sale.
Superman enters into a contract with Batman for the right to use the asset for the next seven years.
 7. IFRS 16 Leases 62

Annual payments of $1,000,000 are to be paid at the year end. The interest rate implicit in the lease
is 5%. The present value of the annual lease payments is 4.5 million. The remaining useful life of the
machine is greater than the lease period.
Give the combined Journal Entries for the sale and leaseback transaction

QUESTION BANK SUMS

SECTION A: 79,80

ANSWER KEY TO QUIZ

1. Answer:
Initial Liability Measurement:
Cashflow Discount factor PV
1st year 20000 1/1.05^1 19048
nd
2 year 20000 1/1.05^2 18140
3rd year 30000 1/1.05^3 25915
Total 63103

Initial Right of use of Asset measurement:

Initial PV of lease liablity 63103
Direct costs 6000
Total 69103

Journal entries

Right of use of asset DR 69103

Lease liability CR 63103
Cash CR 6000
2. D

Total rent payable = (4000+12000+12000)/2=14000

Rent pro rata to 31st December 20X9 in P/L = 14000*9/12=10500
An accrual of 6500 needs to be created in the BS since 4000 has already been paid for as initial
payment
 7. IFRS 16 Leases 63

3. B

The sale is not treated as a sale as the asset’s useful life, and the lease term have the same number
of years(10 years).
Therefore the proceeds from the asset is considered as a loan and considered In NCL.
The finance cost = 9m * 5% = 0.45m
Depreciation = 8m/10 = 0.8m
Total expense = 1.25m

Case 2: Transfer is a sale

HINT: Lease period < Asset’s useful life

Journal entries to be passed are:

Cash DR XX Sale entry
Right of use of asset DR XX Lease back entry
Non-Current assets CR XX Sale entry
Profit CR XX Sale entry
Lease liability CR XX Lease back entry
Right to use asset formula ( gives the amount for rights retained )
(PV of Lease Payments/Sale proceeds of Asset) * Old carrying value

Profit formula ( gives the amount for rights transferred )

((Selling price of asset – PV of lease payments)/Selling of asset) * Gain on disposal

4. Answer:

Cash DR 5m
Right to use asset DR 3.6m = (4.5/5)*4
Asset CR 4m
Lease liability CR 4.5m
Profit/loss (bal fig) CR 0.1m = ((5-4.5)/5)*(5-4)

ANSWER KEY TO APPLY YOUR KNOWLEDGE

1. Solution:

Statement of P/L:
Depreciation(W1) 50000
Finance Costs(W2) 40000

Statement of financial position:

NCA
Right of use of asset(500000 – 50000) 450000
NCL
Lease(W2) 380000
CL
Lease(440000-380000) 60000
 7. IFRS 16 Leases 64

W1 Depreciation

To be depreciated over 5 years

Expense : 500000/5 years * 6/12(pro rata) = 50000

W2 Lease (interest is pro rata for 6 months)

Year end B/f Interest Initial balance Paid Balance@1stOct Interest c/f
31/3/13 - - 500000 (100000) 400000 40000 440000

31/3/14 440000 40000 (100000) 380000

There is no interest charged in the first half of the first year and that the interest charged in the first
half of the second year reflects the interest on the balance at 1 October. Once calculated, the split
for noncurrent and current liabilities works as normal.
 8. Financial Instruments 65

8. Financial Instruments

Syllabus Area B7a-b-c-d-e-f:

- Explain the need for an accounting standard on financial instruments.
- Define financial instruments in terms of financial assets and financial liabilities
- Explain and account for the factoring of receivables.
- Indicate for the following categories of financial instruments how they should be measured and
how any gains and losses from subsequent measurement should be treated in the financial
statements:
i) amortised cost
ii) fair value through other comprehensive income ( including where an irrevocable election has
been made for equity instruments that are not held for trading)
iii) fair value through profit or loss
- Distinguish between debt and equity capital
- Apply the requirements of relevant accounting standards to the issue and finance costs of:
i) Equity
ii) redeemable preference shares and debt instruments with no conversion rights (principle of
amortised cost)
iii) convertible debt

A contract which gives rise to a financial asset for one party and a financial liability or equity for
the second party.

Related Standards:

IAS 32 Financial Instruments: Presentation

For classification of financial instruments and their presentation in the financial statements

IFRS 9 Financial Instruments

Deals with how the financial instruments are measured and when they should be recognised in the
financial statements.

IFRS 7 Financial Instruments: Disclosure

Deals with disclosures to the financial statements about the financial instruments

FINANCIAL ASSETS FINANCIAL LIABILITIES

‘A financial asset is any asset that is: ‘A financial liability is any liability that is a
 cash contractual obligation:
 a contractual right to receive cash or  to deliver cash or another financial
another financial asset from another asset to another entity
entity  to exchange financial assets or liabilities
 a contractual right to exchange with another entity under conditions
financial assets or liabilities with that are potentially unfavourable
another entity under conditions that  that will or may be settled in the
are potentially favourable entity’s own equity instruments.'
 an equity instrument of another entity' (IAS 32, para 11)
(IAS 32, para 11)  Financial liabilities could also be trade
 Financial assets could also be trade payables, debenture loans, redeemable
receivables, options, investments in preference shares.
equity shares.
 8. Financial Instruments 66

FINANCIAL ASSETS
 8. Financial Instruments 67

A. EQUITY
[Link] VALUE THROUGH P/L(DEFAULT INTIAL TREATMENT:
TREATMENT if nothing mentioned.) 1. Fair Value of Financial Assets(equity) is
HINT: FOR TRADING PURPOSE(SHORT TERM) capitalised.
2. Transaction costs are expensed in P/L

SUBSEQUENT TREATMENT:
1. Fair Value is remeasured at every year
end
2. Any gains/losses in the Initial FV and
year end FV will go to the P/L.
[Link] VALUE THROUGH OCI (alternative INTIAL TREATMENT:
treatment) 1. Fair Value of Financial Assets(equity) is
HINT: HELD FOR LONG TERM PURPOSE capitalised.
2. Transaction costs are capitalised.
For knowledge purpose:
Election to designate long term investment via SUBSEQUENT TREATMENT:
FV through OCI is so as to prevent any 1. Fair Value remeasured at every year
volatility in the share price being affected in end.
the entity’s profits. 2. Any gains/losses in the Initial FV and
year end FV will go to the OCI.
3. From OCI it is further transferred to
investment reserve in equity.(If
Investment is sold then this investment
reserve is either transferred to retained
earnings or left in equity section itself)

1. Mr. X buys $1m $1 ordinary shares in Mr. Y’s Co. at a price of $2 as at 1st June 20X2. Transaction
Costs are 1% of the Fair Value. He intends to hold this holding for a short period of time which
would be estimated for around 9 months. As at year end 31st Dec 20X2, the share price
increased to $3 due to a favourable analyst report. How will this Financial asset be treated in the
books of Mr X?
 8. Financial Instruments 68

[Link]. X buys $1m $1 ordinary shares in Mr. Y’s Co. at a price of $2 as at 1st June 20X2. Transaction
Costs are 1% of the Fair Value. He intends to hold this holding for a long period of time which would
be estimated for around 5 years. As at year end 31st Dec 20X2, the share price increased to $3 due to
a favourable analyst report. How will this Financial asset be treated in the books of Mr X?

QUESTION BANK FV THROUGH EQUITY FA

SECTION A: 85,86,91,93

B. DEBT

[Link] VALUE THROUGH P/L(DEFAULT INTIAL TREATMENT:

TREATMENT if nothing mentioned.) 1. Fair Value of Financial Assets(DEBT) is
capitalised.
HINT: FOR TRADING PURPOSE (SHORT TERM) 2. Transaction costs are expensed in P/L

SUBSEQUENT TREATMENT:
1. Fair Value is remeasured at every year
end
2. Any gains/losses in the Initial FV and
year end FV will go to the P/L.
3. Interest Income goes in P/L (Interest
Income @ Coupon rate)
[Link] COST (HOLDING TILL MATURITY) INTIAL TREATMENT:
1. Fair Value of Financial Assets(debt) is
Tests to pass: capitalised.
1) Business Model Test: holding the asset till 2. Transaction costs are capitalised.
maturity
2) Cashflow test: Contractual cashflows should SUBSEQUENT TREATMENT:
be received (Principal & Interest) Amortised Cost Table :

b/f + Effective interest rate – cash received = c/f

1)b/f = FV + transaction cost to be capitalised

2)Effective interest rate on b/f = b/f * Interest%
(as Interest Income in P/L)
3) c/f is the year end figure to put in Financial
asset in B/S.

HINT: in last year the c/f value should be 0

Asset is remeasured using amortised cost table

for finding year end value & Interest Income in
P/L calculated using Effective Interest Rate.
 8. Financial Instruments 69

[Link] VALUE THROUGH OCI INITIAL TREATMENT:

1. Fair Value of Financial Assets(debt) is
Tests to pass: capitalised.
1) Business Model Test: holding the asset till 2. Transaction costs are capitalised.
maturity but may sell in between.
2) Cashflow test: Contractual cashflows should SUBSEQUENT TREATMENT:
be received (Principal & Interest) b/f + Effective Interest Rate – Int received = c/f

1) b/f = FV + transaction cost to be capitalised

2) Effective Interest calculated on b/f for every
year as in AMORTISED COST TABLE, which goes
in P/L as Interest Income.
3) Compare the c/f value with the Fair Value as
at year end, and the difference between this
will go to the OCI, which would further be
transferred to Investment Reserve in the Equity
section.

FV THROUGH AMORTISED COST (DEBT)

3. A company invests $10,000 in 10% loan notes. The loan notes are repayable at a premium of $675
after 3 years. The effective rate of interest is 12%. The company intends to collect the contractual
cash flows, which consist solely of repayments of interest and capital and have therefore chosen to
record the financial asset at amortised cost. What amounts will be shown in the statement of profit
or loss and statement of financial position for the financial asset for years 1–3?
 8. Financial Instruments 70

FV THROUGH OCI (DEBT)

On 1 January 20X1, JK Co. bought a $100,000 5% bond for $95,00 incurring acquisition costs of
$2,000. Interest is received annually in arrears. The bond will be redeemed at a premium of $5,960
over nominal value on 31 December 20X3. The effective rate of interest is 8%. The fair value of the
bond was as follows:
31 December 20X1 $110,000
31 December 20X2 $104,000

i) Show the treatment of the bond if the bond will be held till maturity but maybe sold in between if
opportunity of better returns arises.'
ii) Show the treatment of the bond if it has been bought for short term trading for the Year 1.

QUESTION BANK
SECTION A: 84,87,92
 8. Financial Instruments 71

FINANCIAL LIABILITIES

A. LOAN NOTES:

INITIAL MEASUREMENT :
Initially Recognised at its Fair Value, which is Net Proceeds of the cash received less the costs of
issuing this liability.

Fair Value of Financial Liability = Net Proceeds of Cash received – Costs of issuing the liability

SUBSEQUENT MEASUREMENT:
Loan notes will be carried at amortised cost, other than liabilities held for trading, which are unlikely
to be seen within FR.

Amortised Cost = Initial Value + Effective Interest – Interest Paid

E.g. Bond, which is issued for $1000, is redeemable at $1245. The duration of the bond is 5 years,
and interest is paid at 6%. The effective Interest rate is 10%. Value of bond changing over its life.

Initial measurement: $1,000

Subsequent measurement :

Year b/f Effective Cost paid c/f

Int(P/L
expense)
1 1000 100 (60) =1000+100-60 1040
2 1040 104 (60) =1040+104-60 1084
3 1084 109 (60) =1084+109-60 1133
4 1133 113 (60) =1133+113-60 1186
5 1186 119 (1245+60) =1186+119-1305 0
 8. Financial Instruments 72

B. PREFERENCE SHARES

Redeemable (obligation to pay) Irredeemable (no obligation to pay)

Dividends paid  Show in P/L Dividends paid  Show in equity
, i.e. Add to Finance Cost , i.e. Subtract dividends from Retained
earnings.
Initial and Subsequent measurement: Initial and Subsequent measurement:
Same as loan notes/bonds. They are classified as equity.

C. CONVERTIBLE BONDS:
Lender has the option of choosing shares over cash; has characteristics of both equity and
liabilities.

Initial Measurement:
Liability element:
Liability is measured at fair value, which is the Present Value of future Cashflows (interest + principal
amount), which is discounted using the market rate of interest for Non-convertible debt
instruments.

Equity Element:
Equity element = Loan proceeds – Liability element

Subsequent Measurement:
Liability element:
Measured at amortised cost :
Initial Value + Market Rate Interest – Interest Paid

Equity element:
Not re-measured and remains at the same value on SOFP until the debt has been redeemed.

Illustration 1

Crackle LLP issues a convertible loan that pays interest of 4% per annum in arrears. The market rate
is 10%, being the interest rate for an equivalent debt without the conversion option. The loan of $8
million is repayable in full after three years or convertible to equity. Discount factors are as follows:

Year Discount factor at 810%

1 0.909

2 0.826

3 0.751
Required:

Split the loan between debt and equity at inception.

 8. Financial Instruments 73

Solution:

At inception:

Year Cash flow ($000) DF PV ($000)

1 320 0.909 291
2 320 0.826 264
3 8320 0.751 6,248

$000
Total value of debt 6,803
Equity (Bal Fig) 1,197

Total Cash received 8,000

5. SRC LLP issues a convertible loan that pays interest of 2% per annum in arrears. The market rate is
8%, being the interest rate for an equivalent debt without the conversion option. The loan of $5
million is repayable in full after three years or convertible to equity.

Required: Split the loan between debt and equity at inception and calculate the finance charge for
each year until conversion/redemption.

QUESTION BANK
SECTION A: 83,88,89,90

DERECOGNITION OF FINANCIAL INSTRUMENTS

FINANCIAL ASSETS FINANCIAL LIABILITIES

'when, and only when, the contractual rights to – 'when, and only when, the obligation
the cash flows from the financial asset expire' specified in the contract is discharged or
(IFRS 9, para 3.2.3), cancelled or expires' (IFRS 9, para 3.3.1).
the difference between the carrying amount of the asset or liability, and the amount received or
paid for it, should be included in the profit or loss for the period.

FACTORING OF RECEIVABLES
 8. Financial Instruments 74

This is a scenario where the company transfers its receivables to another company (factor) for
managing and collection of the receivables. The company transferring the receivables would get an
advance on the value of receivables transferred.

WITH RECOURSE (Business retains risk and WITHOUT RECOURSE(Business does not retain
rewards) TRANSFER IS NOT A SALE risk and rewards) TRANSFER IS A SALE
The factor can return any unpaid debts to the Factor bears the risk of irrecoverable debts
business, which indicates that the business
retains the risk of the irrecoverable debts.
In this situation, the transaction is treated like In this situation, the transaction is treated like a
a secured loan against these receivables rather sale, and the receivables are derecognised from
than a sale. Interest is charged on this secured the financial statements.
loan, and no derecognition of the receivables
should be done in the financial statements.
1) Dr Cash 1) DR Cash
Cr Loan CR Trade Receivables
2) DR Interest expense (Finance Cost)
CR Loan

DISCLOSURE OF FINANCIAL INSTRUMENTS (IFRS 7)

Main Disclosures required are:

1. Carrying amount of each class of financial instrument in Statement of Financial Position or notes.
2. Entity must disclose income, expense, gains and losses for each class of financial instrument in
the statement of P/L and OCI or notes.
3. Nature and extent of risks faced by entity. Entity’s exposure to risk, policies for managing risks
and managements objectives should also be disclosed.
 8. Financial Instruments 75

ANSWER KEY TO QUIZ

1.

Fair Value = 1000000*2 = 2000000 in Balance Sheet as Financial Assets

Transaction Costs = 2000000* 1% = 20000 in P/L as Transaction Costs
Fair value as at year end = 1000000*3 = 3000000
Gain in P/L = (3-2)*1000000 = 1000000

Initial Measurement
P/L
Transaction Costs: 20000

B/S
Fair Value of Financial Asset: 2000000

Subsequent Measurement:

P/L
Gain In FV of Financial Assets in P/L: 1000000

B/S
Fair Value of Financial Assets: 3000000

2.

Fair Value = 1000000*2 = 2000000 in Balance Sheet as Financial Assets

Transaction Costs = 2000000* 1% = 20000 Capitalised in B/S
Fair value as at year end = 1000000*3 = 3000000
Gain in P/L = (3-2)*1000000 = 1000000

Initial Measurement
B/S
Fair Value of Financial Asset : 2020000

Subsequent Measurement:
OCI
Gain In FV of Financial Assets in OCI: 1000000

B/S
Fair Value of Financial Assets: 3000000
Investment Reserve (equity section): 1000000 (transfer from OCI to Investment Reserve)
 8. Financial Instruments 76

3.

This financial instrument appears to be a debt instrument which passes both the business model test
and the contractual cash flow characteristics test. It can be measured at amortised cost.

b/f + Effective Interest(12%) – Cash received = c/f

Y1 10000 + (10000*12%)= 1200 - (10000*10%)=1000 = 10200
Y2 10200 + (10200*12%)=1224 - (10000*10%)=1000 = 10424
Y3 10424 + (10424*12%)=1251 - (10000*10%)+10675(bal fig is redeemed)=11675 0

In last year the loan notes will be redeemed at a premium which would be Repayments of Principal
and the Interest Payments hence the balancing figure is the redeemed amount.

If any transaction costs would be there, then they would be capitalised, and this would be added to
the b/f value.

4.

The business model is to hold the asset until redemption, but sales may be made to invest in other
assets will higher returns. Therefore, the debt instrument will be measured at fair value through
other comprehensive income.

The asset is recognised at its fair value plus transaction costs of $97,000 ($95,000 + $2,000).

Interest income will be recognised in profit or loss using the effective rate of interest calculated on
Amortised Cost Table—

AMORTISED COST TABLE

YEAR b/f Effective Cash paid (5%) c/f

Interest(8%)
20X1 97000 7760 (5000) 99760
20X2 99760 7981 (5000) 102741
20X3 102741 8219 (5000) 105960

The asset must be revalued to fair value at the year end, and the gain (compare FV at y/e to Total
figure) will be recorded in other comprehensive income.
YEAR b/f Interest per Interest Total Fair Value Gain/loss
AMORTISED received (b/f + at year end
COST TABLE Interest per
Amortised
cost table-
Interest
received)
20X1 97000 7760 (5000) 99760 110000 10240
20X2 110000 7981 (5000) 112981 104000 (8981)
20X3 104000 8219 (5000) 1259 0 (1259)
Redeem (105960)
value
 8. Financial Instruments 77

ii) Initial Measurement: 95000

Year-end measurement: 110000

Gain transferred to PL: 15000

Interest Income to be recorded in PL: 5000

Acquisition costs $5960 to be expensed in PL

5.

