FR Study Guide Questions and Answers 4th Edition

Study guide
Questions and Answers

FINANCIAL REPORTING
To be used in conjunction with Financial Reporting, 4th Edition.

ii | FINANCIAL REPORTING
Contents
Question 1.1 1
Question 1.2 2
Question 1.3 3
Question 1.4 4
Question 1.5 6
Question 1.6 8
Question 1.7 9
Question 1.8 10
Question 1.9 11
Question 1.10 12
Question 1.11 14
Question 1.12 16
Question 1.13 18
Question 2.1 19
Question 2.2 20
Question 2.3 22
Question 2.4 23
Question 2.5 25
Question 2.6 27
Question 2.7 29
Question 2.8 31
Question 2.9 34
Question 2.10 35
Question 2.11 38
Question 3.1 51
Question 3.2 52
Question 3.3 53
Question 3.4 54
Question 3.5 55
Question 3.6 57
Question 3.7 59
Question 3.8 60
Question 3.9 61
Question 3.10 62
Question 4.1 63
Question 4.2 65
Question 4.3 67
Question 4.4 70
Question 4.5 74
Question 4.6 76
Question 4.7 79
Question 4.8 83
Question 4.9 85
Question 4.10 86
Question 4.11 87
Question 4.12 89
Question 4.13 91
CONTENTS | iii
Question 5.1 92
Question 5.2 94
Question 5.3 96
Question 5.4 98
Question 5.5 99
Question 5.6 100
Question 5.7 102
Question 5.8 103
Question 5.9 104
Question 5.10 106
Question 5.11 108
Question 5.12 111
Question 5.13 114
Question 5.14 116
Question 5.15 120
Question 5.16 126
Question 5.17 128
Question 5.18 130
Question 5.19 141
Question 5.20 143
Question 5.21 144
Question 5.22 146
Question 5.23 148
Question 5.24 149
Question 5.25 150
Question 6.1 152
Question 6.2 153
Question 6.3 154
Question 6.4 156
Question 6.5 157
Question 6.6 158
Question 6.7 160
Question 6.8 161
Question 6.9 162
Question 7.1 163
Question 7.2 166
Question 7.3 168
Question 7.4 170
Question 7.5 172
Study guide Questions and Answers | 1
Question 1.1
According to the Conceptual Framework, who are the primary users of general purpose financial
reports, and why do you think they are regarded as the primary users?
According to para. OB5 of the Conceptual Framework, the primary users of general purpose
financial reports are existing and potential investors, lenders and other creditors who do not have
the ability to require a reporting entity to provide information. As such, they rely on the general
purpose financial reports for information.
Other users may find the reports useful, but these reports are not specifically directed at them.
This includes management (who can obtain information internally), regulators and members of
the general public (Conceptual Framework, paras OB9 & OB10).
2 | FINANCIAL REPORTING
Question 1.2
Consider the following statement:
By focusing on the information needs of investors, lenders and other creditors, financial
reporting will not be useful for other users.
Do you agree or disagree? Give reasons for your answer.
The focus of financial reporting is on the information needs of primary users, but this does not
mean that financial reports will be irrelevant to other users. Although the reports may not be
specifically tailored to meet their needs, other parties, such as regulators and members of the
public, may find general purpose financial reports useful (Conceptual Framework, para. OB10).
One reason for this is that the information needs of primary users and other groups of users
overlap. For example, customers of a construction company may need information about
cash flows, sources of funds and risk to assess whether the company is likely to continue its
operations. This may help them to decide whether to trust the construction company with a
long-term project. They would not wish to hire a company to do a job that it could not complete.
Similarly, investors and creditors need information about cash flows, sources of funds and risk to
assess the long-term viability of the construction company.
Question 1.3
Consider the following statement:
The decision-usefulness objective provides unambiguous guidance in resolving financial
reporting problems.
Do you agree? Give reasons for your answer.
The decision-usefulness objective of financial reporting provides some guidance to standard