Initial Recognition (In ‘000)

Year Cash flow Discount factor Present value

1 100 0.926 93
2 100 0.857 86
3 5,100 0.794 4,049

Debt 4,228
Equity (balancing figure) 772
Cash received 5,000

Year Opening balance Interest charged at 8% Interest paid at 2% Closing balance

1 4,228 338 (100) 4,466
2 4,466 357 (100) 4,723
3 4,723 377 (100) 5,000

HINT: The carrying amount of the liability at the end of the 3 years will equal the amount to be
repaid.
 9. IAS 37 Provisions, Contingent Liabilities and Contingent Assets 78

9. IAS 37 Provisions, Contingent Liabilities and Contingent Assets

Syllabus Area B8a-b-c-d-e-f

- Explain why an accounting standard on provisions is necessary
- Distinguish between legal and constructive obligations.
- State when provisions may and may not be made and demonstrate how they should be
accounted for.
- Explain how provisions should be measured.
- Define contingent assets and liabilities and describe their accounting treatment and required
disclosures.
- Explain why an accounting standard on provisions is necessary.
i) warranties/guarantees
ii) onerous contracts
iii) environmental and similar provisions
iv) provisions for future repairs or refurbishments.

Why the development of this standard with respect to provision?

1. Since provisions are expensed to P/L, the new management of the entity would set up large
provisions, which would decrease the profit and hence this could be blamed onto the old
management of the organisation.
2. When there was a need to reach targets to get profits, these provisions would be written back
which would thus increase the profit, would happen without any disclosure. Hence the new
management would be looked upon as efficient and having growth, whereas this was actually
created due to discharge of the provisions.
3. Provision was recognised as a result of making expenditure rather than having an obligation to
do so.
4. No proper disclosure would make it difficult to track any movements of the provision in the year.

OBJECTIVE OF IAS 37:

 'Appropriate recognition criteria and measurement bases are applied to provisions,
contingent liabilities and contingent assets, and that
 Sufficient information is disclosed in the notes to the financial statements to enable users to
understand their nature, timing and amount.' (IAS 37 Objective)
 9. IAS 37 Provisions, Contingent Liabilities and Contingent Assets 79

PROVISION:
'A provision is a liability of uncertain timing or amount' (IAS 37, para 10).
'A liability is a present obligation of the entity arising from past events, the settlement of which is
expected to result in an outflow from the entity of resources embodying economic benefits'
(Framework para 4.4 (b)).

RECOGNITION OF A PROVISION:
'A provision shall be recognised when:
1. An entity has a present obligation (legal or constructive) as a result of a past event,
2. A reliable estimate can be made of the amount of the obligation, and
3. It is probable that an outflow of resources embodying economic benefits will be required to
settle the obligation

If these conditions are not met, no provision shall be recognised' (IAS 37, para 14).

1. An entity has a present obligation (legal or constructive) as a result of a past event which
would give rise to a potential outflow of economic resources. The obligation could be
legal/contractual or constructive( expectation from the company due to a course of past
practice irrespective of a legal requirement to do the task)

2. A reliable estimate can be made of the amount of the obligation.

If provision relates only to one event, then measured using the most likely outcome
If provision relates to multiple events, then measured using the expected values approach.

3. It is probable that an outflow of resources embodying economic benefits will be required

to settle the obligation. Not a probable flow then recognise a contingent liability.
 9. IAS 37 Provisions, Contingent Liabilities and Contingent Assets 80

CONTINGENT LIABILITY:
 ‘A possible obligation that arises from past events and whose existence will be confirmed
only by the occurrence or non-occurrence of one or more uncertain future events not wholly
within the control of the entity, or
 A present obligation that arises from past events but is not recognised because: it is not
probable that an outflow of resources embodying economic benefits will be required to
settle the obligation, or the amount of the obligation cannot be measured with sufficient
reliability (IAS 37, para 10)

A contingent liability will only be disclosed as note to the financial statements only, no entries are to
be made in the financial statements except the disclosure.

Illustration 1

During the year to 31 March 20X9, a customer commenced legal proceedings against a company,
claiming that one of the food products that it manufactures had caused several members of his
family to become seriously ill. The company’s lawyers have advised that this action will probably not
succeed.

Should the company disclose this in its financial statements?

Solution

 Legal advice is that the claim is unlikely to succeed.

 It is unlikely that the company has a present obligation to compensate the customer and
therefore no provision should be recognised.
 There is, however, 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.

CONTINGENT ASSET:
'A contingent asset is a possible asset that arises from past events and whose existence will be
confirmed only by the occurrence or non-occurrence of one or more uncertain future events not
wholly within the control of the entity' (IAS 37 para 10).

Accounting Treatment:
DEGREE OF PROBABILITY OUTFLOW INFLOW
Virtually certain(>95%) Recognise liability Recognise asset
Probable(50-95%) Recognise provision Disclose Contingent asset
 9. IAS 37 Provisions, Contingent Liabilities and Contingent Assets 81

Possible(5-50%) Disclose contingent liability Ignore

Remote(<5%) Ignore Ignore

SCENARIOS FOR PROVISIONS:

1. WARRANTY PROVISIONS
2. GUARANTEES
3. FUTURE OPERATING LOSSES
4. ONEROUS CONTRACTS
5. ENVIRONMENTAL PROVISIONS
6. RESTRUCTURING PROVISIONS

WARRANTY PROVISIONS
Provision is required at the time of the sale rather than the time of the repair/replacement as the
making of the sale is a past event which would give rise to an obligation.
The provision required at the time of sale is the number of repairs expected in the future multiplied
by the expected cost of each repair, and these should be reviewed at the end of each accounting
period in the light of further experience.
 9. IAS 37 Provisions, Contingent Liabilities and Contingent Assets 82

GUARANTEES
Mr. A guarantees on behalf of Mr. B to pay off a loan if the other entity is unable to do so.
A provision should be made for this guarantee in the books of Mr. A if it is probable that the
payment will have to be made. If it is not probable, then it should be disclosed as a contingent
liability.

 The company gives warranties on its products. The company’s statistics show that about 5%
of sales give rise to a warranty claim.
 The company has guaranteed the overdraft of another company. The likelihood of a liability
arising under the guarantee is assessed as possible.

1. What is the correct action to be taken in the financial statement for these items?

CASE 1 CASE 2
A Create a provision Disclose by note only
B Disclose by note only No action
C Create a provision Create a provision
D Disclose by note only Disclose by note only

ONEROUS CONTRACTS
'An onerous contract is a contract in which the unavoidable costs of meeting the obligations under
the contract exceed the economic benefits expected to be received under it' (IAS 37, para 10).

Signing the contract would make it a past event, giving rise to the obligation to make payments will
be the measure of excess of costs over the benefits.

Provision for this net cost should be recognised as an expense in the statement of P/L when the
contract becomes onerous.
In further periods this provision would be increased by the unwinding of the discount and reduced
by any charges made.

FUTURE OPERATING LOSSES/FUTURE REPAIRS

NO PROVISION to be made for future operating losses or repairs as they arise in the future, which
could be avoided (shut down of the division or sell the asset which needs repair) and thus, no
obligation exists.
 9. IAS 37 Provisions, Contingent Liabilities and Contingent Assets 83

ENVIRONMENTAL PROVISIONS: (same as Dismantling costs in Tangible NCA chapter)

Environmental provisions will be made if there is either a legal or constructive obligation to carry out
this work.
This will be discounted to present value at a pre-tax market rate.

Non-Current assets DR XX (in PV terms discounted @ pre-tax market rate)

Provisions(NCL) CR XX (in PV terms discounted @ pre-tax market rate)

Every year there will be unwinding of interest and added to Finance Charge in P/L.

RESTRUCTURING PROVISIONS:

'A restructuring is a programme 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' (IAS 37, para 10).
For a provision to happen, there should be a detailed formal plan which is approved, and the plan
has been announced to those who are going to be affected by it.
The provision should include direct expenditure arising from restructuring and should exclude costs
associated with ongoing activities. (e.g. Retraining or relocating staff, marketing or investment in
new systems and distribution networks are to be excluded as they relate to the future conduct of
the business)

2. For a provision to be recorded as under restructuring provisions which one of the following need
to be met?
i) Detailed and formal plan is approved.
ii) Constructive obligation to create an environmental provision.
iii) The plan has been announced to those who are going to be affected by it.
iv) Loss has occurred in the future in the business operations.
v)

QUESTION BANK
SECTION A: 94,96,100,101,102,103,104,105,111
 9. IAS 37 Provisions, Contingent Liabilities and Contingent Assets 84

ANSWER KEY TO QUIZ

1. A
2. i) and iii)
 10. IAS 10 Events After Reporting Period 85

10. IAS 10 Events After Reporting Period

Syllabus Area B8g

- Events after the reporting period
i) distinguish between and account for adjusting and non-adjusting events after the reporting
period
ii) Identify items requiring separate disclosure, including their accounting treatment and required
disclosures.

These are events which occur between the reporting date and the date which the financial
statements are approved for issue by the board of directors. They could be favourable and
unfavourable ones for the company.

ADJUSTING EVENTS NON-ADJUSTING EVENTS

Adjusting events are events after the reporting Non-adjusting events are events after the
date which provide evidence that they existed reporting date which provide evidence that
at the reporting date. they arose after the reporting date.

MATERIAL then DISCLOSE it to Financial

Statements.

NOT MATERIAL then IGNORE it.

Examples:
1. Bankruptcy of a customer 1. Fall in value of investments
(irrecoverable debts arising after
reporting date)
2. Sale of inventory below its cost 2. Announcing a restructuring
providing evidence of NRV.
3. Discovery of frauds or errors. 3. The destruction of a major production plant
by a fire after the reporting date
4. Amounts received or receivable in 4. A major business combination after the
respect of insurance claim which were reporting date
being negotiated at the reporting date
5. Determination of purchase/sale of PPE. 5. Abnormally large changes in asset prices or
foreign exchange rates after the reporting date.
6. Settlement of outstanding court case.

QUESTION BANK
SECTION A: 95,97,98,99
 11. IAS 2 Inventory and IAS 41 Agriculture 86

11. IAS 2 Inventory and IAS 41 Agriculture

Syllabus Area B10a

- Describe and apply the principles of inventory valuation

A. Definition :
Inventories include assets held for sale in the ordinary course of business (finished goods),
assets in the production process for sale in the ordinary course of business (WIP) and
materials and supplies that are consumed in production (Raw materials).

B. Measurement:
Inventories are valued at the lower of cost and Net Realisable Value(NRV)

COST:
Purchase price (includes import duties, transport and handling costs)
(+) Any directly attributable costs (all costs to bring an asset to location and condition to use)
(+) Costs of conversion (direct labour, expenses, production overheads)

Do not include administrative overheads, abnormal wastage, storage costs and selling
overheads in the cost of inventory.

NRV: NRV is the estimated selling price in the normal course of business less the estimated
selling costs.

Methods of valuing inventory:

1. FIFO (used where inventory are ordinarily interchangeable)
2. AVCO (used where inventory are ordinarily interchangeable)
3. ACTUAL UNIT COST (used where inventory are not ordinarily interchangeable)

C. Disclosures:
1. Amount of inventories carried at NRV
2. Total carrying amount
3. Accounting policy adopted
4. Inventory amount recognised as expense during the period
5. Write down of inventory to NRV.

Illustration 1

Value the following items of inventory:

A. Materials costing $12,000 bought for processing and assembly for a profitable special order.
Since buying these items, the cost price has fallen to $10,000.
B. Equipment constructed for a customer for an agreed price of $18,000. This has recently been
completed at a cost of $16,800. It has now been discovered that, in order to meet certain
regulations, conversion with an extra cost of $4,200 will be required. The customer has accepted
partial responsibility and agreed to meet half the extra cost.

Solution

A. Value at $12,000. $10,000 is irrelevant. The rule is lower of cost or NRV, not lower of cost or
replacement cost. Since the special order is known to be profitable, the NRV will be above cost.
 11. IAS 2 Inventory and IAS 41 Agriculture 87

B. Value at NRV, i.e. $15,900, as this is below cost of $16,800. (NRV = contract price, $18,000 – our
share of modification cost, $2,100).
 11. IAS 2 Inventory and IAS 41 Agriculture 88

3. The below costs are relating to a unit of a product provided by AMAZON

Cost of raw materials $10, Direct labour $5
During the current year, $16,000 of production overheads were incurred.
6,000 units were produced during the year, which is lower than the normal level of 8,000 units. This
was due to machine breakdown which produced few faulty products, and hence 1,000 units had to
be scrapped. At the year-end, 500 units are in closing inventory.
How much will the closing inventory be valued at year end?
A. 7500
B. 8500
C. 5000
D. 6000

QUESTION BANK
SECTION A: 106,107,108,110,115,116
IAS 41 AGRICULTURE

Syllabus Area B10b

- Apply the requirements of relevant accounting standards for biological assets

(Exceptions: Intangible asset (IAS 38) and Land related to agricultural activity (IAS 16))

BEARER PLANT (IAS 16:PPE) BIOLOGICAL ASSET(IAS 41) BIOLOGICAL PRODUCE(IAS 41)
1. Held for supply and 1. Probable that future At date of Harvest:
agricultural produce. economic benefits will Measured at FV (-) estimated
2. Remote likelihood of flow to the entity and costs to sell and any gain or
being sold is held for biological losses on initial recognition in
3. Held for more than a produce. P/L.
year. 2. Cost or fair value of
the asset can be After date of harvest:
reliably measured. Biological produce becomes
3. The asset is controlled inventory and should be
by the entity and is in accounted for as under IAS 2
the business for less Inventory (lower of cost and
than a year. NRV). The cost for inventory
should be FV(-)costs to sell at
the point of harvest.
E.g. Vines, tea bushes, fruit Initial measurement: E.g.
trees, sheep(used as an asset), Fair value (-) estimated costs Milk (IAS 41)  Cheese (IAS 2)
etc. classed as bearer plants to sell Wool (IAS 41)Yarn (IAS 2)
and treated as property, plant (No FV then use cost model)
and equipment rather than
accounted as under IAS 41. Subsequent measurement:
Remeasure FV (-) estimated
costs to sell at every year end
and take the gain/loss to P/L.
E.g. Sheep for meat, wool,
milk.
 11. IAS 2 Inventory and IAS 41 Agriculture 89

Government grants received

for biological assets measured
at fair value are reported as
income when the grant
becomes receivable.

If this grant is conditional, then

it is recognised only when the
conditions are met.

4. Farmville owns a dairy farm. At 1st January 20X4, he owns 80 buffaloes worth $700 each in the
local village market. At 31st December 20X4, he owns 90 cows worth $900 each. During the year, he
sold 20 tons of milk at an average price of $3000 a ton. When the buffaloes are sold at the local
market, the selling costs are 2%. What will be the P/L and Financial position adjustments?

QUESTION BANK:
SECTION A: 109, 112, 113, 114
 11. IAS 2 Inventory and IAS 41 Agriculture 90

ANSWER KEY TO QUIZ

3. B

Raw materials 10
Direct labour 5
Production overheads(16000/8000) 2
17
Value of closing inventory = 17 * 500 =8500

4.

P/L
Revenue from milk sales ( 20 * 3000) = 60000
Gain in increase of buffaloes value(W1) = 24500

Balance sheet
NCA
Buffaloes(W1) = 79380

W1
Buffaloes value at 1st January (80*700) * 98% = 54880
Buffaloes value at 31st December (90 * 900) * 98% = 79380
Increase in value = 24500
 12. IFRS 13 Fair Value Measurement 91

12. IFRS 13 Fair Value Measurement

Syllabus Area B12:

‘Fair value is the price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date (i.e. an exit price).’

LEVEL OF INPUTS
LEVEL 1 INPUT Comprises quoted prices(observable) in active
markets for identical assets and liabilities at the
measurement date. Regarded as the most
reliable evidence of fair value and is likely to be
used without making any adjustment.
LEVEL 2 INPUT They are observable inputs which are not
included in Level 1 inputs and are observable
directly or indirectly. They are quoted prices for
similar and not identical assets and liabilities in
active markets and price for identical or similar
assets and liabilities in inactive markets.
They are likely to require some form of
adjustment to arrive at fair value
measurement.
LEVEL 3 INPUT Unobservable inputs for asset or liability which
is based upon the best information which is
available which are available to market
participants.

MEASUREMENT:
When measuring fair value, an entity shall take into account the characteristics of the asset or
liability. Which are, condition and location of the asset and restrictions, if any, on the sale or use of
the asset
An entity shall measure the fair value of an asset or a liability using the assumptions that market
participants would use when pricing the asset or liability, assuming that market participants act in
their economic best interest.

QUESTION BANK
SECTION A: 117
 12. IFRS 13 Fair Value Measurement 92

IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors

Syllabus Area B11:

‘IAS 8 governs the following topics:

1. Selection of accounting policies
2. Changes in accounting policies
3. Changes in accounting estimates
4. Correction of prior period errors.’

[Link] of ‘Accounting policies are the specific principles, bases, conventions, rules
accounting policies and practices applied by an entity in preparing and presenting financial
statements' (IAS 8, para 5).
‘Financial statements provide information that is:
 Relevant to the economic decision-making needs of users
 Reliable in that the financial statements
 represent faithfully the financial position, financial performance
and cash flows of the entity
 reflect the economic substance of transactions, other events
and conditions and not merely the legal form
 are neutral, i.e. free from bias – are prudent, and – are
complete in all material respects' (IAS 8, para 10)

2. Changes in Change in the form of recognition, presentation or measurement basis

accounting policies needed only if:
 ‘is required by an IFRS Standard or
 results in the financial statements providing reliable and more relevant
information' (IAS 8, para 14).
Change should be applied retrospectively with adjustment to the opening
balance of retained earnings in the statement of changes in equity. If this is
not possible, then these should be applied prospectively in the current
year’s statement of P/L.

[Link] Accounting estimate is the judgement made by the management based on

estimates the latest information.
Since this is just an estimation, there needs to be a change, and these
changes are applied prospectively.
These effects should be applied in the statement of P/L in the period of
change, and if subsequent periods are affected, then in the subsequent
periods too.
‘The requirements of IAS 8 are:
 The effects of a change in an accounting estimate should be included in
the statement of profit or loss in the period of the change and, if
subsequent periods are affected, in those subsequent periods.
 The effects of the change should be included in the same income or
expense classification as was used for the original estimate.
 If the effect of the change is material, its nature and amount must be
disclosed.’
E.g. Scrap value of assets, useful lives of assets, depreciation method of
NCA, warranty provision, etc
 12. IFRS 13 Fair Value Measurement 93

[Link] of Prior period errors are misstatements or omissions from the financial
prior period errors statements for one or more than one period.
Current period errors that are discovered in that period should be corrected
before the financial statements are authorised for issue.
Prior period errors are corrected by restating the opening balance of assets,
liabilities and equity as if the error had never occurred and adjustment of
retained earnings opening balance in statement of changes in equity or
disclosing in the financial statements at beginning of the earliest
comparative period.
E.g. Mathematical mistakes, mistakes in applying accounting policies, fraud.

QUESTION BANK
SECTION A: 118,119
 94

13. IFRS 15 – Revenue From Contracts With Customers

Syllabus area B14a-b-c-d-e-f

- Explain and apply the principles of recognition of revenue:
(i) Identification of contracts
(ii) Identification of performance obligations
(iii) Determination of transaction price
(iv) Allocation of the price to performance obligations
(v) Recognition of revenue when/as performance obligations are satisfied.
- Explain and apply the criteria for recognising revenue generated from contracts where
performance obligations are satisfied over time or at a point in time.
- Describe the acceptable methods for measuring progress towards complete satisfaction of
a performance obligation.
- Explain and apply the criteria for the recognition of contract costs.
- Apply the principles of recognition of revenue, and specifically account for the following
types of transaction:
i) principal versus agent
ii) repurchase agreements
iii) bill and hold arrangements
iv) Consignments
- Prepare financial statement extracts for contracts where performance obligations are
satisfied over time.

The revenue is recognised as under a 5 step model: IPTPS

I Identify the contract
P Identify the separate Performance obligations in a contract
T Identify Transaction price
P Allocate transaction Price to different Performance obligations in the contract
S Recognise Revenue when the performance obligation is Satisfied

Step 1: Identify the contract

A contract is 'an agreement between two or more parties that creates enforceable rights and
obligations' (IFRS 15, Appendix A).

A contract can only be recognised if it meets the following criteria: C CRAP

‘An entity can only account for revenue if the contract meets the following criteria:
C : the contract has Commercial substance
C : it is probable that the entity will collect the Consideration to which it will be entitled in exchange
for the goods or services that will be transferred to the customer.'
R : the entity can identify each party’s Rights regarding the goods or services to be transferred
A : the parties to the contract have Approved the contract and are committed to perform their
respective obligations
P : the entity can identify the Payment terms for the goods or services to be transferred.’ (IFRS 15,
para 9).
 13. IFRS 15 – Revenue From Contracts With Customers 95

1. Max LLP has a year end of 31st March 20X5. On 30th September 20X5, they signed a contract with a
customer to provide them with a machinery on 31st March 20X5. Control over the machinery has
been passed on to the customer on 31st March 20X5. The customer will pay $0.5m on 30th July
20X6. By year end Max LLP did not believe that it was probable that they would collect the
consideration that they were entitled to. Can revenue be recognised in this case?

Step 2: Identify the separate Performance obligations in a contract

There might be multiple performance obligations which need to be satisfied in a contract.

The distinct performance obligations in a contract need to be identified.
Performance obligations may not be limited to the goods or services that are explicitly stated in the
contract. An entity’s customary business practices published policies, or specific statements may
create an expectation that the entity will transfer goods or services to the customer.

Apply Your Knowledge 1:

A Motorcycle company enters into a contract with the customer to sell a motorcycle which would
include a certain years’ of free servicing to the motorcycle.

The company must choose if the nature of a performance obligation is to provide the specified
goods or services itself (i.e. the entity is the principal) and if to arrange for another party to provide
the goods or service (i.e. the entity is an agent)
If an entity is an agent, then revenue is recognised based on the fee or commission to which it is
entitled.
 13. IFRS 15 – Revenue From Contracts With Customers 96

2. Tom Co's revenue includes $1 million for goods and services that it sold, acting as an agent for
Jerry. Tom Co earned a commission of 10% on the sales of goods and services and returned the
difference of $0.9 million (included in the cost of sales) to Jerry. How should the agency sale be
treated in Tom’s statement of profit or loss?

Step 3: Determining the transaction price

The transaction price is the 'amount of consideration to which an entity expects to be entitled in
exchange for transferring promised goods or services to a customer' (IFRS 15, Appendix A).

Amounts which are collected on behalf of third or external parties like sales tax are excluded.

‘When determining the transaction price, an entity shall consider the effects of all of the following:
 Variable consideration
 The existence of a significant financing component in the contract
 Non-cash consideration
 Consideration payable to a customer' (IFRS 15, para 48).

Scenarios:
1. Financing
2. Consideration payable to a customer

[Link]:

There could be a possibility that the customer is provided a significant financing benefit by the
entity. In that case, the consideration receivable needs to be discounted to its present value at the
rate at which the customer would borrow funds and unwinding of discount done every year.
HINT:
There is a difference between the Cash Selling price of goods and the Amount of promised
consideration
Long Time difference between payment date and transfer of goods and services to the customer.

3. Control of asset transferred on 1st Jan 20X1 and the payment date is 1st Jan 20X3. The amount to
be transferred is $1m for the asset, interest rate at which the customer borrows is 10%. At what
amount should revenue be recognised?

[Link] payable to a customer

If any amount is paid to the customer in exchange for goods and services, then it is considered to be
a purchase transaction, and this should be accounted for as same if they had been purchased from
suppliers.
If this amount is paid to a customer and it is not for any goods or services, then the entity should
reduce it from the transaction price.
 13. IFRS 15 – Revenue From Contracts With Customers 97

4. P(seller) enters into a contract with Q(buyer) for a transaction amount of 10 million worth of
goods. If P pays Q to compensate Q for late delivery of goods by paying 0.5 million. If goods worth 2
million has been transferred at year end, What is the revenue which should be recognised by P?

Step 4: Allocate transaction Price to different Performance obligations in the contract

The transaction price for each performance obligation should be allocated to it based on the
proportion to it’s stand alone selling prices (observable Price of a good or service which is sold
separately in similar circumstances to the same customer)

Discounts:
A discount should be allocated to each performance obligation in the contract.
A discount should only be allocated to a specific component of the transaction if that component is
regularly sold separately at a discount.

5. Raj LLC sells an asset and one year’s free support for $200,000. It usually sells the machine for
$190,000 but does not sell support for this machine as a stand-alone product. Other support services
offered by Raj LLC get a mark-up of 50%. It is expected that the support will cost Raj LLC $40,000.
 13. IFRS 15 – Revenue From Contracts With Customers 98

STEP 5: RECOGNISE REVENUE

Revenue is recognised 'when (or as) the entity satisfies a performance obligation by transferring a
promised good or service to a customer' (IFRS 15, para 31).

SCENARIOS:
1. Consignment Inventory
2. Repurchase Agreements
3. Bill and Hold Arrangements

1. Consignment Inventory
This issue arises where one entity is legally entitled to the inventory, but the other entity keeps the
inventory in its premises or warehouse. The entity having majority indicators of control (5
INDICATORS OF TRANSFER OF CONTROL) is said to recognise this in its financial statements.

2. Repurchase Agreements
In a scenario where the party sells the asset but has a right to repurchase this same asset in the
future, this is not considered as a sale but a loan against the asset. (Assume that the asset is kept as
collateral for the loan proceeds for simpler understanding)
Indicators of such a scenario are: (FURBS)
 (F)Fair value of an asset at date > Option to repurchase amount at that date (option to
repurchase the asset amount is less than the fair value of the asset)
 (U)Entity continues to use the asset.
 (R)Majority of risks and rewards of ownership of this asset lies with the entity itself.
 (B)The sale of the asset is to a financial institution(bank or finance company)
 (S)The sale of the asset is below the fair value of the asset. (FV > consideration received)

Treatment of such arrangement:

Since the asset will not be considered as a sale but a mere secured loan against the asset, so there
will be an Interest rate on it.

If the transfer of the asset is not a sale:

(Proceeds from the transfer of an asset by bank * Effective Interest rate%)

If the transfer of the asset is a sale

 13. IFRS 15 – Revenue From Contracts With Customers 99

6. Albus sells a with a cost of $1000 to a bank for its fair value of $1500 on 1st Jan 2015. Albus has
the option to repurchase this inventory on 31st Dec 2022 for $2200. He is also responsible for the
risks, rewards and maintenance of the asset and also has possession of this asset in his warehouse.
At 31st Dec 2022, inventory is expected to have a fair value of $4000. How should this be treated in
the financial statements as at year end? Effective interest rate is 5%

3. Bill and hold arrangements

Contract in which one party bills the customer for the goods, but the billing party retains physical
possession of product until it’s transferred to the customer at a point in time in the future.

To include this amount in revenue, the customer should obtain control over the goods, even if it is
physically with the billing entity.

If there is a fee for holding these goods, then these performance obligations should be recognised
over time, and revenue would be recognised on this.

Conditions for bill and hold arrangements: (PURI)

 (P) Product ready for physical transfer to the customer
 (U)Billing entity cannot use or sell the asset to be transferred to the customer.
 (R)Customer has requested such an arrangement.
 (I)Product should be identified belonging to the customer

Performance obligation satisfied at a point in Performance obligation satisfied over time

time
Entity determines the point in time when the 'An entity transfers control of a good or service
customer obtains control of the asset (use and over time and, therefore, satisfies a
get benefits from use of the asset. performance obligation and recognises revenue
over time, if one of the following criteria is met:
5 INDICATORS OF TRANSFER OF CONTROL: A. The customer simultaneously receives
 Customer has legal title to asset. and consumes the benefits provided by
 Physical possession of asset has been the entity’s performance as the entity
transferred by an entity to the performs
customer B. The entity’s performance creates or
 Customer has accepted the possession enhances an asset (for example, work
of the asset. in progress) that the customer controls
 Risks and rewards of ownership of an as the asset is created or enhanced, or
asset is with the customer C. The entity’s performance does not
 The entity giving the rights of the asset create an asset with an alternative use
has a right to payment for the asset by to the entity, and the entity has an
the customer. enforceable right to payment for
performance completed to date' (IFRS
15, para 35).
'For each performance obligation satisfied over
time, an entity shall recognise revenue over
time by measuring the progress towards
complete satisfaction of that performance
obligation' (IFRS 15, para 39).
 13. IFRS 15 – Revenue From Contracts With Customers 100

Methods used :

Output method:
Value of work completed/Contract Price

Input method:
Cost incurred to date/Total expected costs

Revenue will be recognised based on the

amounts of progress made compared to the
total price.

Illustration 1

The following information relates to a construction contract:

Contract Price: $1,000,000

Costs to date: $450,000

Estimated costs to complete: $350,000

Estimated stage of completion: 60%

What amounts of revenue, costs and profit should be recognized in the statement of profit and
loss?

Solution:

$
Revenue ($1,000,000 * 60%) 600,000
Costs ($450,000 + $350,000) * 60% (480,000)

Profit 120,000

QUESTION BANK
SECTION A: 124,126,129

Steps For Satisfying performance obligation over a period of time: (VERY IMPORTANT)

Step 1 : Identify Profit / Loss

Contract Price X
Less: Costs incurred to date (includes depreciation) (X)
Less: Costs to complete (X)
Profit / Loss XX

Step 2: Determine the progress %

Methods used :
Input method : Costs incurred to date / Total costs *100
Output Method: Work completed(certified) / Total contract price *100
 13. IFRS 15 – Revenue From Contracts With Customers 101

Step 3: Record in Statement of P/L (Annual figures)

Scenario A: If in Step 1 there is PROFIT

Recognise revenue on % of Progress = Contract price * progress % X
Recognise Total Cost on % of Progress = Total cost * progress % (X)
Profit in P/L XX

Scenario B: If In Step 1 there is LOSS

Recognise revenue on % of Progress = Contract price * progress % X
Recognise Total Cost on % of Progress = Total cost * progress % (X)
Any remaining losses ( Compare the Red marked XX i.e difference amount) (X)
Loss in P/L XX

Scenario C: If in Step 1 the P/L is unknown

Recognise Revenue as cost incurred to date X
Recognise Cost upto Cost incurred to date (X)
XX

Step 4: Record in Financial Statements (BS) (Cumulative figures)

Method 1 (Technically correct method as per IFRS 15)
Revenue recognized to date X
Less: Amounts invoiced to date (X)
Contract asset/ (liability) X/(X)

Method 2 (Valid as per old standard IAS 11, valid only up to & including June 2022)
Costs Incurred to date(Actual costs) X
Profit/loss to date X/(X)
Amounts billed to date (X)
Contract asset/ Contract Liability XX/(XX)

Illustration 2

On 1st April 20X7, Norway entered into a contract with a customer to construct a specialized building
for $12 million. Norway is not able to use the building for themselves any time during the
construction.

At 31st March 20X8, Norway had incurred costs of $8 million. Costs to complete are estimated to be
$8 million. Norway measures the progress towards completion based on costs incurred.

At 31st March 20X8, Norway had received $2m million from the customer.

How should this transaction be recorded in the year ended 31st March 20X8?

Solution:

The construction of the building should be accounted for as an obligation settled over time.

Norway should recognise revenue based on progress towards satisfaction of the construction of the
building.

Step 1: Overall Contract

 13. IFRS 15 – Revenue From Contracts With Customers 102

$000
Price 12,000
Costs to date (8,000)
Costs to complete (8,000)
Overall Loss (4,000)
As the contract is loss making, Norway should provide for the entire loss immediately.

Step 2: Progress

An input method is used to calculate the progress, being costs to date compared to total costs.

$8,000 / $16,000 = 50%

Step 3: SPOL

$000
Revenue ($12,000 * 50%) 6,000
Cost of sales ($16,000 * 50%) (8,000)
Cost of sales (Provision to recognize the full loss) (2,000)

Loss (4,000)

Revenue and expenses should be recorded based on the progress to date. However, doing this
would only recognise 50% of the loss. Therefore, a provision is made in order to recognise the full
loss of $4 million immediately.

Step 4: SOFP

Method 1 :

$000
Revenue recognised to date 6000
Less: Amounts invoiced to date (2000)

Contract Asset 4000

Method 2:

$000
Costs to date 8,000
Loss to date (4,000)
Less: Amount billed till date (2,000)

Contract Asset 2,000

 13. IFRS 15 – Revenue From Contracts With Customers 103

7. On 1st January 20X5, Lager entered into a contract with a customer to build a machinery for
consideration of $10m. Lager is not able to use the machinery themselves at any point during the
building period. At 31st December 20X5, Lager had incurred costs of $6m. Costs to complete are
estimated at $6m. Lager measures progress towards completion based on costs incurred. At 31st
December 20X5, Lager had received $3 million from the customer.
Required: How should this transaction be accounted for in the year ended 31 December 20X5?

QUESTION BANK
SECTION A : 125,127,128,130,131,132,133,135,137,139

CONTRACT COST

‘IFRS 15 says that the following costs must be capitalised:

 The incremental costs of obtaining a contract.
 The costs of fulfilling a contract if they do not fall within the scope of another standard (such
as IAS 2 Inventories) and the entity expects them to be recovered.’

These Capitalised costs are then amortised as and when revenue is recognised. (expensed in COS
when contract progresses)
Where revenue recognised over time:

Outcome is a profit Outcome is a loss Outcome is unknown

Revenue and costs are Full loss should be recognised Revenue recorded to the level
recognised according to immediately, and provision as of costs till date.
progress. an onerous contract should be Costs should be recognised as
recorded. an expense in the period in
Revenue * Progress X which they incur.
Cost * Progress (X)
Profit XX Revenue = costs , thus 0 profit.
 13. IFRS 15 – Revenue From Contracts With Customers 104

ANSWER KEY TO QUIZ

1.

The contract cannot be accounted for, and no revenue should be recognised as it is not probable
that the entity will collect the consideration to which they would be entitled in exchange of goods
and services.

2.

Tom should not have included $1 million in its revenue as it is acting as the agent and not the
principal. Only the commission element of $100,000 ($1 million × 10%) can be recorded in revenue.
The following adjustment is therefore required:
Dr Revenue 900,000
Cr Cost of sales 900,000

3.

There is a long time difference between the payment date and the transfer of asset date. Hence the
revenue should be recognised at the present value of this consideration amount which would be
(1m*(1/1.1^2)) = 0.826m should be recognised as receivable, and the unwinding of 10% should
happen every year by increasing(recognising) the Finance Income and increase the value of the
receivable.

4.

Payment of 0.5m of 10m = (0.5/10) = 5%

Therefore P reduces 5% from the goods transferred of 2 million and hence should recognise revenue
of (2m*95%) = 1.9million as at year end.

5.

Selling price of machine if sold separately = 190000

Selling price of support if sold separately = 60000 (40000*150%)
Total selling price of product + support if sold separately = 250000

Since they have sold it at 200000, there is a discount, and hence this needs to be allocated
separately to each performance obligation.

Discount they are receiving is 50000(250000-200000), hence 20% on the total selling price
(50000/250000)
IFRS 15 says that an entity must consider whether the discount relates to the whole bundle or to a
particular performance obligation. In the absence of additional information, it is assumed here that
it relates to the whole bundle.

The transaction price allocated to the machine is $152,000 ($190,000 × 80%).

The transaction price allocated to the technical support is $48,000 ($60,000 × 80%).
The revenue will be recognised as and when the performance obligations are satisfied.
 13. IFRS 15 – Revenue From Contracts With Customers 105

6.
• Sale of asset to bank
• Repurchase amount at y/e(2200) < Fair value at y/e(4000)
• Risks and rewards with Albus
Since this is a repurchase agreement, this asset should be still recognised in its financial statements,
and the proceeds of 1000$ 1500 $ should be considered as loan proceeds from the bank. As this
transaction, in essence, is a loan, it has an effective interest of $700 (2200-1500) over the 8 year
period, which gives an effective rate of 5% every year.