setters because it provides the underlying purpose that should be served in making deliberations
about accounting standards. That is, the standard setters should seek to determine what types
of information are most useful for decisions made by users of financial statements. However,
the decision-usefulness objective fails to provide unambiguous guidance in solving financial
reporting problems, because any evaluation of the usefulness of items of information to users
is biased by their familiarity with the information. It is difficult to find evidence of the usefulness
of information that is not available. Also, decision-usefulness may vary between users because
they make different types of decisions, such as whether to sell their shares or whether to
extend credit. Even for similar decisions, users may use different decision-making models,
giving rise to different information needs. Finally, the decision-usefulness objective is capable
of multiple interpretations and has been used to support a variety of measurement approaches
in accounting standards.
Question 1.4
In its first year of operations, Tower Ltd purchased and paid for widgets costing $50 000.
During that year, Tower Ltd sold 60 per cent of the widgets. The widgets on hand at the end of
the year cost $20 000. The sales were on credit terms. Tower Ltd received $37 000 in cash from
customers, and $3000 remained uncollected at the end of the year. During the last quarter of the
first year of operations, Tower Ltd entered into a property insurance contract for losses arising
from fire or theft. The annual premium of $4000 was paid in cash and the insurance expired nine
months after the end of the reporting period.
Calculate Tower Ltd’s profit for the first year of operations on an accrual basis and on a cash basis.
Explain the difference between the two measures. Which of the two profit measures is more
useful for assessing Tower Ltd’s performance during its first year of operations? Give reasons
for your answer.
Alternative measures of profit of Tower Ltd for the first year of operations:
Cash basis Accrual basis