7. Solution:

Step 1 : Identify Profit / Loss

Contract Price 10m
Less: Costs incurred to date (6m)
Less: Costs to complete (6m)
Profit / Loss (2m)

Step 2: Determine the progress %

Methods used :
i) Input method : Costs incurred to date / Total costs *100
6m/12m * 100 = 50%

ii) Output method: Work Certified/ Total contract price * 100

Step 3: Record in Statement of P/L (Annual figures)

Scenario B: If In Step 1 there is LOSS

Recognise revenue on % of Progress = Contract price(10m) * progress(50%) 5m
Recognise Total Cost on % of Progress = Total cost(12m) * progress(50%) (6m)
(1m)
Any remaining losses ( Compare the Red marked no. i.e difference amount(-2-(-1)) (1m)
Loss in P/L (2m)

Step 4: Record in Financial Statements (BS) (Cumulative figures)

Method 1
Revenue till date : 5m
Invoiced amount till date : (3m)
Contract asset: 2m

Methods 2
Costs Incurred to date(Actual costs) 6m
Profit/loss to date (2m)
Amounts billed to date (3m)
Contract asset 1m

ANSWER KEY TO APPLY YOUR KNOWLEDGES

1.
A Motorcycle company enters into a contract with the customer to sell a motorcycle which would
include a certain years’ of free servicing to the motorcycle.
 13. IFRS 15 – Revenue From Contracts With Customers 106

The company must choose if the nature of a performance obligation is to provide the specified
goods or services itself (i.e. the entity is the principal) and if to arrange for another party to provide
the goods or service (i.e. the entity is an agent)
If an entity is an agent, then revenue is recognised based on the fee or commission to which it is
entitled.
 14. IAS 21 The Effects Of Changes In Foreign Exchange Rates 107

14. IAS 21 The Effects Of Changes In Foreign Exchange Rates

Syllabus Area B15a-b

- Explain the difference between functional and presentation currency and explain why
adjustments for foreign currency transactions are necessary.
- Account for the translation of foreign currency transactions and monetary/nonmonetary
foreign currency items at the reporting date.

FUNCTIONAL CURRENCY PRESENTATION CURRENCY

‘The currency of the primary economic ‘The currency in which the financial statements
environment in which an entity operates' (IAS are presented’ (IAS 21, para 8).
21, para 8).
PRIMARY FACTORS:
 This currency is influencing the selling
price of goods and services.
 Currency of country whose regulations
and competitive organisations set the
selling price of goods and services.
 Currency influencing raw materials,
labour of goods and services.
SECONDARY FACTORS:
 Currency of funds obtained from
financing activities.
 Currency of receipts of operating
activities

EXCHANGE RATES:
Historic Rate (Spot Rate) Average Rate Closing Rate
This is the rate at which the This is the average rate This is the rate at the reporting
transaction takes place. throughout the accounting date.
period.

Monetary Items Non-Monetary Items

Easily converted to cash. Items which give no right to receive or deliver
E.g. Receivables, loans, payables cash
E.g. Plant and machinery, Inventory
Monetary assets and liabilities retranslated Non-monetary assets and liabilities are not
using the Closing Rate at the reporting date, retranslated at the reporting date unless
with gains and losses to go in P/L. carried at fair value, whereby translate at the
rate when the fair value was established.

Initial Recognition :
Translate @Spot Rate(historic rate)

Subsequent Recognition:
 14. IAS 21 The Effects Of Changes In Foreign Exchange Rates 108

If Transaction is settled during accounting If Transaction is not settled during accounting

period – SETTLED TRANSACTION period- UNSETTLED TRANSACTION
Translate at date the receipt/payment using If the transaction is unsettled at the reporting
the spot rate at date of settling the date then the following should be done:
transaction.
If transaction is a Monetary asset, then it is
The gain and loss on the exchange difference retranslated at the closing rate, and the
between the Initial Recognition amount and gain/loss on the exchange difference between
date at which the transaction settled will go to initial recognition and this transaction at closing
the P/L as gain or loss. rate will go to P/L. (Receivables,payables,loans)

If the transaction is a Non-monetary asset,

then it should remain at the historic rate as at
the reporting date. ( Inventory, Plant &
machinery)

TREATMENT OF EXCHANGE
DIFFERENCES

RELATES TO NON-TRADING
RELATES TO TRADING TRANSACTIONS:
TRANSACTIONS:

DISCLOSED IN
DISCLOSED IN
INTEREST RECEIVABLE & SIMILAR
OPERATING INCOME/EXPENSES
INCOME/ FINANCE COST

Illustration 1

On 1 January 20X6 Foster Co, a company that uses the dollar ($) as its functional currency, buys
goods from an overseas supplier, who uses Dinar (D) as its functional currency. The goods are priced
at D50,000.

Payment is still outstanding at the reporting date of 31 March 20X6.

The prevailing exchange rates are:

1 January 20X6 D1.75 : $1

31 March 20X6 D1.90 : $1

Record Journal Entries for above transactions.

Solution:

Initial Transaction

Translate at historic rate: D50,000 / 1.75 = 28,571

$
 14. IAS 21 The Effects Of Changes In Foreign Exchange Rates 109

Dr Purchases 28,571
Cr Payables 28,571

At Reporting Date

Payables are monetary items, so retranslate at the closing rate on 31 March 20X6, reducing payables
balance to D50,000 / 1.90 = 26,315 an recognizing a gain of $2,256 ($28,571 - $26,315) in the SOPL.

$
Dr Payables 2.256
Cr SPL Exchange Gain 2,256

1. Jones Inc. has its functional currency as the $USD. It trades with several suppliers overseas and
bought goods costing 400,000 Dinar on 1 December 2017.

Jones paid for the goods on 10 January 2018. Flower’s year-end is 31 December.
The exchange rates were as follows:
1 December 2017 4.1 Dinar : $1USD
31 December 2017 4.3 Dinar : $1USD
10 January 2018 4.4 Dinar : $1USD
Show how the transaction would be recorded in Jones’s financial statements.

QUESTION BANK
SECTION A: 120, 121, 122, 123
 14. IAS 21 The Effects Of Changes In Foreign Exchange Rates 110

ANSWER KEY TO QUIZ

1. SOLUTION:

Functional currency (1)

1 December 2015
DR Purchases $97,561
CR Payables $97,561
(400,000 Dinar / 4.1 = $97,561)

31 December 2015
Retranslate the monetary balance (payable) at the closing rate (4.3 Dinar:$1)
(400,000 Dinar / 4.3 = $93,023)

Reduction in payables = $97,561 - $93,023 = $4,538

DR Payables $4,538
CR Profit or loss $4,538

Do not retranslate the non-monetary balance (inventory), and leave it at $97,561 at the reporting
date.

10 January 2016
Translate the payment at the exchange rate on the day of the transaction
(400,000 Dinar/4.4 = $90,909)
DR Payables $93,023
CR Bank $90,909
CR Profit or loss $2,114
 111

15. IAS 12 Income Taxes

Syllabus Area B9a-b-c

- Account for current taxation in accordance with relevant accounting standards.
- Explain the effect of taxable temporary differences on accounting and taxable profits.
- Compute and record deferred tax amounts in the financial statements.

A. CURRENT TAX

Current tax is the amount of income taxes payable (recoverable) in respect of the taxable profit for a
period. It is an estimated figure charged on the profits of the entity, which would be recorded as
Income tax expense in Profit & Loss and Income tax payable in current liability as it is not paid
immediately.

Journal entry for Tax payable by the company:

Income Tax Expense (P/L) DR XX

Income Tax Expense (CL in BS) CR XX

B. UNDER OR OVER PROVISION of TAX

When cash settled against the previous year’s tax estimate is either more or less compared to the
estimate, then a case of over or under provision arises.

OVER PROVISION UNDER PROVISION

Arises when tax estimate in the previous year Arises when tax estimate in the previous year
was more and settled amount against it was was less and settled amount against it was
lesser. more.
i.e. Tax Charge > Actual Tax Payments i.e. Tax Charge < Actual tax payments
A Credit balance of Income tax in the trial A Debit balance of Income tax in the trial
balance is an indicator of over provision. balance is an indicator of under provision.

Deduct from the IT expense for this year. Add to the IT expense for this year.
 15. IAS 12 Income Taxes 112

EG. Current Year is 2019 EG. Current Year is 2019

Current Year liability = 200000 Current Year liability = 200000
Estimated Previous Year liability = 170000 Estimated Previous Year liability = 170000
Settled with Tax authorities = 150000 Settled with Tax authorities = 180000

There will be an over provision here since the There will be an under provision here since the
Tax charge(170000)>Actual tax Tax charge(170000)<Actual tax
payments(150000) payments(180000)

Over provided, so deduct the differential Under provided for so add the differential
amount of 20000(170000-150000) from the amount of 10000(180000-170000) to current
current year’s IT expense. year’s IT expense.

P/L for 2019 P/L for 2019

IT expense = 200000 (- IT expense = 200000
)Over provision = (20000) (+)Under provision = 10000
P/L figure = 180000 P/L figure = 210000

Balance sheet (no change) Balance sheet (no change)

Current liability = 200000 Current liability = 200000

1. The trial balance relates to Jordan as at 31st March 2011:

Debit Credit
$ $
Current tax 200000

A provision for current tax for the year ended 31st March 2011 of $1.5 million is needed. The balance
on current tax in the trial balance represents the under/over the provision of the tax liability for the
year ended 31st March 2010.

What will be the P/L figure?

A. $1.3 million
B. $1.7 million
C. $1.5 million
D. 0.2 million

QUESTION BANK
SECTION A: 140,141,142,143
 15. IAS 12 Income Taxes 113

C. DEFERRED TAX
Is a concept of allocating tax charge to particular accounting periods. The need for this arises as tax
authorities have their own computation of taxable profits while profits as per financial statements
would be different.
The difference in accounting & taxable profits could be due to permanent or temporary differences.
However, it is the temporary difference that will give rise to the deferred tax concept.

Temporary difference occurs when expense or gain is allowed for both accounting and income tax
purposes but recorded in different time periods. E.g. Depreciation as per tax authorities could be
higher in initial years but lower in later years, and in accounting books, depreciation has been
charged at a steady rate on life.

Permanent differences are one-off differences between accounting and taxable profits caused by
certain items not being taxable/ allowable. E.g. entertaining a business client is disallowed as per
income tax.

Following example is a demonstration of the reason why deferred arises and how it is dealt with:
Asset worth 600$ is purchased at the beginning of 1st year. Life of the asset is 3 years.
Income tax authorities give a capital allowance of 50% in the first year and then onwards a 25%
allowance. Tax rate is 10%

As per financial statements:

Items 1st year 2nd year 3rd year
Profit before depreciation 1000 1000 1000
Depreciation -200 -200 -200
Profit after depreciation 800 800 800
Income Tax expense 70+10 85-5 85-5
Tax Liability 10 10 -5 = 5 5-5=0

As per income tax authorities:

Items 1st year 2nd year 3rd year
Profit before Capital allowance 1000 1000 1000
Capital allowance -300 -150 -150
Profit after capital allowance 700 850 850
Income Tax expense 70 85 85

As we can see the in first table, Income tax expense does not match the accruals tax, and to make it
tax expense as per the accruals concept, we have to make the deferred tax correction (In red). After
the correction, tax expense recorded in first table is exactly 10% of accounting profits. The increase
in deferred tax needs to be recorded as a liability in the first year, which is $10. Then onwards the
liability is decreasing as the payment is $5 more in coming years.
 15. IAS 12 Income Taxes 114

From an exam point of view, it is best to follow a 5 step approach to calculate & record impacts of
deferred tax:

1. If deferred tax liability is not given, then find:

Carrying Value of asset – Tax base = Temporary difference (Note: Tax base is CV from tax
authorities point of view)

2. Temporary difference X Tax rate = Closing deferred tax liability/ asset (liability if CV> tax base,
else deferred tax asset)

3. Record the closing deferred tax liability as Non current liability.

4. Changes in deferred tax liability should be recorded in Profit & loss. i.e. Increase in liability as
expense and decrease in liability as a deduction to Income tax expense.

5. Deferred tax on any revaluation gain should be reduced against the revaluation gain in the OCI
and should be added to closing deferred tax liability if not included it.

2. Ganguly Co’s accounting books show the following:

Income tax expense on current year profits $75,000
Under provision in relation to the previous year $5,500
Opening provision for deferred tax $2,300
Closing provision for deferred tax $2,900
What is the income tax expense that will be shown in the statement of profit or loss for the year?

A. 70100
B. 81100
C. 79900
D. 75000

3. Kohli bought an asset which costs $1500. Tax depreciation to date has amounted to $300, and
depreciation charged in the financial statements to date is $140. The rate of income tax is 30%.

Charge in relation to the asset?

A. DT asset of $48
B. DT liability of $42
C. DT asset of $42
D. DT liability of $48
 15. IAS 12 Income Taxes 115

4. On 1ST April 20X5, Langer LLC decided to revalue its land for the first time. A valuation expert
reported that the market value of the land on that date was $90,000. The land was originally
purchased 8 years ago for $75,000. The estimated provision for income tax for the year ended 31st
December 20X5 is $10,000. The difference between the carrying amounts of the net assets of Langer
(including the revaluation of the land above) and the tax base at 31st December 20X5 is $32,000. The
opening balance on the deferred tax account was $3,600. Langer’s rate of income tax is 30%.
Show the effects in P/L, BS and Changes In Equity.

QUESTION BANK
SECTION A: 144,145,146

ANSWER KEY TO QUIZ

1.
IT expense 1.5m
Overprovision (0.2m)
P/L figure 1.3m

2.

IT expense on current period years: 75000

Under provision of previous year 5500
Increase in deferred tax(2900-2300) 600

P/L statement 81,100

3.

Since CV of asset > Tax base of asset it is DT liability

The Temporary difference is (300-140) = $160
The DT liability = 160*30% = 48
 15. IAS 12 Income Taxes 116

4.
Statement of P/L:
IT expense (W1) 11500
OCI:
Revaluation gain (90000-75000) 15000
Deferred tax (15000*30%) (4500) 10500

Statement of Financial Position:

NCA:
Land 90000

Equity
Revaluation surplus 10500

NCL
Deferred Tax 9600

CL
IT payable 10000

Statement of Changes in Equity

Revaluation Gain (90000-75000) 15000
Deferred tax on revaluation (15000*30%) (4500)
10500

W1 Deferred Tax
Balance c/f (32000*30%) 9600
(-)Balance b/f (3600)
Increase In DT 6000

W2 IT expense
Year end estimate 10000
Increase in DT(6000(W1) - 4500(tax on reval)) 1500
11500
 16. IAS 33 – EPS 117

16. IAS 33 – EPS

Syllabus Area B13a

- calculate the eps in accordance with relevant accounting standards (dealing with bonus
issues, full market value issues and rights issues)
- explain the relevance of the diluted eps and calculate the diluted eps involving convertible
debt and share options (warrants)

EPS is regarded as the most important indicator for measuring the company’s performance over the
period and also to compare the company’s EPS with those of the different entities as well as
compare it with them over different accounting periods.

EPS measures performance from the perspective of investors and potential investors and shows the
amount of earnings available to each ordinary shareholder so that it indicates the potential return
on individual investments.

IAS 33 – EPS applies to those companies whose shares are publicly traded. The EPS is calculated
using the consolidated figures.

BASIC EPS = EARNINGS/SHARES

EARNINGS Is the Group PAT less Non Controlling Interest less irredeemable preference share div.
SHARES are the weighted average number of ordinary shares in issue during the period.

EPS changes with each and every type of transaction, and they are namely:
1. ISSUE OF SHARES AT FULL MARKET PRICE
2. BONUS ISSUE
3. BONUS AND MARKET ISSUES COMBINED
4. RIGHTS ISSUE

A. ISSUE OF SHARES AT FULL MARKET PRICE:

Hint: Add new issue of shares to the next calculation and then pro rata it.

This type apportions the earnings over the weighted average equity shares, which takes into
account the date any new shares are issued in the year

EG. 1
Earnings = 110,000
Weighted Average no of equity shares:
At 1st Jan 20X1, there are 100,000 $1 shares, and at 1st July 20X1, an additional 30,000 $1 shares
are issued
 16. IAS 33 – EPS 118

Calculate EPS for 20X1

DATE PERIOD NO. OF SHARES PRO RATA MONTHS TOTAL

=(No of shares* Pro
rate months)
1st Jan to 30th June 100000 6/12 (100,000*6/12)
=50,000
1st July to 31st Dec (100000+30000) 6/12 (130,000*6/12)
=130,000 =65,000
Weighted Average no of equity shares 115,000

EPS = EARNINGS/WEIGHTED AVERAGE EQUITY SHARES

= 110000/115000
EPS = 0.95

1. Harry Potter’s earnings for the year end as at 31st December 20X9 are $2,000,000. On 1st
January 20X9, the issued share capital of Harry Potter was 4,000,000 ordinary shares of $1 each.
The company issued 1,500,000 shares at full market value on 1st July 20X9. What will be the EPS
for Harry Potter for 20X9.

A. 0.42
B. 0.5
C. 0.36
D. 0.72
 16. IAS 33 – EPS 119

B. BONUS ISSUE

HINT: 1. Assume Bonus shares are deemed to have been issued at the start of the year and
2. Multiply the no of shares at the start of the year with a Bonus Fraction(BF) to get no. of
shares.

There is no change in % ownership of the company after a bonus issue, it is just a different way to
compensate the equity shareholders when dividends are not paid or if the company is facing any
liquidity issue.

Apply Your Knowledge 1:

Earnings for 20X2 = 1,000,000

Earnings for 20X1 = 8,16,000
The Bonus issue has been declared for 1st August 20X2 in a ratio of 1 share for every 5 shares held.
The no of shares as at the start of the year(1st Jan 20X2) is 4000000 $1 share. What is the EPS for the
year?