$ $
Sales 37 000 40 000
Cost of goods sold (50 000 ) (30 000 )
Insurance expense (4 000 ) (1 000 )
Profit (loss) for the year (17 000 ) 9 000
The accrual basis includes all of the sales revenue generated during the period, whereas under
the cash basis, revenue is recognised when cash is received. Thus, the uncollected credit sales
of $3000 at the end of the period are excluded. If the accounts receivable are collected in the
following year, they will be included in the sales revenue for that year under the cash basis.
Another difference between the two measures of profit is that the accrual basis determines
cost of sales as the cost of inventory that has been consumed during the period. Accordingly,
under the accrual basis of accounting, cost of sales includes the cost of widgets to the extent
that they have been sold, whereas the widgets on hand at the end of the period are recognised
as an asset. In contrast, all payments for the acquisition of inventory are included as cost of sales
using the cash basis.
Under the accrual basis of accounting, the expenditure on the insurance premium is recognised
as an expense to the extent that it relates to the current period. In this case, 25 per cent of the
insurance premium is recognised as an expense because three months of the 12-month period
covered by the insurance contract have expired. The unexpired portion of the premium is
75 per cent because there are nine months remaining of the 12-month contract. The insurance
premium is recognised as an asset (prepaid insurance) to the extent that it relates to a period of
insurance cover that remains unexpired at the end of the reporting period. In contrast, under the
cash basis of accounting, the entire insurance premium is recognised as an expense in the period
in which the payment is made.
The accrual basis provides more useful information about the performance of the entity because
it compares revenue with expenses incurred in the same period. Further, under the accrual basis
of accounting, assets are recognised when expenditure results in future economic benefits that
are expected to flow to the entity. For example, the accrual basis recognises that Tower Ltd has
a resource, namely inventory, from which it expects to obtain future cash inflows through sale.
The prepaid insurance premium represents future economic benefits because Tower Ltd will be
covered for property losses arising from fire or theft during the next nine months.
An understanding of accrual accounting and why the recognition of income and expenses
does not always coincide with the receipt and payment of cash is assumed knowledge in the
Financial Reporting subject. If you have found the calculations and reasoning in the answer to
this question to be challenging, it is recommended that you revise balance day adjustments and
the basics of calculation of cash flows from an introductory financial accounting textbook before
attempting Module 2 of this subject.
Question 1.5
Coalite Ltd participates in an emissions trading scheme. It holds emission trading allowances,
which provide a permit for a specified amount of carbon emissions for the year. If its operating
processes result in carbon emissions, Coalite Ltd must deliver sufficient emission trading
allowances to the government to ‘pay’ for the amount of carbon emitted during the year. If it
does not hold enough emission trading allowances, Coalite Ltd will need to buy more to settle
its obligation to the government. If the company’s holding of trading allowances is surplus to its
needs, the allowances may be sold.
Assume that in determining how to apply the fundamental qualitative characteristics, the chief
financial officer (CFO) of Coalite Ltd has completed the first step by identifying the emission trading
allowances held as being potentially useful to the users of the company’s financial statements.
(a) Identify the type of information about emission trading allowances that would be most
relevant if it were available and could be faithfully represented.
(b) Do you think the information that you suggested is likely to be available and able to be
represented faithfully? If not, what might be the next most relevant type of information
about the emission trading allowances?
The purpose of this question is to help you to appreciate the role of professional judgment
in applying principles such as the fundamental qualitative characteristics. Answers may vary
depending on what type of information is suggested as being most relevant to users’ decision-
making processes. The following suggested answer should not be viewed as a unique solution
to the problem.
(a) The market value of the emission trading allowances is tentatively suggested as the most
relevant type of information about the phenomenon.
(b) Market value might be assumed to be available and as being able to be represented
faithfully. If this is the case, it should be used. However, if it is assumed that the available
market value is not from an active market, it could be concluded that the market value
cannot be represented faithfully. A reason for this is that it might be necessary to make
some adjustments to the most recently traded price to estimate a current market value.
Accordingly, an alternative type of information, such as the cost of the emission trading
allowances or their market value at the time they were acquired, might be used if
Coalite Ltd had received them as a government grant.
Question 1.6
The objectives of IFRS 13 Fair Value Measurement include establishing a common definition of fair
value and common guidance for fair value measurement. The standard prescribes the following
fair value measurement hierarchy (in descending order):
Level 1 Quoted price for an identical asset or liability
Level 2 Model with no significant unobservable inputs
Level 3 Model with significant unobservable inputs.
Explain how the enhancing qualitative characteristics, comparability and verifiability, are applied
in the requirements of IFRS 13.
IFRS 13 applies comparability by establishing a single definition of fair value and hierarchy for
its measurement instead of having different definitions and measurement frameworks within
the IFRSs.
The standard applies verifiability by identifying a quoted price, which is directly verifiable, as the
preferred measurement. Similarly, a Level 2 estimation model that has no significant unobservable
inputs is preferred over a Level 3 estimation model, which includes some significant unobservable
inputs. Some aspects of Level 3 measurements can be verified, including processes such as
calculations used in applying the model and any observable inputs.
Question 1.7
The Sydney Harbour Bridge was officially opened on 19 March 1932. The total cost of the bridge
was approximately 6.25 million Australian pounds ($13.5 million) and was eventually paid off in
1988 (Sydney Online 2014).
Explain some of the limitations of using historical cost for the subsequent measurement of the
Sydney Harbour Bridge.
Subsequent measurement of the Sydney Harbour Bridge at the AUD equivalent of its historical
cost could have implications for the decision-usefulness of the statement of financial position
because the historical cost of the bridge is merely a historical record of the financial sacrifice
made to construct it. The historical cost, particularly one incurred so long ago, is not a relevant
measure of the future economic benefits expected to be derived from using the bridge.
There may also be implications for the comparability of financial statements that recognise
this asset because the financial statements may include costs relating to assets acquired
at different times. The Sydney Harbour Bridge, reported at its historical cost equivalent of
AUD 13.5 million, could be recognised at a lower value than other, more recently constructed
assets and, in accounting terms, may be immaterial in size. Further, ratios could be distorted by
the comparison of current income with a historical cost, in the light of changes in the purchasing
power of currency since 1932.
In this regard, historical cost has been criticised on the grounds that it aggregates costs incurred
at various times as though they are equivalent in economic terms. However, allowing for the time
value of money, the presumption is open to criticism.
In summary, the question highlights one of the major deficiencies of historical cost—that is,
with the passage of time historical costs become dated and, therefore, have limited relevance
to decision-making.
Question 1.8
Stanley Ltd holds a parcel of Alpha B redeemable 7 per cent cumulative preference shares issued by
Alpha Ltd. The Alpha B preference shares are unlisted. Stanley Ltd’s financial accountant measured
the value of the shares using the market price of Alpha A preference shares, which are listed,
redeemable, cumulative 5 per cent preference shares, issued by Alpha Ltd. The Alpha A preference
shares have a very similar maturity date to the Alpha B preference shares. The accountant
determined the yield of the Alpha A preference shares by reference to the quoted price and to
the timing and amount of the contractual cash flows. The accountant then applied the same yield
in a discounted cash flow model, using the contractual cash flows of Alpha B preference shares.
Which input level has the accountant used to measure the fair value of the Alpha B preference
shares? Give reasons for your answer.
The measurement technique for the Alpha B shares uses Level 2 inputs because their measurement
was based on a similar security in an active market, the Alpha A shares. It is not Level 1 because the
observed price is not for an identical security. The Alpha B preference shares held by Stanley Ltd
are unlisted and have a different coupon rate.
Question 1.9
Refer to Question 1.7 regarding the Sydney Harbour Bridge. How might using an alternative
measure, such as current cost, overcome the limitations of cost outlined in that question?
Current cost could provide more decision-useful information because it is based on the amount
of cash or cash equivalents that would be required currently to acquire (or construct) the asset,
which may be considered more relevant than historical cost.
This information may also be considered to be more comparable because the financial statements
that include current cost relating to assets will be measured at the same time, rather than at
different times. In that way, the Sydney Harbour Bridge reported at a current cost would be
recognised at a value that has the same basis as any other bridge constructed at a later time.
Question 1.10
Using the information provided in Example 1.6, prepare the journal entries to be recorded by
the lessee (B Ltd) throughout the lease term.
The journal entries to be recorded by the lessee (B Ltd) throughout the term of the lease are
as follows.
Year ended 30 June 20X4

30.06.X4 Dr Cr
Right-of-use vehicle 67 813
Lease liability 49 813
Prepaid executory costs† 1 800
Cash 19 800
(Initial recording of lease asset/liability)

01.07.X4 Dr Cr
Executory costs 1 800
Prepaid executory costs 1 800
(Reversal of prepayment)
30.06.X5
Interest expense 4 483
Cash 19 800
(Second lease payment)
Depreciation expense 15 453

Accumulated depreciation 15 453
(Depreciation charge for the period ($67 813 – $6 000) / 4)

01.07.X5 Dr Cr
30.06.X6
Cash 19 800
(Third lease payment)

(Depreciation charge for the period)

01.07.X6 Dr Cr
30.06.X7
Cash 19 800
(Fourth lease payment)

(Depreciation charge for the period)

01.07.X7 Dr Cr
30.06.X8
Interest expense 496
Cash 6 000
(Return of leased vehicle)

(Depreciation charge for the period—
rounding adjusted in final year)

Right-of-use vehicle 61 813

†
Prepaid costs: because the benefits of insurance and maintenance will not be received until
following period.
Question 1.11
Using the information provided in Example 1.7 prepare the journal entries to be recorded by
the lessor (A Ltd) throughout the lease term.
The journal entries to be recorded by the lessor (A Ltd) throughout the term of the finance lease
are as follows.

30.06.X4 Dr Cr
Motor vehicle 68 000
Cash 68 000
(Purchase of motor vehicle)
Lease receivable 68 000

(Lease of motor vehicle)

Cash 2 647
(Payment of initial direct costs)
Cash 19 800
Reimbursement in advance† 1 800
(Receipt of 1st lease payment)

01.07.X4 Dr Cr
Reimbursement in advance 1 800
Reimbursement revenue 1 800
(Reversal of accrual)
30.06.X5
Insurance and maintenance expenses 1 800
Cash 1 800
(Payment of costs on behalf of lessee)
Cash 19 800
Interest revenue 4 738
(Receipt of 2nd lease payment)

01.07.X5 Dr Cr
30.06.X6
Cash 1 800
Cash 19 800
(Receipt of third lease payment)

01.07.X6 Dr Cr
30.06.X7
Cash 1 800
Cash 19 800
(Receipt of third lease payment)