2. Doraemon has a share capital of 7,000,000 $1 equity shares as at 1st Jan 20X2. He makes a bonus
issue for 1 share for every 7 held on 1st July 20X2. The PAT for 20X2 is 4,000,000 and 20X1 is
3,500,000. What is the EPS for 20X2?
A. 0.57
B. 0.5
C. 0.65
D. 0.4

C. BONUS AND MARKET ISSUES COMBINED

HINT: When there is a bonus issue, then use the Bonus Fraction from the start of the year till
before the bonus issue is made. This would also take into consideration if there is a Full
market issue before the bonus issue but not after the bonus issue.
When shares are issued at full MV, then add to shares of previous date period for further
calculation but if it is a Bonus issue, then don’t, it will be total of previous calculation only.
 16. IAS 33 – EPS 120

3. Mr. X had 4 million shares in issue on 1st January 20X5. He issued 2,000,000 shares at market value
on 1st April 20X5, followed by a 1 for 6 bonus issue on 1st August 20X5, with a further 500,000 issued
at market value on 1 October 20X5. Profit for the year ended 31st December 20X5 is $2,000,000,
what will be the basic EPS?

A. 0.621
B. 0.305
C. 0.434
D. 0.715

D. RIGHTS ISSUE

Rights issue are shares offered to existing shareholders at a price below the full market price.
(combination of Issues at full MV and bonus issues).
In rights issue to make it easier, we follow a step by step approach
E.g. The total shares as at 1st Jan 20X1 is 4m $1 equity shares, and there is a rights issue at 1st July
20X1 in the Ratio of 1:5 at $7/share. Market price of each share is $10. Earnings for the year are
4m.
RATIO = 1:5 ( 1 share to get at $7 for every 5 shares held in the company)

STEPS:

1. Calculate the Theoretical ex-rights price:

TERP= ((Shares held in ratio * MV)+(Shares we are to get in ratio * Discounted price))
(Total of the shares held and shares to get)
TERP = ((5*10) + ( 1 * 7)) / (5+1)
= $9.5

2. Find Bonus Fraction

Bonus Fraction = Market Price of a share before issue / TERP
= 10/9.5
= 1.052
3. APPLY THE BONUS FRACTION FROM BEGINNING OF THE YEAR & STOP AT RIGHTS ISSUE
DATE ( BF to not be included in Rights issue calculation)

DATE HINT NO. OF SHARES Bonus PRO TOTAL

PERIOD Fraction RATA =(No of shares* Pro
(Calculated MONTHS rate months*Bonus
in step 2) Fraction)
1st Jan 4000000 1.052 6/12 (4000000*1.052*6/12)
to 30th =2104000
June
1st July Add (4000000+(4000000/5*1) - 6/12 (4800000*6/12)
to 31st Rights =4800000 =2400000
Dec issue
shares
Weighted Average no of equity shares 4,504,000
EPS = 4000000/4504000 = 0.88

Last year restated EPS = Last year EPS * (1/Bonus Fraction)

 16. IAS 33 – EPS 121

QUESTION BANK
SECTION A:147,148,149,152,153

LIMITATIONS OF EPS:

1. EPS is dependent on earnings figure which is subject to areas of judgement. These could be
sensitive in nature. E.g. provisions
2. Using earnings figure solely as a key performance measure would be far too simplistic for
performance analysis.
3. Comparing your company’s EPS to that of the other company would not be a correct basis as
the no. of shares in issue is not related to the amount of capital employed.
EG. Company A has 1m shares in issue with reserves of ½ million whereas Co. B has 1.5m
shares but has reserves of 100000.
4. Different companies use different accounting policies, and hence it would be difficult to
compare the EPS of one company to another.
5. In times of rising prices, EPS will increase as profits increase. There might not be growth in
earnings, but profits just increasing due to an increase in price levels.
6. EPS has historical value as it is based on historical accounts rather than predictive value.

DILUTED EPS

An EPS will decrease due to either increase in shares or decrease in earnings.

Increase in shares could be in the form of a bonus issue, rights issue, conversion of convertible
debts/loans into shares, exercise price for options, new issue of equity shares.

To deal with DILUTED EPS, we have to adjust the earnings and the number of shares taking into
account the number of shares assuming convertibles and options converted to equity shares.
Diluted EPS is the EPS which will be taking into consideration any convertible instruments which
would be converted to equity shares in the future and thus increase the no. of shares.

IMPORTANCE OF DEPS are:

1. Gives warning to equity shareholders that the return on their investment may fall in the
future years.
2. Would give Current Year’s EPS if all future convertible instruments are converted now.

DILUTED EPS = Earnings + Notional extra earnings

No. of shares + notional extra shares
 16. IAS 33 – EPS 122

 Notional extra earnings will be the interest saved on convertible instruments, and tax will
be charged on this additional earnings. Therefore add interest saved and subtract the tax
on this additional earnings.
 'For the purpose of calculating DEPS, the number of ordinary shares shall be the weighted
average number of ordinary shares calculated as for basic EPS, plus the weighted average
number of ordinary shares that would be issued on the conversion of all the dilutive
potential ordinary shares into ordinary shares. Dilutive potential ordinary shares shall be
deemed to have been converted into ordinary shares at the beginning of the period or if
later, the date of the issue of the potential ordinary shares' (IAS 33, para 36)

HINT: Whenever the convertible instruments to convert to equity shares are given, choose the
option with the highest number of equity shares on conversion.

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Mr. Sharma issued a convertible loan note of $ 1.5m on 1st Jan 20X2 and a nominal value of $100
of each loan note for conversion. The loan note has an effective interest rate of 7%. Tax rate is
30%.
Conversion into a number of shares is:
On 31st Dec 20X7 : 130 shares
On 31st Dec 20X8 : 122 shares
On 31st Dec 20X9 : 114 shares
On 31st Dec 20Y0 : 110 shares
Mr. Sharma already has 3.5m shares in issue at $1 ordinary shares. Its earnings(PAT) is $2.5m for
20X2. What will be the diluted EPS and EPS for 20X2?

4. Harshad Mehta had 5 million shares in issue at 1st Jan 20X2, but on 31st Dec 20X2, it had in
issue $3,000,000 convertible loan notes 20X4- 20X7. The loan notes carry an effective rate of 8%.
Income tax rate of 30%. The earnings for the year are $2,600,000. The loan notes will be
convertible into ordinary $1 shares as follows:
20X4 150 $1 shares for $100 nominal value loan stock
20X5 130 $1 shares for $100 nominal value loan stock
20X6 125 $1 shares for $100 nominal value loan stock
20X7 120 $1 shares for $100 nominal value loan stock

Calculate the diluted earnings per share for the year ended 31st December 20X2.

A. 0.520
B. 0.321
C. 0.291
D. 0.283
 16. IAS 33 – EPS 123

QUESTION BANK
SECTION A: 150,151,154,155,156

OPTIONS AND WARRANTS TO SUBSCRIBE FOR SHARES

An option or a warrant will give the holder of this option the right to buy the shares at a
predetermined price in the future.
When this option is exercised, there will be cash to be received by the entity, and hence the Diluted
EPS should take this into consideration.

The no. of shares issued on the exercise of the option would be split into:
1. Shares issued when cash received to buy shares at fair value
2. Remainder of shares treated like bonus issue( which are issued for no consideration at all).
Only this is added to the no. of shares calculation to get the Diluted EPS.
TO get the no. of free shares, the formula is:
No. of options * ((Fair value – exercise price) / Fair value) = Free shares

EG.
On 1st January 20X5, Mr. C has 2 million ordinary shares in issue and issues options for a further ½
million shares. The profit for the year is $250,000. During the year to 31 December 20X5, the fair
value of 1 ordinary share was $2, and the exercise price for the shares under option was $1.
What will be the DEPS be for the year ended 20X5?

Earnings = 250000
No. of shares = 2250000
In issue = 2000000
Options = 500000*((2-1)/2) = 250000 free shares

Hence DEPS = 250000/2250000 = 0.11

 16. IAS 33 – EPS 124

5. Harshad Mehta had 5 million shares in issue at 1st Jan 20X2, but on 31st Dec 20X2, there were
outstanding options to purchase 1million ordinary $1 shares at $2/share. The fair value of ordinary
shares is $3/share. The earnings for the year are $2,600,000.

What will be the diluted EPS for the year 20X2?

A. 0.368
B. 0.521
C. 0.426
D. 0.487

ANSWER KEY TO QUIZ

1. A

DATE PERIOD NO. OF SHARES PRO RATA MONTHS TOTAL

=(No of shares* Pro
rate months)
1st Jan to 30th June 4000000 6/12 (4000000*6/12)
=2000000
1st July to 31st Dec (4000000+1500000) 6/12 (5500000*6/12)
=5500000 =2750000
Weighted Average no of equity shares 4750000

EPS for 20X9= Earnings / Weighted average no of equity shares

= 2000000 / 4750000
EPS for 20X9 = 0.42

2. B

DATE PERIOD NO. OF SHARES Bonus Fraction TOTAL

(1+(1/7)) = 8/7 =(No of shares*
Bonus Fraction)
1st Jan to 31st Dec 7000000 8/7 (7000000*8/7)
=8000000
Weighted Average no of equity shares 8,000,000

EPS 20X2 = 4000000/8000000 = 0.5

Comparitive EPS for 20X1 = 0.5 * 7/8 = 0.4375 or (3500000/8000000)
If no bonus issue then EPS for would have been (3500000/7000000)=0.5 for 20X1.
 16. IAS 33 – EPS 125

3. B
DATE HINT NO. OF SHARES Bonus Fraction PRO RATA TOTAL
PERIOD (1+(1/6))=7/6 MONTHS =(No of shares* Pro
rate months*Bonus
Fraction)
1st Jan 4000000 7/6 3/12 (4000000*7/6*3/12)
to 31st =1166667
March
1st April Add (4000000+2000000) 7/6 4/12 (6000000*7/6*4/12)
to 31st shares =6000000 =2333333
July issued
at MV
1st Aug Total 6000000 7/6 2/12 (6000000*7/6*2/12)
to 30th remains =1166667
Sept same
1st Oct Add 6000000+(6000000/6*1)+500000 - 3/12 (7500000*3/12)
to 31st Bonus =7500000 =1875000
Dec shares
and
new
shares
issued
at MV
Weighted Average no of equity shares 6541667

EPS = 2000000/6541667 =0.305

4. C

Earnings = 2600000
Interest saved = 3000000*8% = 240000
Tax on interest saved = 240000*30% = 72000
Adjusted earnings = 2600000+240000-72000 = 2768000

Shares :
In issue = 5000000
Convertibles to shares = (3000000/100) * 150 = 4500000
Total shares = 5000000+4500000 = 9500000

Diluted EPS = 2768000/9500000 = 0.291

5. D

Earnings = 2600000
No of shares
In issue = 5000000
Free shares = Options * ((Fair value – exercise price)/Fair value)
= 1000000*((3-2)/3)
= 333333
Total shares = 5000000+333333 = 5333333

DEPS= 2600000/5333333 = 0.487

 16. IAS 33 – EPS 126

ANSWER KEY TO APPLY YOUR KNOWLEDGES

1.

DATE PERIOD NO. OF SHARES Bonus Fraction TOTAL

(1+(1/5)) = 6/5 =(No of shares*
Bonus Fraction)
1st Jan to 31st Dec 4000000 6/5 (4000000*6/5)
=4800000
Weighted Average no of equity shares 4,800,000

EPS 20X2 =1000000/4800000

= 0.208
Comparative EPS for 2011 is = 0.208 * 5/6 = 0.17 or (816000/4800000)=0.17
Without bonus issue it would have been (816000/4000000)=0.204 for 20X1.

2.

Basic EPS = 2500000/3500000 = 0.714

Diluted EPS
Earnings = 2500000
Interest saved = 1500000*7% = 105,000
Tax on interest saved = 105000*30%= 31,500
Earnings + notional earnings = 2500000+105000-31500 =2573500

Shares:
NO of shares in issue = 3500000
Shares in conversion = 1500000/100 * 130 =1950000
Total shares = 5450000

Diluted EPS = 2573500/5450000 = 0.472

 16. IAS 33 – EPS 127

PO6 – RECORD AND PROCESS TRANSACTIONS AND EVENTS

Description
You use the right accounting treatments for transactions and events. These should be both
historical and prospective – and include non-routine transactions.

Elements
a. Implement or operate systems to record and process accounting data using emerging
technology where appropriate or feasible.
b. Gather information for end-of-period accounting entries – and prepare estimates for
adjustments to inter-company accounts.
c. Verify, input and process routine financial accounting data within the accounting system
using emerging technology where appropriate or feasible.
d. Prepare and review reconciliations and other accounting controls.
e. Make sure you’re using accounting standards and policies when you’re processing
transactions and events.
 16. IAS 33 – EPS 128

SYLLABUS AREA C:

Preparation of financial statements(Group Accounts)

 17. Consolidation of Financial Statements and Profit or Loss 129

17. Consolidation of Financial Statements and Profit or Loss

Syllabus Area D2a-b-c-d-e-f-g

- Prepare a consolidated statement of financial position for a simple group (parent and one
subsidiary and associate) dealing with pre and post acquisition profits, non-controlling
interests and consolidated goodwill.
- Prepare a consolidated statement of profit or loss and a consolidated statement of profit or
loss and other comprehensive income for a simple group dealing with an acquisition in the
period and noncontrolling interest.
- Explain and account for other reserves (e.g. share premium and revaluation surplus).
- Account for the effects in the financial statements of intra-group trading.
- Account for the effects of fair value adjustments (including their effect on consolidated
goodwill) to:
i) depreciating and non-depreciating non-current assets
ii) Inventory
iii) monetary liabilities
iv) assets and liabilities not included in the subsidiary’s own statement of financial position,
including contingent assets and liabilities
- Account for goodwill impairment
- Describe and apply the required accounting treatment of consolidated goodwill.

DEFINITIONS:

IFRS 10 Consolidated Financial Statements uses the following definitions in Appendix A:

 'parent – an entity that controls one or more entities'
 'subsidiary – an entity that is controlled by another entity' (known as the parent)
 'control of an investee – an investor controls an investee when the investor is exposed, or
has rights, to variable returns from its involvement with the investee and has the ability to
affect those returns through its power over the investee.'
Other important definitions:
 ‘Group Formation: A group is formed when one company owns more than 50% of the
ordinary shares of another company.
 Group concept: From a legal point of view, every company is a separate entity, but from an
economic point of view, the companies are one. Once this situation arises, it becomes
mandatory for the parent company to produce consolidated financial statements showing
the position and results of the whole group.
 Goodwill: 'Goodwill is an asset representing the future economic benefits arising from other
assets acquired in a business combination that are not individually identified and separately
recognized' (IFRS 3)
 Positive Goodwill: Excess of consideration transferred and amount of any NCI over the net
identifiable assets acquired, and liabilities assumed on the date of acquisition.
 Negative Goodwill: Arises where the cost of the investment is less than the value of net
assets purchased.
 Uniform accounting policies: If a member of the group uses accounting policies other than
those adopted in the consolidated financial statements for like transactions and events in
similar circumstances, appropriate adjustments are made to that group member's financial
statements in preparing the consolidated financial statements to ensure conformity with the
group's accounting policies.'
 17. Consolidation of Financial Statements and Profit or Loss 130

Control is identified by IFRS 10 as the sole basis for consolidation and comprises the following three
elements:
1. 'power over the investee
2. exposure, or rights, to variable returns from its involvement with the investee
3. the ability to use its power over the investee to affect the amount of the investor's returns'
(IFRS 10, para 7)

EXEMPTIONS TO PREPARATION OF GROUP FINANCIAL STATEMENTS:

1. Parent’s debt or equity instruments are not traded on the public market.
2. Parent itself produces Consolidated Financial statements complying with relevant standards
available for public use.
3. The parent itself is a wholly owned subsidiary or a partially-owned subsidiary, and its
owners, including those not otherwise entitled to vote, have been informed about, and do
not object to, the parent not preparing consolidated financial statements.
4. The parent did not file its financial statements with a securities commission or other
regulatory organisation for the purpose of issuing any class of instruments in a public
market.

A) PRINCIPLES OF CONSOLIDATED FINANCIAL STATEMENTS:

Syllabus Area A4a-b-c-d-e-f-g-h-i-j
- Describe the concept of a group as a single economic unit.
- Explain and apply the definition of a subsidiary within relevant accounting standards.
- Using accounting standards and other regulation, identify and outline the circumstances in
which a group is required to prepare consolidated
financial statements.
- Describe the circumstances when a group may claim exemption from the preparation of
consolidated financial statements.
- Explain why directors may not wish to consolidate a subsidiary and when this is permitted by
accounting standards and other applicable regulation.
- Explain the need for using coterminous year ends and uniform accounting policies when
preparing consolidated financial statements.
- Explain why it is necessary to eliminate intra group transactions.
- Explain the objective of consolidated financial statements.
- Explain why it is necessary to use fair values for the consideration for an investment in a
subsidiary together with the fair values of a subsidiary’s identifiable assets and liabilities
when preparing consolidated financial statements.
- Define an associate and explain the principles and reasoning for the use of equity
accounting.
 17. Consolidation of Financial Statements and Profit or Loss 131

[Link] following statements of financial position have been prepared at 31st December 20X7.

Tom Jerry
$ $
Non-current assets:
Property, plant & equipment 85,000 18,000
Investment: Shares in Jerry 60,000
Current assets 160,000 84,000
Total 305,000 102,000

Equity:
Ordinary $1 shares 65,000 20,000
Share premium 35,000 10,000
Retained earnings 70,000 25,000
170,000 55,000

Current liabilities 135,000 47,000

305,000 102,000

Tom acquired 20,000 ordinary $1 shares in Jerry on 1 January 20X7, when Jerry’s retained earnings
stood at $20,000, and its share premium was $10,000. On this date, the fair value of the 20% non-
controlling shareholding in Jerry was $12,500. The Tom Group uses the fair value method to value
the noncontrolling interest.

Prepare the consolidated statement of financial position Tom as at 31 December 20X7.

 17. Consolidation of Financial Statements and Profit or Loss 132

RULES:

1 Cancel Investment in subsidiary, Share capital & Share premium of

subsidiary.
2 Add Goodwill and NCI
3 Adjust Retained earnings and make it group retained earnings
4 Workings :
1. Group Structure
2. Net worth of subsidiary
3. Goodwill
4. NCI
5. Group Retained Earnings

SOLUTION:
TOM JERRY Consolidated
Non current assets
Property plant & equipment 85000 18000 103000
Investment : Shares in Jones 60000 0
Goodwill 22500

Current Assets 160000 84000 244000

Total Assets 369500

Equity
Share Capital 65000 20000 65000
Share premium 35000 10000 35000
Retained Earnings 70000 25000 74000
Non-Controlling Interest 13500

Current Liabilities 135000 47000 182000

369500

W1 Group Structure
T >J
80%(control)
 17. Consolidation of Financial Statements and Profit or Loss 133

Net worth of At At Reporting Post

W2 Subsidiary Acquisition date acquisition
Share Capital 20,000 0
Share Premium 10,000 0
Retained Earnings 20,000 5000

5000

50,000

W3 Goodwill
Purchase Consideration 60,000 80%
+ Non Controlling Interest (NCI) 12,500 20%
(-) (Net worth) -50,000 100%

Goodwill 22,500

W4 NCI at reporting date

NCI at acquisition 12500
Add: NCIs share in post acquisition profits 1000

13500

W5 Group Retained Earnings

Parents RE 70000
Add: Parents share in post acquisition profits 4000

74000

B) Two Methods for Valuing Goodwill

1. Proportion of Net Asset Method

2. Fair Value Method

J Apply Your Knowledge 1:

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Alistair acquired 60% of the ordinary share capital of Joe on 31st July 20X1 for $240,000. At this date,
the net asset of Joe was $360,000.
Calculate goodwill which arises on acquisition if :
i) Non Controlling Interest (NCI) is valued using the Proportion of net assets method?
 17. Consolidation of Financial Statements and Profit or Loss 134

ii) NCI is valued using the Fair value method, and the Fair value of NCI on acquisition is
$150,000?

Impairment of Goodwill
1. Regardless of the method, deduct impairment from goodwill at acquisition.
2. Check the method:
Proportion of net assets method: Deduction of impairment only from W5
GRE
Fair value method: Deduct parents share from W5 GRE & NCIs share from
W4 NCI
C) FV Adjustments of Subsidiary at acquisition date
Subsidiary’s assets & liabilities must be measured at fair value on the acquisition date.
Example: An asset in the books at acquisition date was valued at 5m, however its market
value was 7m. It had a remaining life of 4 years at the date of acquisition.

W2 Net worth of Subsidiary At Rep Post

acquisition acquisition
SC
SP
RE 20,000 5,000
FV increase in subs building +2,000 -500

Impacts
1 Add the increase in At acquisition
column.
2 Deduct the extra dep from the
post column.
3 Add the increase and deduct the
dep from Asset in Balance in
sheet.

D Intra group balance

There are instances where parent and subsidiary trade with
each other as well. Such as : Lending of loan, payment of
dividend, sale of goods etc.

When trade occurs within the group i.e. if a parent is selling to

a subsidiary or vice versa, then there will arise a situation of
common payables & receivables if the transaction is done on
credit. From the group's point of view, this is absurd as this will
mean that a receivable & payables is towards oneself.
Therefore adjustments to nullify the common balance is
necessary.

For example:
 17. Consolidation of Financial Statements and Profit or Loss 135

P sold goods to S for 5000 on credit. As a result there is a

current account balance of $5000 in both the books.

P S
Receivables 5000

Payables 5000

Impact
1. Cancel out the common payables & Receivables as the
group can’t show payables towards its own self and
receivables from its own self.

E Cash in transit & Goods in transit

At the year-end common balances (current accounts) may
not agree due to cash in transit or goods in transit.

P's record shows 9000 owning to Slate, but slate records

show 10,000 owed by P.
Difference is explained due to cash in transit

This is a situation where payments or goods are released

but are on the way and have not been received by the
opposite party yet.
P S Consolidated
Current Assets
Receivables (-1000-9000+15000+17000) 15000 17000 22000
Cash (+1000 1000
Current Liabilities
Payables (-9000 + 13000 + 11000 ) 13000 11000 15000

Impacts for Cash in transit

1. Adjust for the cash in transit as if already received and
reduce the reduce the receivables by the cash received.
2. Now, the receivables & payables will match, deduct the
common balance.

Impacts for Goods in transit

1. Adjust for goods as if already received. Add the goods in
transit to the payables amount.
2. Now, the receivables & payables will match, deduct the
common balance.
 17. Consolidation of Financial Statements and Profit or Loss 136

( Apply Your Knowledge 2:

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Inter-company current accounts

Current accounts and cash in transit

Plant Shrub
$000 $000
Non-current assets
Property,plant&equipment 100 140
Investment in S at cost 180
Current assets
Inventory 30 35
Trade receivables 20 10
Cash 10 5
340 190

Equity and liabilities

Share capital: Ordinary $1 shares 200 100
Share premium 10 30
Retained earnings 40 20
250 150
Non-current liabilities: 10% loan notes 65 –
Current liabilities 25 40
340 190

Notes:
Plant bought 80,000 shares in Shrub in 20X1 when Shrub’s reserves included a share
premium of $30,000 and retained earnings of $5,000.
Plant's records show $6,000 owing to Shrub, but Shrub's records show $8,000 owed by
Plant. The difference is explained as cash in transit. No impairment of goodwill has
occurred to date.

Plant uses the proportion of net assets method to value the non-controlling interest.
Prepare Plant’s consolidated statement of financial position as at 31 March 20X7.

Solution
Plant Group consolidated statement of financial position as at 31 March 20X7

$000 $000
Assets
Non-current assets:
Intangible assets – goodwill (W3) 72
Property, plant & equipment
(100 + 140) 240
312
 17. Consolidation of Financial Statements and Profit or Loss 137

Current assets
Inventory (30 + 35) 65
Trade receivables
(20 + 10 – 2 (CIT) – 6 (inter-co)) 22
Cash (10 + 5 + 2 (CIT)) 17

104
416

Equity and liabilities

Share capital 200
Share premium 10
Retained earnings (W5) 52
Non-controlling interest (W4) 30
292
Non-current liabilities: 10% loan notes 65
Current liabilities (25 + 40 – 6(inter-co)) 59
416

Workings:
Note: Cash in transit (CIT)
The $2,000 cash in transit should be adjusted in order to reconcile the intra-group
balance.
Assume that the cash has been received and therefore:
· increase Shrub's cash balance by $2,000 to $7,000
· decrease Shrub's receivables balance by $2,000 to $6,000
The outstanding intercompany balance requiring cancelling is therefore
$6,000.

(W1) Group structure

(W2) Net assets of Shrub

Reporting Post-
date acquisition
Acquisition
$000 $000 $000
Share capital 100 100 –
 17. Consolidation of Financial Statements and Profit or Loss 138

Share premium 30 30 –
Retained earnings 5 20 15

135 150 15

(W3) Goodwill
$000
Parent investment at fair value 180
NCI value at acquisition
(20% × 135 (W2)) 27
207
Less:
Fair value of net assets at acquisition (W2) 135

Goodwill on acquisition 72

(W4) Non-controlling

NCI value at acquisition(as in W3 NCI share of post-

acquisition reserves 27

NCI share of post-acquisition reserves 3

(20% x 15 (W2))
30

(W5) Group retained earnings

Plant retained earnings 40

80% of Shrubs post-acquisition retained earnings 12
(80% x 15( W2))

52

Apply Your Knowledge 2:

 17. Consolidation of Financial Statements and Profit or Loss 139

Statement of financial position of P and S as at 30 June 20x8 are given below:

Non-current assets:

Land
Plant & equipment
Investments

Current assets:
Inventory
Receivables
Bank

Ordinary share capital 50c

Retained earnings

Non-current liabilities: 8% loan stock

Current liabilities

(i) P acquired 75% of S on 1 July 20X5 when the balance on S’s retained earnings was $1,150. P paid $3,500 for its
(ii) At the reporting date, P’s payables included an amount due to S of $400. This did not agree to the correspondin
(iii) At the date of acquisition, it was determined that S’s land, carried at the cost of $2,500, had a fair value of $3,7
(iv) The P group uses the fair value method to value the non- controlling interest. For this purpose, the subsidiary sh
(v) Goodwill has become impaired by $100.
Required:
Prepare the consolidated statement of financial position of the P group as at 30 June 20X8

Solution
Consolidated statement of financial position as at 30 June 20X8 Non-current assets
Goodwill (W3)
Land (4,500 + 2,500 + 1,250 (W2))
Plant & equipment (2,400 + 1,750 + 500 – 300 (W2))
Investments (8,000 – 3,500 – (60% × 500))
 17. Consolidation of Financial Statements and Profit or Loss 140

Current assets
Inventory
(3,200 + 900)
Receivables
(1,400 + 650 – 100 (CIT) – 400 (inter-co))
Bank (600 + 150 + 100 (CIT))

Equity
Share capital
Retained earnings (W5)
Non-controlling interest (W4)

Non-current liabilities (4,000 + 500 – (60% × 500))

Current liabilities (2,800 + 1,300 – 400)

Workings:

(W1) Group structure

P ----------- > S 70%

(W2) Net assets

Share capital

Retained earnings

Fair value: land

Fair value: plant

Depreciation adjustment (500 × 3/5)
 17. Consolidation of Financial Statements and Profit or Loss 141

(W3) Goodwill
Parent holding (investment) at fair value

NCI((2,000 shares × 25%) × $2.20)

Less: Fair value of net assets at acquisition (W2)

Goodwill on acquisition

Impairment

Goodwill per SFP

(W4) Non-controlling interest

NCI value at acquisition (as in (W3))

(25% × 1,700)

Less: NCI share of impairment (25% × 100)

(W5) Group retained earnings

100% P

75% of S post-acq retained earnings (W2)

(75% × 1,700)

75% Impairment (75% × 100)

F) Unrealized Profits on sale of inventory (URP)

This situation arises when goods or a non-current asset have been sold within the group at a prof
unrealized profit absorbed by the group. The impact of this unrealized profit needs to be remove

INVENTORY
 17. Consolidation of Financial Statements and Profit or Loss 142

Impacts:
1. Regardless of the seller, remove the URP from inventory.
2. Check who is the seller?
Parent ---> Remove the URP from W5 GRE
Subsidiary ---> Remove URP From W2 Post

Note: The URP is adjusted as it is an unrealised profit from a group point of view. As
a group can’t make a profit by selling it to its own self. Therefore all figures are adjusted
for the time when inventory entered the group at the first point.
 17. Consolidation of Financial Statements and Profit or Loss 143

1. Lyon has 80% control over Nathan. Nathan transferred goods to Lyon at a transfer price of
$18,000 at a mark-up of 50%. Two-thirds of these goods remained in inventory at the year end.
What will be the adjustment in the consolidated Financial statements?

B] Non -current Asset

If a sale of non-current assets has happened within the group.

1. Regardless of the seller or buyer, remove URP from NCA in consolidated FS and add back
excess depreciation to NCA in consolidated FS

2. Check whose the seller?

Parent ---> Remove the URP from W5 GRE
Subsidiary ---> Remove URP From W2 Post

3. Check whose the buyer?

Parent ---> Add back excess depreciation to W5 GRE
Subsidiary --> Add back excess depreciation to W2 Post

2. Shikhar acquired 80% of Dhawan a few years ago. Shikhar transferred an item of plant to Dhawan
for $6,000 on 1st January 20X3. The plant originally cost Shikhar $10,000 and had an original, useful
economic life of 5 years when purchased 3 years ago. The useful economic life of the asset has not
changed as a result of the transfer. What is URP, and how should this be treated in Financial
statements for the year ended 31st December 20X3?
Also, show adjustments if Dhawan had sold the same NCA to Shikhar.

Practice Question:

Health (H) bought 90% of the equity share capital of Safety (S), two
years ago on 1 January 20X2 when the retained earnings of Safety
stood at $5,000. Statements of financial position at the year end of 31
December 20X3 are as follows.

$000 $000
Non-current assets:
Property, plant & equipment 100 30
Investment in Safety at cost 34

134 30
Current assets:
Inventory 90 20
Receivables 110 25
 17. Consolidation of Financial Statements and Profit or Loss 144

Bank 10 5

210 50

344 80

Equity:
Share capital 15 5
Retained earnings 159 31

174 36
Non-current liabilities: 120 28
Current liabilities 50 16

344 80

Safety transferred goods to Health at a transfer price of $18,000 at a

mark-up of 50%. Two-thirds of these goods remained in inventory at
the year end. The current account in Health and Safety stood at
$22,000 on that day. Goodwill has suffered an impairment of $10,000.
Health uses the fair value method to value the non-controlling interest.
The fair value of the non-controlling interest at acquisition was $4,000.
Prepare the consolidated statement of financial position at 31
December 20X3.

Solution

Non-current assets $000

Goodwill (W3) 18
Property, plant & equipment (100 + 30) 130

148
Current Assets
Inventory (90 + 20 – 4 (W6)) 106
Receivables
(110 + 25 – 22 intra-group
receivable) 113
Bank (10 + 5) 15
234

382

Equity
 17. Consolidation of Financial Statements and Profit or Loss 145

Share capital 15
Group retained earnings (W5) 169.8
NCI (W4) 5.2

190
Non-current liabilities (120 + 28) 148
Current liabilities
(50 + 16 – 22 intra-group payable) 44

382

Working paper:
(W1) Group structure

H >S 90%

(W2) Net assets

Reporting
date Post- acquisition
Acquisition
$000 $000 $000
Share capital 5 5
Retained earnings 5 31 26
PUP (W6) 4 4

10 32 22

(W3) Goodwill
Parent holding
(investment) at fair value 34
NCI value at acquisition 4

38
Less:
Fair value of net assets at
acquisition (W2) 10

Goodwill on acquisition 28
Impairment 10

Goodwill per SFP 18

(W4) Non-controlling interest

NCI value at acquisition
(W3) 4
NCI share of post-acquisition
reserves
 17. Consolidation of Financial Statements and Profit or Loss 146

(10% × 22 (W2)) 2.2

Less: NCI share of impairment
(10% × $10) 1

5.2

(W5) Group reserves

100% Health 159
90% Safety post-acquisition
(90% × 22 (W2)) 19.8
Impairment (W3)
(90% × $10) 9
169.8

G Deferred Consideration, Contingent Consideration & Share exchange

Contingent Consideration:
Contingent Consideration is an agreement to settle an amount in the future
provided certain conditions are met. Any contingent consideration should be
included at fair value, which will be given in the exam.

Payment made at a later date

A cash payment of 4 million was made now & 3 million will be made in 3 years
time,
The cost of capital is 10%. Find the cost of investment.

Purchase Consideration
Cash : 4 million 4000000
PV of Cash paid at later date : (3 million / 1.1^3) = 2253944 2253944

6253944
1st day journal entry

DR. Investment 6253944

CR. Cash 4000000
CR. Liability 2253944

At 1st year end

DR. Finance Cost 225394.4

CR. Liability 225394.4

Balance Sheet at 1st year end : Liability : (2253944 + 225394) = 2479338

 17. Consolidation of Financial Statements and Profit or Loss 147

Share exchange
Apple acquired 24 million $1 shares of Banana by offering 2 shares for every 3 shares
acquired. Apple has a nominal value of $1/ share and a market value of $2 per share. He
also paid 10 million cash. Find the cost of investment.

Shares issued by Apple = 24 million * 2/3= 16 million shares 16000

MV of shares issued = 16million * $2 32000

Purchase Consideration
Cash = 10 million
Share exchange = 32 million
Total PC = 42 million

DR. Investment 42 million

CR. Cash 10 million
CR. Share Capital 16 million (16 million shares X $1 )
CR. Share premium 16 million ( 16 million shares X $1 )

Illustration 1

ABC Ltd acquired 30 million shares of PQR Ltd on 1st April 20X5 for cash consideration of $10 million.
A share exchange of 2 shares for every 5 shares acquired was also offered. The market price of ABC’s
shares is $3/share. Moreover, a deferred consideration of $4 million will be paid after 5 years. The
cost of capital of the company is 9%.

If the fair value of NCI at acquisition was $8.6 million and the fair value of net assets of PQR at
acquisition is $53.5 million, what is the goodwill arising on acquisition?

Solution:

$M
Purchase Consideration:
Cash 10
Share Exchange (30 * 2/5 * 3) 36
Deferred Consideration [4/(1.09^5)] 2.6
NCI at acquisition 8.6
Less: FV of Net assets of subsidiary (53.5)
Goodwill on Acquisition 3.7

CONSOLIDATED STATEMENT OF PROFIT & LOSS

A Rules:
1 Consolidate Parents & Subsidiary’s Income & Expenses on the basis of months acquired.
 17. Consolidation of Financial Statements and Profit or Loss 148

2 Show a split between Parent & NCI at the end from the total profits.
3 Show the workings :
1. GROUP STRUCTURE (W1)
2. NCIs share in Profit (W2)

W2
Subsidiary’s profit after tax X
(-)Fair value depreciation (X)
(-)PUP (where subsidiary is seller) (X)
(-)Impairment (if using the fair value method) (X)
–––
Adjusted subsidiary profit X
–––
Non-controlling interest (Adjusted Subsidiary Profit × NCI%) XX
 17. Consolidation of Financial Statements and Profit or Loss 149

3. The statements of profit or loss for Rahul and Ravi for the year ended 31st December 20X6 are
given below. Rahul acquired 75% of the ordinary share capital of Ravi many years ago.
Rahul Ravi
$000 $000
Revenue 2,400 800
Cost of sales and expenses (2,160) (720)
–––––– ––––––
Trading profit 240 80
Investment income:
Dividend received from Ravi 3
–––––– ––––––
Profit before tax 243 80
Income tax expense (115) (40)
–––––– ––––––
Profit for the year 128 40
–––––– ––––––

B. Intra group purchases & sales

Adjustment: Cancel common purchases & sales

C. Loan interest & expense

Adjustment: Nullify the common interest & expense line item.

D. Dividend income from subsidiary

Adjustment: Nullify the dividend income from subsidiary

E. URP of Inventory

1. Regardless of the seller, Add the URP to the cost of sales.

2. Check who is the seller:
Parent is the seller: Nothing required further
Subsidiary is the seller : Deduct URP from (W2) subsidiarys profit.