01.07.X7 Dr Cr
30.06.X8
Cash 1 800

Interest revenue 826
(Return of vehicle at end of lease)

†
Reimbursement of executory costs are carried over to the next period when they will be paid by the lessor.
Question 1.12
An entity has 500 employees who are provided with 10 days sick leave for each year of service
on a non-vesting accumulating basis. At 30 June 20X6, 20 per cent of employees had taken their
full entitlement of sick leave. The remaining employees had an average of 12 days’ accumulated
leave. Past experience indicates that:
• 20 per cent of employees use all of their sick leave in the year in which they become entitled
to it and therefore have no accumulated sick leave at the end of the year
• 50 per cent of the entity’s employees use six days of accumulated sick leave in years
subsequent to their accumulation
• 30 per cent of employees take two days of accumulated sick leave in years subsequent to
their accumulation.
Assume that the average annual salary per employee is $40 000 and that employees have a
five‑day working week.
(a) Measure the nominal amount of the provision for sick leave as at 30 June 20X6 in accordance
with IAS 19.
(b) Explain whether it is important to know the timing of the payments to employees for
accumulated sick leave in future reporting periods.
(a) At 30 June 20X6, 20 per cent of the entity’s employees had taken their full entitlement of
sick leave during the year. The remaining 80 per cent of employees have an average of
12 days accumulated sick leave. If the provision for sick leave was based on the average
number of accumulated days per employee then the provision would be calculated using
a total of 4800 days (500 employees × 80% × 12 days). However, the provision for sick leave
should be based on payments ‘expected’ to be paid to employees in the short-term (IAS 19,
paras 11–14). Therefore, the provision for sick leave should be calculated using data on the
past experience of employees taking accumulated sick leave. This is calculated as follows:

Number of Number of sick
employees days expected Total number
expected to to be taken of sick leave
Total employees % take sick leave per employee days expected
500 50% 250 6 1 500
500 30% 150 2 300
1 800
Given an average annual salary per employee of $40 000 and a five-day working week,
the payment per sick day would be: $40 000 / 260 = $153.85 (5 days × 52 weeks =
260 working days per year).
Therefore, the amount of the provision for sick leave:

= Total expected number of days of sick leave × Payment per sick day
= 1800 × $153.85
= $276 930
(b) The expected timing of payments is important in determining how the liability should be
measured. The liability for sick leave that the entity expected to settle within 12 months
after the reporting period is measured at the nominal amount. Liabilities for compensated
absences expected to be settled beyond 12 months after the period are measured using
PV techniques in accordance with IAS 19 Employee Benefits.
Question 1.13
At 30 June 20X7, Maynot Ltd has 100 employees. For simplicity, assume that the employees
have the following periods of service:
Years of service Number of employees
2 10
4 40
8 30
10 10
15 10
100
The employees of Maynot Ltd are employed under an award that provides for LSL on the
basis of 90 calendar days after 13 years of service and nine days per year of service thereafter.
After 10 years of service, employees are entitled to a pro rata payment if they resign or their
employment is terminated.
Outline the steps that you would need to take and the factors that you would need to consider
in determining Maynot Ltd’s liability for LSL.
To determine the amount of LSL for Maynot Ltd, it is first necessary to determine those
employees who will become entitled to receive a payment as a result of services provided up
to the reporting date. All employees with 10 or more years of service are currently entitled to
a payment. Although Maynot Ltd has 80 employees who are currently not entitled to LSL at
30 June 20X7, some will eventually be paid LSL for services that they have already provided.
Therefore, the first issue to assess is the probability of those employees not currently entitled to
LSL actually receiving a payment for LSL. This assessment would be based on past data either
for the whole entity or for groups of employees where, for example, staff turnover rates may
vary between different groups of employees.
Question 2.1
(a) Refer to Note 1 of the 2016 financial statements of Techworks Ltd. Explain how the summary
complies with the requirements of paras 112 and 117 of IAS 1.
(b) Refer to the ‘Case study data’ section at the end of this module. Prepare the initial section
of the accounting policy notes relating to the significant accounting policies of Webprod Ltd.
(a) The accounting policies of Techworks Ltd comply with the requirements of IAS 1 as follows:
–– the accounting policies present information about the preparation of the financial
statements and the specific accounting policies adopted in the notes to the financial
statements (para. 112(a))
–– the basis of preparation of the financial statements (prepared in accordance with
Australian Accounting Standards as issued by the Australian Accounting Standards
Board (AASB) and the International Financial Reporting Standards (IFRS) as issued by
the International Financial Accounting Standards Board (IASB) and the requirements
of the Australian Corporations Act is disclosed in the notes (para. 112(a))
–– the measurement basis (historic cost, except for derivatives and certain financial assets
measured at fair value) has been identified that was used in preparing the financial
statements (para. 117(a))
–– in accordance with para. 117(b), the summary describes accounting policies relevant for
a proper understanding of the financial statements.
(b) The notes to the financial statements of Webprod Ltd would include the following initial Note:
1. Statement of significant accounting policies
(A) Basis of preparation
The financial statements of Webprod Ltd are general purpose financial statements that
have been prepared in accordance with the IFRSs. It has been prepared on the basis of
historical cost, except for land and factory buildings, which are measured on a fair value
basis. An independent valuer determines fair value on an annual basis. The accounting
policies of Webprod Ltd are consistent with those of the previous year.
Question 2.2
(a) Refer to Note 1(b) ‘Accounting policies’ in the notes to financial statements of the 2016
financial statement of Techworks Ltd. This note refers to certain new accounting standards
and interpretations that have been published by the IASB and AASB and that are mandatory
for 30 June 2016 reporting period.
Which accounting standards have been identified by the directors of Techworks Ltd as those
that have not been adopted at 30 June 2016 but that are likely to impact on the financial
statements in future reporting periods?
(b) Under Section 334(5) of the Corporations Act, Australian companies have the option of early
adopting accounting standards. These are accounting standards that have been issued by the
IASB or AASB but do not apply until a future financial reporting period. Review Note 1(b)
‘Accounting policies’ in the notes to financial statements of the 2016 financial statement of
Techworks Ltd. Has Techworks Ltd early adopted any AASB accounting standards?
(c) Refer to sections 5 and 6 of the ‘Case study data’. Prepare any disclosures necessary to be
included in the notes to the financial statements.
(a) As detailed in Note 1(b) basis of accounting, the following Accounting Standards have been
issued by the AASB, but have not been adopted in the preparation of the 30 June 2016
financial statements:
• AASB 9 Financial Instruments (has a mandatory application date for financial years
commencing on or after 1 January 2018)
• AASB 16 Leases (has a mandatory application date for financial years commencing
on or after 1 January 2019).
(b) As detailed in Note 1(b) basis of accounting, the following Accounting Standards have
been early adopted by Techworks Ltd:
• AASB 15 Revenue from Contracts with Customers.
The group has elected to early adopt AASB 15 Revenue from Contracts with Customers,
as issued in December 2014, which would otherwise be mandatory, effective for annual
reporting periods beginning on or after 1 January 2018. The initial application date for the
group is 1 July 2014. The group has elected to apply the standard on a full retrospective
basis as permitted by AASB 15 whereby the cumulative effect of retrospective application
is recognised at the date of initial application by adjusting opening retained profits or
other relevant components of equity. Comparatives for the 30 June 2015 year have also
been restated.
(c) The notes to the financial statements of Webprod Ltd would include the following:
1. Statement of significant accounting policies
(B) Change in accounting policy
During the 20X7 reporting period, IAS 23 Borrowing Costs was issued. As a result,
Webprod Ltd changed its accounting policy on the treatment of borrowing costs.
Previously all borrowing costs were expensed as incurred. The transitional provisions
of IAS 23 require borrowing costs that relate to qualifying assets and that are incurred
after the date the standard is applied to be capitalised. In addition, no adjustments are
to be made to the opening balances of the financial statements.
From 1 July 20X6, any borrowing costs relating to qualifying assets were capitalised