COS = (Opening inventory + Purchases - Closing Inventory) + URP

F URP of NCA

1. Regardless of the seller, Add the URP to cost of sales and Less the excess dep from COS.

2. Check who is the seller:

Parent is the seller: Nothing required further
Subsidiary is the seller : Deduct URP from (W2) subsidiarys profit.
 17. Consolidation of Financial Statements and Profit or Loss 150

3. Check who is the buyer :

Parent is the buyer: Nothing required further
Subsidiary is the buyer: Add the depreciation to the (W2) subsidiarys profit.

G. Impairment of Goodwill
Adjustment:
1. Charge the impairment in the line mentioned by the examiner else to operating expenses.
[Link] the FV method is used, then deduct the impairment from W2 NCI working.

H. FV change in subsidiary’s asset at the date of acquisition

Adjustments:
1. Charge the depreciation to the line mentioned by the examiner else to cost of sales.
2. Deduct the FV depreciation from W2 NCI working.

4. Set out below are the draft statements of profit or loss of Prague and its subsidiary company
Sydney for the year ended 31 December 20X7.

On 1 January 20X6, Prague purchased 75,000 of Sydney’ total share

capital of 100,000 $1 ordinary shares.

Statements of profit or loss for the year ended 31 December 20X7

Prague Sydney
$000 $000
Revenue 600 300
Cost of sales (360) (140)
––––– –––––
Gross profit 240 160
Operating expenses (93) (45)
––––– –––––
Profit from operations 147 115
Finance costs – (3)
––––– –––––
Profit before tax 147 112
Income tax expense (50) (32)
––––– –––––
Profit for the year 97 80

The following additional information is relevant:

(i) During the year, Sydney sold goods to Prague for $20,000, making a mark-up of one third.
Only 20% of these goods were sold before the end of the year, the rest were still in inventory.
(ii) Goodwill has been subject to an impairment review at the end of each year since acquisition
and the review at the end of the current year revealed a further impairment of $5,000.
Impairment is to be recognised as an operating cost.
 17. Consolidation of Financial Statements and Profit or Loss 151

(iii) At the date of acquisition, a fair value adjustment was made, and this has resulted in an
additional
depreciation charge for the current year of $15,000. It is a group policy that all depreciation is
charged to the cost of sales.
(iv) Prague values the non-controlling interest using the fair value method.

Prepare the consolidated statement of profit or loss for the year ended 31 December 20X7 for the
Prague group.

ASSOCIATE

A Rules for Accounting for Associate

1. Line by line items are not clubbed as it is considered outside the group.
2. It is represented as a single line item :
In Balance Sheet as 'Investment in Associate'
In Profit & Loss as 'Profit from Associate'
3. Impacts of any trading between Parent & Associate should not be nullified, as he
is
considered outside the group.
4. Exception: As a practice, URP has always been adjusted. Regardless of the seller,
deduct the URP upto parents share from
(i) Profit from Associate
(ii) Investment in Associate
(iii) GRE

5. Treatments:
(i) Profit from Associate :
Share in Associates Profit for the year
(-)Impairment of Associate
(-) URP (Parent %)

(ii) Investment in Associate

Cost of Investment in Associate
+ Share in Associate profit post acquisition
(-) Impairment of Associate
(-) URP (Parent %)

(iii) GRE
Parents RE
Parents share in subs post acq RE
Parents share in Associates Post accq RE
(-) Impairment of Associate
(-) URP (Parent %)
 17. Consolidation of Financial Statements and Profit or Loss 152

5.
P S A

Non-current assets
Property, plant and equipment 14,000 7,500 3,000
Investments 10,000 – –
–––––– –––––– ––––––
24,000 7,500 3,000
Current assets 6,000 3,000 1,500
–––––– –––––– ––––––
30,000 10,500 4,500

Equity Share capital ($1 ordinary shares) 10,000 1,000 500

Retained earnings 7,500 5,500 2,500
–––––– –––––– ––––––
17,500 6,500 3,000

Non-current liabilities 8,000 1,250 500

Current liabilities 4,500 2,750 1,000
–––––– –––––– ––––––
30,000 10,500 4,500

Further information:
(i) Alison acquired 75% of the equity share capital of South several years ago, paying $5
million in cash. At this time, the balance on South's retained earnings was $3 million.
(ii) Alison acquired 30% of the equity share capital of West on 1 October 20X6, paying
$750,000 in cash. At 1 October 20X6, the balance on West’s retained earnings was $1.5
million.
(iii) During the year, Alison sold goods to West for $1 million at a mark-up of 25%. At the
year-end, West still held one quarter of these goods in inventory.
(iv) As a result of this trading, Alison was owed $250,000 by West at the reporting date. This
agrees with the amount included in West's trade payables.
(v) At 30 September 20X8, it was determined that the investment in the associate was
impaired by $35,000.
(vi) Non-controlling interests are valued using the fair value method. The fair value of the
non-controlling interest in South at the date of acquisition was $1.6 million.

Group Disposals

SYLLABUS AREA D2h

- Explain and illustrate the effect of the disposal of a parent’s investment in a subsidiary in the
parent’s individual financial statements and/or those of the group (restricted to disposals of
the parent’s entire investment in the subsidiary).

When a shareholding in a subsidiary is disposed of, it must be reflected in:

 17. Consolidation of Financial Statements and Profit or Loss 153

 the parent company’s individual financial statements and

 the group financial statements.
Calculation for Parent Company’s Financial Statements
Gain to the Parent Company:

Sale Proceeds X
(-) Carrying Amount of Investment (X)
Parent Gain/Loss on disposal XX

Gain/loss should be disclosed separately on the face of the parent’s SOPL and after profit from
operations

Calculation for Consolidated Financial Statements-Full disposal

Disposal of the whole subsidiary

SOPL
-100% of the subsidiary’s results are to be consolidated to date of disposal
- Gain/loss on disposal

SOFP
-AT y/e no shares held by the parent and so disposed subsidiary is not included in group SOFP.
-Gain/loss on disposal is to be included in retained earnings

Gain on disposal
Sale Proceeds X
(W1) Net Assets at date of disposal X
(W2) Net goodwill at date of disposal X
(W3) NCI at date of disposal (X) (X)

Group Gain/loss on disposal XX

HINT:
Any Tax on the disposal gain should be calculated using the gain in the parent’s Individual Financial
Statements.
 17. Consolidation of Financial Statements and Profit or Loss 154

W1 Net Assets at date of disposal

Net asset b/f X
(+/-) Profit/(loss) for Current period to disposal date X/(X)
Dividends paid prior to disposal (X)
Net assets at disposal XX

W2 Goodwill at the date of disposal

Consideration X
(+) NCI at acquisition(FV or net assets proportion method) X
X
(-) 100% of FV of net assets at acquisition (X)
Goodwill at acquisition X
(-) Impairments to date of disposal (X)
Goodwill at date of disposal XX

W3 NCI at disposal date

1. Fair value method

NCI at acquisition X
NCI % of Subsidiary’s retained profits post acq up to disposal X
NCI % of impairment (X)
NCI at disposal date XX

2. Proportion of net assets method

NCI at acquisition X
NCI % of subsidiary’s retained profits post acq upto disposal X
NCI at disposal date XX

6. Roll acquired an 80% investment in Cat for $4,000 two years ago. It is group policy to measure
non-controlling interests at fair value at the date of acquisition. The fair value of the non-controlling
interest in Cat at the date of acquisition was $1600, and the fair value of Cat's net assets was $3,800.
The goodwill has not been impaired. Roll disposed of all of its shares in Cat for sale proceeds of
$6,000. The fair value of Cat’s net assets at the date of disposal was $4,800.

Required:
Calculate the profit/loss on disposal that would be recorded in:
1 Roll's individual statement of profit or loss.
2 Roll's consolidated statement of profit or loss.
 17. Consolidation of Financial Statements and Profit or Loss 155

ANSWER KEY TO APPLY YOUR KNOWLEDGE

1.

Proportion of Net Asset

(i) method
Purchase Consideration 240000 Above Networth
Add: NCI (360000 * 40) 144000 At networth
-
Less: Networth 360000

Goodwill 24000

(ii) Fair Value method

Purchase Consideration 240000 Above Networth
Add: NCI 150000 Above Networth
Less: Networth -360000

Goodwill 30000

ANSWER KEY TO QUIZ

1.

Cost Price 100

Profit : 50
Selling Price 150

Selling Price Profit

150 50
18000 ?
Using Cross Multiplication, we get Profit as 6000.
2/3 of the inventory remains in the inventory at the year end, and hence the
Unrealised Profit(URP) = 6000*2/3 = 4000

Impacts :
1] In consolidated Financial statements, subtract the URP(4000) from the Inventory section.
2]Since the Subsidiary sells to the Parent, we remove the URP(4000) from the W2 Post Acquisition
Column.
 17. Consolidation of Financial Statements and Profit or Loss 156

2.

Case A: Parent sold to subsidiary.

Regardless
Balance Sheet
NCA ( -2000 +1000)
Old depreciation : 4000/2 = 2000
New depreciation : 6000/2 = 3000
Excess depreciation = 1000

Check whose the seller?  Parent

W5 GRE
Less : URP - 2000

Check whose the buyer ?  Subsidiary

W2 Post Acquisition Column

Add: Excess dep 1000

Case B: Subsidiary sold to Parent

Regardless
Balance Sheet
NCA ( -2000 +1000)
Old depreciation : 4000/2 = 2000
New depreciation : 6000/2 = 3000
Excess depreciation = 1000

Check whose the seller? Subsidiary

W2 Post
Less: URP -2000

Check whose the buyer ? Parent

W5 GRE
Add: Excess dep +1000
 17. Consolidation of Financial Statements and Profit or Loss 157

3.

Consolidated Statement of Profit

and Loss Workings Notes
Rough ‘000
Revenue 2400+800 3200.00 W1 Group Structure
-
Cost of Sales 2160+720 2880.00 P --- S
75%
Trading Profit 320.00
Dividend from Ravi W2 NCIs share in Profit
Subsidiarys Profit 40
Less : Adjustments
(these are items affecting
Profit before tax 320.00 subsidiary’s profits) 0
IT Expense 115+40 -155.00 Adjusted Profit 40
NCIs share (25% X 40) 10
Profit for the year 165.00
Profit attributable to
165 X
Parent 75% 155.00
165 X
NCI 25% 10.00

4.

Consolidated Statement of Profit

& Loss
Rough Calculation ‘000 Workings Notes
Revenue -20+600+300 880.00 W1
-20 + 4 +
(Cost of Sales ) 15+360+140 (499.00) Group Structure
Gross Profit 381.00 P --- S
75%
(Operating expenses) 5+93+45 (143.00)
Profit from operations 238.00 W2
NCIs share in
Finance costs 3 (3.00) profits
Profit before tax 235.00 Subsidiary Profit 80
Less: URP -4
Income tax expense 50+32 (82.00) Less: Impairment -5
Less: Additional
dep -15
Profit for the year 153.00 Adjusted Profit 56
Profit attributable to: NCIs share(25%) 14
Parent 139.00
NCI 14.00 W3
 17. Consolidation of Financial Statements and Profit or Loss 158

URP

CP 100
P 33.33 ?
SP 133.33 16000

URP 4000

5.

Statement of Financial Position

Assets
NCA
PPE (14000+7500) 21500
Investments (-5000-750 +10000) 4250
Goodwill 2600
Investment in Associate 1000

Current Assets 9000

Total Assets 38350

Equity & Liabilities

Equity
SC 10000
GRE 9625
NCI 2225

NCL 9250

CL 7250

Total Equity & Liabilities 38350

W1 Group Structure
P S
75%

W2 Net Assets of Subsidiary At Acq RE Post

SC 1000
 17. Consolidation of Financial Statements and Profit or Loss 159

RE 3000 2500
4000 2500 NCI 625
GRE 1875

W3 Goodwill
Purchase Consideration 5000
Add: NCI at acquisition 1600
Less: Net worth -4000

2600

W4 NCI
NCI at
acquisition 1600
Add: NCIs share 625

2225

W5 GRE
Parents RE 7500
Add: Parents share in Sub 1875
Add: Parents share in Associates 300
Less: URP from Associate -15
Less: Impairment of Associate -35
9625

W6 Investment in Associate
Cost of Investment 750
Parents share in post acq profit 300
(2500-1500) * 30%
Less: URP from Associate -15
Less: Impairment of Associate -35
1000

W7 URP from Associate

CP 100 CP 100
P 25 P 25
SP 125 250 SP 125 1000

URP 50 Profit 200

Parents share in URP 15 URP 50
Parents share in URP 15
(30% of 50)
 17. Consolidation of Financial Statements and Profit or Loss 160

6.

1. Gain in Roll’s Individual SOPL

Sale proceeds 6000

Carrying amount of investment (4000)
Gain on disposal 2000

2. Gain in Consolidated SOPL

Sale Proceeds 6000
Less: Carrying value of subsidiary at disposal
Net assets at disposal 4800
Goodwill at disposal(W1) 1800
Less: NCI at disposal(W2) (1900) 4700
1300

W1 Goodwill
Fair Value of Cat’s Investment 4000
Fair value of NCI at acquisition 1600
Fair value of subsidiary’s net assets at acquisition (3800)
Goodwill at acquisition/disposal 1800

W2 NCI at disposal date

NCI at acquisition 1600
NCI % of post acquisition reserves 200
(20% * (4800-3800)
NCI at disposal date 1800
 17. Consolidation of Financial Statements and Profit or Loss 161

PO7 – PREPARE EXTERNAL FINANCIAL REPORTS

Description

You take part in preparing and reviewing financial statements and all accompanying information and
you do it in accordance with legal and regulatory requirements.

Elements

a. Contribute to drafting or reviewing primary financial statements according to accounting

standards and legislation.
b. Make sure that your organisational policies are fit for the purpose of preparing external
financial statements.
c. Classify information correctly.
d. Review financial statements and correct for errors and account for – or disclose – events
after the reporting date.
e. Prepare or review narrative and quantitative information to include with financial
statements.
 17. Consolidation of Financial Statements and Profit or Loss 162

SYLLABUS AREA D

Analysing and interpreting the financial of single entities and groups

 18. Ratio & Ratio Analysis 163

18. Ratio & Ratio Analysis

Types of Ratios:

1. Performance Ratios
2. Position Ratios
i) Short term ratios
ii) Long term solvency ratios
3. Investor Ratios

1) PERFORMANCE RATIOS
These Ratios looks at the results of the business and how good or bad the results are
according to the operations of the business in the accounting year.

Commenting:
Comment reasons for increase or decrease in Revenue and factors which would cause higher
or lower profits and take these profits as a % of the revenue and compare it with previous
years, industry average and competitors.

1. GROSS PROFIT MARGIN = GROSS PROFIT *100 %

REVENUE
This is the margin that the company achieves on its sales, and would be expected to
remain reasonably constant.

2. OPERATING PROFIT MARGIN = OPERATING PROFIT(PBIT) * 100%

REVENUE
This is the margin that the company achieves on its sales after all the expenses have
been deducted to give the actual margin the company is making on each $1 of revenue.

3. Return on Capital Employed (ROCE) = PBIT *100

CAPITAL EMPLOYED

Capital Employed = Long term debts + Equity OR Total assets – Current liabilities

OR

OPERATING PROFIT MARGIN * NET ASSET TURNOVER = PBIT * REVENUE

REVENUE CAPITAL EMPLOYED

This ratio tells us how much PROFIT is being generated by $1 of capital invested in the
business.

4. Return on equity (ROE) = PAT - PREFERENCE DIVIDENDS * 100

EQUITY
This ratio shows returns made for the year on total equity in a business.
Pre Tax ROE = PBT * 100
EQUITY

5. Net Asset Turnover (NCA) = REVENUE

NON CURRENT ASSETS
 18. Ratio & Ratio Analysis 164

This ratio measures of how intensively assets are being worked to generate revenue. Gives a
measure of how much revenue is generated from $1 of capital invested.

Working Capital Turnover = REVENUE

WORKING CAPITAL
 18. Ratio & Ratio Analysis 165

PERFORMANCE/PROFITABILITY RATIOS
RATIO GOOD RATIO BAD RATIO CAUSES OF COMPARE WITH ADDITIONAL POINTS
INDICATES INDICATES BAD RATIO (BENCHMARK)
AND HOW TO
IMPROVE BAD
RATIO
GROSS 1)Increasing 1)Decreasing Change in: 1)Companies Check if GP% &
PROFIT percentage percentage 1)Selling within the Revenue % has
MARGIN indicates indicates price & same sector increased in the
Variable variable selling 2)Last year, GP same proportion.
cost, Raw cost, raw strategy % If they have not
materials materials 2)Sales mix 3) Industry increased in the
are not are rising and reason Average % same proportion,
rising as quicker than of change then either SP has
quick as the the selling 3) Change decreased, or the
selling price price of the in purchase COGS has increased.
of the product. or 2)Could change if the
product 2) The production company has
2)The company are cost adopted market
company is unable to skimming or market
being able pass the penetration strategy.
to pass inflationary Retailers using low
inflationary prices. margin high volume
prices 3)Might and manufacturing
3)Unusually suggest that using high margin
high % the and low volume
attract company is strategy.
competition expanding
from or launching
different a new
players product in a
new market
OPERATING Selling, Selling, 1)Selling, 1)Industry 1)Check for fixed,
PROFIT general & general & general & Average % variable &semi
MARGIN admin admin admin 2)Last year variable costs which
expense are expense are expenses OP% may/may not change
increasing increasing at are 3)Check last with revenue.
at lesser a greater increasing year to this 2)Align A/C policies
rate than rate than at a greater year cost % like depn & then
sales % sales % rate than change and compare with other
sales % as check whether companies.
compared the increase in
to last year. cost% & sales
2)Check increase % is
individual same.
cost(selling, 4)Inter
general and company
admin comparisions
expense) as made after
a % of sales aligning for
revenue. A/C
policies(depn)
 18. Ratio & Ratio Analysis 166

3)Check the
composition
of cost &
how to
control that
cost
RETURN 1)Increase 1)Decrease 1)change in 1) Last year 1) Check for A/C
ON in profits in profits profit ROCE% policies like
CAPITAL 2)Check for 2)Change in 2) Industry revaluation where
EMPLOYED the life of long term average % ROCE will be lower
(ROCE) asset funding like 3)Comparisons than company not
remaining loans, with revaluing assets.
& how shares to companies in 2) Not replacing
much is fund the same assets will decrease
depn. acquisition industry. value and increase
If a lot is of NCA. 4)Cost of ROCE.
depn, then 3)If return is borrowing 4)Cost of
it may give low, borrowing>ROCE
the wrong business then EPS will drop.
figure as may be 5)Exclude Investment
more cash better at Income from
will be realising associates in the
needed in assets & calculation
future for investing in
purchase of high
assets. interest
bank A/C.
RETURN Shows return made for the year on total equity in the business and the return for
ON EQUITY the equity holders.
(ROE) Important % when acquisition & decision making between 2 companies for
acquisition.
NET ASSET Higher the Higher 1) Low margin
TURNOVER net asset quality businesses have high
turnover could asset turnover
higher the indicate (retailer)
efficiency of higher 2) High margin
the profit business have low
company margins asset
turnover(capital
intensive
manufacturing
industry)

2) POSITION RATIOS
When analysing the position, this can be split down into short-term liquidity (looking at
working capital) and long-term solvency (focusing on debt levels).
 18. Ratio & Ratio Analysis 167

i) SHORT TERM RATIOS – WORKING CAPITAL RATIOS

1. CURRENT RATIO = CURRENT ASSETS

CUREENT LIABILITIES
Ideal Ratio is 1.5:1
Measures adequacy of Current assets to meet it’s current liabilities as they fall due.