during the reporting periods in which construction of the asset took place. During the
20X7 reporting period, Webprod Ltd included $10 146 of borrowing costs as part of
factory, plant and equipment under construction. This change in accounting policy is
also expected to materially affect subsequent reporting periods.
Question 2.3
The following extract is from Note 36 of the 2014 annual report of BHP Billiton (statement of
financial position date is 30 June 2014):
On 2 September 2014, legislation to repeal the MRRT in Australia received the support
of both Houses of Parliament. The repeal will take effect at a later date to be fixed by
proclamation and therefore the MRRT will continue to apply until that date. At 30 June
2014, the Group carried an MRRT deferred tax asset (net of income tax consequences)
of US$698 million. Subject to determination of the effective date, an income tax charge
approximating this amount is expected to be recognised in the 2015 financial year
(BHP Billiton 2014, p. 292).
Comment on whether the preceding event would be regarded as an ‘adjusting event after the
reporting period’ or a ‘non-adjusting event after the reporting period’.
The events outlined in Note 36 of the BHP Billiton 2014 annual report relate to conditions
that arose after the end of the reporting period. The legislation to repeal the MRRT received
support of both Houses of Parliament on 2 September 2014. The event would be considered a
non‑adjusting event.
Question 2.4
Refer to Note 23 Subsequent Events in the notes to financial statements of the 2016 financial
statement of Techworks Ltd. This note refers to two events which have occurred after 30 June
2016 (but before the signing off of the financial report by the directors).
The two events disclosed in Note 23 are:
• renegotiation of the loan facility (and repayments) in August 2016
• declaration of the dividend by the directors on 17 October 2016.
Explain whether these two subsequent events are adjusting or non-adjusting events under IAS 10.
The first subsequent event disclosed in Note 23 relates to the renegotiation of the loan facility
and subsequent repayments. Note 23 states:
The group renegotiated its existing loan finance facility in August 2016; the total amount available
amount under the facility was increased by $60 000 000, which is expected to be drawn down
over the next 12 months. The renegotiated facility will be repaid in three annual instalments,
commencing in August 2021.
This event meets the definition of a non-adjustable event, as it is one that arises after the
reporting date for the first time. In other words, this event did not relate to a condition that
existed at the reporting date. As such, para. 10 of IAS 10 requires that the entity shall not adjust
the financial statements in respect of these events. Instead, the event should be disclosed as a
note in the financial statements (which has been done by Techworks Ltd).
The second subsequent event is the declaration of a final dividend by the directors on
17 October 2016.
Refer to note for the final dividend recommended by directors, to be paid on 17 October 2016.
Once again, the declaration (and payment) of a dividend after 30 June 2016 meets the definition
of a non-adjustable event. As such, the financial statements do not need to be adjusted.
However, note disclosure needs to be made (as is the case).
Furthermore, para. 13 of IAS 10 confirms that if an entity declares a dividend after the reporting
period but before the financial statements are authorised for issue, the dividends are not
recognised as a liability at the end of the reporting period because no obligation exists at
that time. As such, the dividends should be disclosed in the notes to the accounts.
Question 2.5
Venturiac Holdings Ltd’s reporting period ends on 30 June, and the financial statements are
authorised for issue on 31 August. How should the following events be disclosed?
(a) On 30 July, a major drop in the price of shares means that the value of the Venturiac Holding’s
investments has declined by 25 per cent since 30 June.
(b) A debtor who owed a significant sum of money as at 30 June was declared bankrupt on
18 August.
(c) A major explosion occurred on 20 July, causing significant losses for the company.
(a) A major drop in the share price on 30 July is considered a non-adjusting event, as it relates
to an event that does not reflect conditions existing at the end of the reporting period.
The information relevant at 30 June is the market price of the shares at that date, which was
correct at that time. The drop in share prices occurred after 30 June as a result of new
information subsequent to reporting date. Therefore, the investments will not be adjusted
in the statement of financial position, but the nature of the event and its financial effect
should be disclosed in the notes to the financial statements (IAS 10, para. 8).
(b) A debtor who owed a significant sum of money at 30 June and is declared bankrupt on
18 August is likely to be an adjusting event. If the debtor’s account was significantly overdue
at 30 June, the bankruptcy is probably just a confirmation that the debtor could not pay at
reporting date. Here, the event of bankruptcy simply confirms conditions at the end of the
reporting period. Therefore, the accounts receivable in the statement of financial position
would be adjusted accordingly (IAS 10, para. 8).
On the other hand, if the debtor experienced financial problems after 30 June—for example,
where a fire destroyed the debtor’s business in early July, causing extreme financial difficulties—
then it could be argued that the financial statements should not be adjusted. Instead, details of
the bankruptcy should be disclosed in the notes as this would constitute a non-adjusting event
(IAS 10, para. 21).
It is important to note that all circumstances must be taken into account, and professional
judgment is often required when dealing with events after the end of the reporting period.
(c) A major explosion on 20 July is a non-adjusting event as it relates to an event that does
not reflect conditions existing at the end of the reporting period. It should not result in
adjustments of assets and liabilities, but details of the nature and financial effect of the
event should be disclosed (IAS 10, para. 21).
Question 2.6
Refer to Section 8 of the ‘Case study data’. Prepare a single P&L and OCI for Webprod Ltd in
accordance with paras 10A, 81A and 82 of IAS 1.
Notes:
• There was a revaluation increase of buildings by $150 000, and a revaluation decrease of the
land by $230 000. This reduced the balance of revaluation surplus of Webprod Ltd by $80 000.
• For the purposes of this module, ignore any tax effects of revaluations because this topic is
not dealt with until Module 4.
• Question 2.8 will consider an expanded income statement, after classification and other
disclosures have been discussed.
Note: IAS 1 paragraph numbers are provided for your reference.
Statement of profit or loss and other comprehensive income of Webprod Ltd for the
year ended 30 June 20X7
$ IAS 1
Revenue 20 794 434 82(a)
†
Interest revenue accounted for using