2. QUICK RATIO = CURRENT ASSETS – INVENTORY

CURRENT LIABILITIES
This ratio measures the adequacy of current assets, excluding inventory, to see if it meets
the current liabilities. (Exclude any prepayments). Also known as ACID TEST RATIO.

3. INVENTORY TURNOVER RATIO = INVENTORY * 365

COGS
For days multiply with 365, weeks by 52 and months then 12.
This ratio tells us the days it takes to sell the inventory the business has.

INVENTORY TURNOVER PERIOD = COGS times p/a

INVENTORY

Inventory turnover is a measure of the number of times inventory is sold or used in a time
period such as a year.

Inventory used in the calculation is Average inventory or closing inventory.

4. RECEIVABLES COLLECTION PERIOD = RECEIVABLES *365

CREDIT SALES
This ratio tells us how long it takes the company to collect cash from its debtors.

5. PAYABLES COLLECTION PERIOD = PAYABLES *365

CREDIT PURCHASES/COGS
This ratio tells us how long it takes the company to pay its creditors.

IMPORTANT: FOR RECEIVABLES/INVENTORY/PAYABLES TURNOVER TIMES, INVERSE THE

FORMULA AND DO NOT MULTIPLY BY 365/52/12.

RATIO GOOD RATIO INDICATES BAD RATIO CAUSES OF COMPARE ADDITIONA

INDICATES CHANGE/ WITH L INFO
BAD RATIO
HOW TO
IMPROVE
RATIO
CURRENT Current assets can meet Current Check for : 1)Industry 1)Check if
RATIO current liabilities when assets 1)Overdraft average inventory,
they arise due cannot limit 2)Previous cash and
2)CL have decreased, meet 2)Seasonal year ratio receivables
and CA has increased but current nature of Ideal ratio is are not
check liabilities business. 1.5:1. huge
Inventory/receivables/ca when they 3)If Interest component
sh for overtrading* arise due rates are s of CA as
abnormally cash could
 18. Ratio & Ratio Analysis 168

high, this is be put to

probably better use
because the & high
company inventory
has high could mean
levels of slow
borrowing moving
in the stock.
Current
year.
3)Financing
of CA & long
term
liabilities
QUICK Has sufficient liquid Does not Change in: 1)Industry Calculated
RATIO resources to pay off Have 1)Quick average on the
Current liabilities. sufficient assets 2)Previous basis of 6
liquid i.e year ratio week time
resources to bank/cash 3)Compare frame.
pay off /short term with same
Current investments nature
liabilities. 2)Quick business.
liabilities
i.e bank
OD/Trade
payables/ta
x/ dividends
INVENTOR 1)Inventory is fast 1)High days Reliability of 1)Industry As and
Y DAYS moving could show suppliers: Average when
2)Demand is good obsolete or Supplier is 2)Previous products
3) Quality of product is unsaleable unreliable year become
good inventory then hold 3)Target complex,
4) Supply problems from 2)Signify more Raw days should the
dissatisfied suppliers. purchase of materials. match inventory
Raw Demand: days
materials Demand is increases.
now in irregular
anticipation then hold
of price rise. more
3)Lack of finished
demand of goods.
goods.
4)Poor
inventory
control
5)Increase
in costs
6)Purchased
to not have
stockouts.
 18. Ratio & Ratio Analysis 169

RECEIVABL 1) Credit control 1) Receivabl Bad ratios 1)Industry 1) Where

E DAYS department works es taking could bethe Average average
efficiently. longer to cause of: 2)Previous used
2) Could indicate a pay. 1)Deliberate year indicates
company is suffering 2) Lack of policy to 3)Target average
from cash shortage. proper attract more days should days taken
credit trade. match(state by the
control 2)Major d credit customer
department new policy) to pay.
customers 2) Factoring
are being of
allowed receivables
different could result
terms. in lower
receivables
and quicker
collection.
PAYABLE 1) Company takes 1)Long 1)Develop 1)Industry
DAYS discounts period could poor Average
2) Suppliers are cutting indicate reputation 2)Previous
credit terms cause of source of as slow year
company’s free finance. payer and 3)Target
creditworthiness. 2)Long may not be days should
period able to find match
indicates new stated
company is suppliers. credit policy
unable to 2)Existing
pay more suppliers
quickly due may
to liquidity discontinue
problems. to provide
3)More supplies.
reliance is 3)Co. may
placed upon lose out on
payables to prompt
finance discounts.
business.
CASH Comment on movement in cash, Identify where major cash inflows have come from
in the year; Identify where cash has been used, and comment on where cash has
come from, i.e. either debt or other sources.

OVERTRADING (entity has expanded without expanding its capital base)

Indicators:
1) Sales revenue increases rapidly without securing adequate long term capital.
2) Growth % in inventory > Growth % in Revenue
3) Growth % in receivables> Growth % in Revenue
4) Cash & Liquid assets decreases.
5) Trade payables increase rapidly.
6) Over reliance on Trade payables & Bank O/D for finance.

Solution for Overtrading:

 18. Ratio & Ratio Analysis 170

Fixed term Loan funding from a bank rather than relying exclusively on O/D.
 18. Ratio & Ratio Analysis 171

Ii )LONG TERM SOLVENCY RATIOS/GEARING RATIOS

1. GEARING RATIO = DEBT OR DEBT

EQUITY DEBT+EQUITY
Gearing ratios indicate:
 The degree of risk attached to the company and
 The sensitivity of earnings and dividends to changes in profitability and activity level.

1) Increase in gearing indicates borrowings increasing faster than equity or equity falling more
quickly than borrowings.
2) Preference share capital to be included in debt & not equity as it carries the right to a fixed
rate of dividend payables before ordinary shareholders have any right to dividend.
3) If profits are irregular & gearing is high, they will still have to pay interest which might lead
to liquidation or depress the reserves.

High Gearing Low Gearing

Large proportion of fixed return capital used. Provide scope to increased borrowings when
potentially profitable projects are available.
Greater risk of insolvency Can borrow more easily
Return to shareholder will grow
proportionately more if profits are growing.
Suitable to high gearing (cyclical industries) Suitable to low gearing
1)Property Investment 1)Extractive
2)Hotel and leisure service industry where 2)High tech industries
stable profits & assets are not subject to rapid Where profits are irregular & inadequate assets
change. as security

2. INTEREST COVER = PBIT

FINANCE COST
Interest Cover gives the ratio of the ability of a company to pay the interest out of profits
and how many times can interest can cover profits.

1) Low interest cover indicates shareholders that their dividends are at risk as most profits
are eaten up by interest payments.
2) Company may have difficulty financing it’s debts if profits falls.
3) Interest cover of <2 is considered satisfactory
Ideal ratio = 2:1

3. INVESTOR RATIOS

1. EPS – separate chapter

2. P/E RATIO (STOCK MARKET RATIO) = PRICE PER SHARE

EARNINGS PER SHARE
 Represents market’s view of future prospects of share.
 High P/E suggests high growth is expected in future & vice versa for low.
 Calculated as purchase of a number of years earnings but represents market’s
consensus of future prospects of share.
 18. Ratio & Ratio Analysis 172

3. EARNINGS YIELD (INVERSE OF P/E RATIO)

 Earnings as a % of the market price.
 1/(P/E ratio) or Earnings/Price

4. DIVIDEND YIELD = DIVIDEND/SHARE

CURRENT SHARE PRICE
 Lower the dividend yield, more the market is expecting future growth in
dividend & vice versa.
 Compare to yields available on other investment possibilities.

5. DIVIDEND COVER = PAT

DIVIDENDS
 Relationship between available profits & dividends payable out of profits.
 Higher dividend cover more likely it is that current dividend level can be sustained in
future.
 If EPS & Dividends/share increase is marginal from the previous year, then it might
be a policy to satisfy shareholders.
 Dividends cover increases if dividends increase or more profits are made retained in
business.

Limitations of Ratio Analysis:

1. Inconsistent definition of ratios, e.g. ROCE and Gearing

2. Manipulated books which give wrong ratios(creative A/C; window dressing)
3. Different accounting policies & managerial policies
4. Seasonal trading thus not evenly accrued.
5. Impact of price change over time caused by inflation
6. Inter firm comparisions could be misleading.

Additional information for better interpretation:

1. Audited statements would increase credibility.

2. Fair value of asset needed.
3. Risk of business
4. Inflation %
5. Expected price to acquire.
6. Forward looking information like financial position, forecasts, cash budgets, capital
expenditure, etc.
7. Budgeted figures
8. Industry average/figure for similar businesses
9. Market share of the company
10. Sales mix of the company
11. Product range of the company
12. Long term plans of the management.
 18. Ratio & Ratio Analysis 173

Type of questions to be tested:

1. Acquisition of Subsidiary- Good decision?

(Compare before and after the acquisition of subsidiary)
(current year will have subsidiary figures, the previous year will not have so remove
effects & compare)

2. Disposal of subsidiary - Good decision?

(Compare before and after disposal of the subsidiary)
(current year will not have subsidiary figures, previous year will have so remove effects
& compare)

3. Comparison of two different companies ( different a/c policy, e.g. depreciation &
revaluation )

4. Comparison of Company with an industry average

(different y/e of companies a/c policies differ)

5. Cash flow commenting.

6. Comparing performance and position of the current year with last year. (one off events;
new products/change in customers or new entrants)
 174

PO8 – ANALYSE AND INTERPRET FINANCIAL REPORTS

Description
You analyse financial statements to evaluate and assess the financial performance and position of an
entity.

Elements
a. Assess the financial performance and position of an entity based on financial statements and
disclosure notes.
b. Evaluate the effect of chosen accounting policies on the reported performance and position
of an entity.
c. Identify inconsistencies between the information in the financial statements of an entity and
any accompanying narrative reports.
d. Evaluate the effects of fair value measurements and any underlying estimates on the
reported performance and position of an entity.
e. Conclude on the performance and position of an entity identifying relevant factors and make
recommendations to management.
 175

SYLLABUS AREA E:

Statement of Cashflows
 19. IAS 7 Statement of Cashflows 176

19. IAS 7 Statement of Cashflows

‘The objective of IAS 7 Statement of Cash Flows is:

 to ensure that all entities provide information about the historical changes in cash and cash
equivalents by means of a statement of cash flows
 to classify cash flows (i.e. inflows and outflows of cash and cash equivalents) during the
period between those arising from operating, investing and financing activities.’

Future cash flows are regarded in financial management theory, and increasingly in practice in large
companies, as the prime determinant of the worth of a business. Cash flows of a company are more
difficult to manipulate than the profits of the company.

They are classified into:

1. Operating activities
2. Investing activities
3. Financing activities

'Cash: Cash on hand (including overdrafts) and on demand deposits. Cash equivalents: Short-term,
highly liquid investments that are readily convertible to known amounts of cash and are subject to
an insignificant risk of changes in value' (IAS 7, para 6).
 19. IAS 7 Statement of Cashflows 177

A. Proforma for Statement of Cashflows

A] CASHFLOW FROM OPERATING ACTIVITIES
Profit before Tax XX
(+) Finance Cost(from P/L statement) XX
(-) Investment Income (from P/L statement) (XX)
(+) Depreciation XX
(-/+) Profit/loss on disposal of NCA (X)/X
(-) Government Grants Released/Amortised (XX)
(-/+) Decrease/Increase in provisions (X)/X
(-/+) Increase/Decrease in Prepayments (X)/X
(-/+) Decrease/Increase in Accruals (X)/X

Profit before Working Capital Changes XX

(-/+) Increase/Decrease in Inventories (X)/X
(-/+) Increase/Decrease in Trade Receivables (X)/X
(-/+) Decrease/Increase in Trade Payables (X)/X

Cash generated from Operations XX

(-)(W1) Interest Paid (Open + Expense (from P/L)-Close) (X)

(-)(W2) Tax Paid (Open + expense (from P/L)-Close) (X)

Net Cashflow from Operating Activities XX

B] Cash generated from Investing Activities

(+) Sale of NCA XX
(-) Purchase of NCA (XX)
(+) Investment Income Received XX
(Opening Receivables(TR) +Investment Income-Close TR)
(+) Government Grant Received (full amount) XX

Net Cashflow from Investing Activities XX

C] Cashflow from Financing Activities

(+) Cash proceeds by issue of Loan Notes XX
(+) Cash proceeds by issue of shares XX
(-) Dividend Paid to NCI(W4) (XX)
(-) Repayment of Loan Notes/ (XX)
(-) Payment of Lease Liabilities(W3) (XX)
Net Cashflow from Financing Activities XX

Net Increase/Decrease in Cash (A+B+C) XX

Opening balance of Cash(Cash & Cash equivalents) XX
Closing Balance of Cash XX
 19. IAS 7 Statement of Cashflows 178

Calculation of interest paid for the year

To calculate the cashflow for this year for Interest paid, always do
Amount brought forward X
(+) Amount as per P/L X
(-) Amount c/f (X)
Cashflow for the item for this year XX

Calculation of tax paid for the year

Liabilities b/f (current & deferred tax) X

(+) Tax charge per SOPL X
(+) Deferred Tax on Revaluation of PPE X
(-) Liability c/f (current & deferred tax) (X)
Tax Paid for the year XX

Calculation of lease liabilities paid during the year

Liabilities b/f (Current and Non current) X

(+) New additions X
(-) Lease Liability c/f(current and non current) (X)
Lease Liabilities paid for the year XX

Calculation of dividend paid during the year

Retained earnings b/f X

(+) Profit for the year X
(-) Retained earnings c/f (X)
Dividends Paid XX

Calculation of government grants received during the year

Opening (Current Liabilities + NCL) X

(-) Credited to P/L (X)
(-) c/f (Current Liabilities +NCL) (X)
Government Grants received XX

Calculation of acquisitions or sale made during the year

Balance b/f X
(+) Additions X
(+) Revaluation X
(-) Disposals (X)
(-) Depreciation (X)
Balance c/f XX

HINT: To check whether your CASHFLOW answer is right

Opening CF + Net Increase/Decrease in CF should equal Closing CF for the year.
 19. IAS 7 Statement of Cashflows 179

B. Advantages and disadvantages of Cash flows

ADVANTAGES DISADVANTAGES
Assist user in making a judgement about timing, Based on historical information and thus do not
amount and certainty of cashflows provide complete information for assessing the
future cashflows.
More Difficult to manipulate, so can get a Little scope of manipulation of cashflows
better understanding of the company as (eg delaying payments to supplier till a specific
compared to profits which can be manipulated period of time, either after year end or quarter
according to the accounting policies. end, to show better result for the
year/quarter.)
Relationship between profitability and cash Cashflow sacrificed in the short term can give
generating ability and hence can tell the quality positive profits for the long term as it will help
of the profit which is been achieved. the company achieve its strategic goals
(eg. Investing in NCA)
Huge cash balance may indicate that the
company is not making good use of the cash
and hence cannot generate more profit, also
they are paying an invisible interest of
Oppurtunity Cost.
Helps the analysts to make financial models for
discounting future cash flows and give
valuations of the company and give accuracy of
the past valuations.
Gives information on liquidity, viability and
adaptability, which is often used to obtain
information on liquidity.

C. Interpretations of Cash flows.

* Cash generation from operating activities
This amount should be compared to the operating profit of the company.
Overtrading may be indicated by:
1. high profits and low cash generation
2. large increases in inventory, receivables and payables.
When discussing cash flow from operations, comments should be made regarding working capital
management and giving any particular reasons for movements in inventory, receivables and
payables, discussing the impact they may have on cash flow and customer/supplier relations going
ahead.

* Dividend and interest pay-outs

When businesses cannot cover the interest and dividend pay outs, then it is a cause of concern for
the business, and they may have problems to continue as a going concern. One can look at the
Interest Coverage and Dividend Coverage Ratios for a better understanding.
 19. IAS 7 Statement of Cashflows 180

* Cash generated from Investing activities:

 Investment > Depreciation indicates the company investing in NCA and hence expanding.
 Investment=Depreciation indicates company investing at a rate of existing ones wearing out
hence Stable
 Investment<Depreciation indicates the company’s NCA base is not being maintained, and
hence NCA won’t be able to generate profits and hence going concern would be an issue.

Potential indicators for selling old vs new assets

 If cash generated from selling NCA is high, it means that the company has sold new assets
and is difficult to continue further as profits will reduce due to selling assets giving the
production of goods and services.
 If cash generated from selling NCA is low, it means that the company has sold old assets and
this is normal as old assets should be sold or scrapped. However, this should also be backed
by purchase of fresh NCA to ensure the continuity of the activities.

* Cash generated from Financing Activities:

If new loans are taken then this imply future commitment of interest payments which would be paid
from profits and hence reduce the profits and hence these profits would be less to be distributed as
dividends.
19. IAS 7 Statement of Cashflows 181
19. IAS 7 Statement of Cashflows 182
19. IAS 7 Statement of Cashflows 183
19. IAS 7 Statement of Cashflows 184
19. IAS 7 Statement of Cashflows 185
19. IAS 7 Statement of Cashflows 186
19. IAS 7 Statement of Cashflows 187
19. IAS 7 Statement of Cashflows 188
19. IAS 7 Statement of Cashflows 189