the effective interest method 12 283
Other income 25 000 ‡
Expenses excluding finance costs (19 438 004 )§
Operating profit 1 393 713

Finance costs (103 654 ) 82(b)
Profit before tax 1 290 059
Income tax expense (387 018 )|| 82(d)
Profit for the year 903 041 81A(a)
Items that will not be reclassified to profit or loss
Other comprehensive income (net of tax):
Revaluation surplus 82A
Revaluation surplus—land (230 000 )
Revaluation surplus—buildings 150 000
Other comprehensive income for the year, net of tax (80 000 )# 81A(b)
Total comprehensive income for the year 823 041 81A(c)
Note: Allocations between non-controlling interests and parent entity owners will not be dealt
with until Module 5 and have not been incorporated into the ‘Case study data’.
Calculations
†
Calculation of revenue $
Sales 19 194 434

Telecommunications project revenue 600 000
Grant revenue 1 000 000
20 794 434
‡
Other income
Profit on sale of factory plant 25 000
§
Calculation of expenses excluding finance costs $
Cost of sales 12 046 232
Loss on write-down of inventory 24 921
Under-applied overhead expense 87 500
Employee benefits expense retail 166 320
Doubtful debts expense 5 400
Amortisation expense 85 000
Damages expense 620 000
Warranty expense 12 300
Audit fees 25 000
Consulting fees—auditor 30 000
Advertising campaign—new product 380 000
Selling and marketing expenses 2 415 000
Other administrative expenses 3 530 077
19 438 004

||
1 290 059 × 0.30 = $387 018
#
Balance as at
Revaluation surplus 20X6 20X7 30 June 20X7
Land 400 000 (230 000 ) 170 000
Buildings 300 000 150 000 450 000
Total 700 000 (80 000 ) 620 000
Note: According to IAS 16 (para. 40), the revaluation decrease of land is recognised in P&L only if there
is no existing credit balance in the revaluation surplus in respect of that asset. If there is an existing credit
balance, the decrease will be first adjusted to the extent of the credit balance existing in the revaluation
surplus account. If the revaluation decrease exceeds the credit balance in the revaluation surplus account,
the excess is recognised in P&L. As per Section 3.3 of the Case data, the 20X6 credit balance of the
revaluation surplus of the land was $400 000, hence, the entire revaluation decrease of $230 000 will be
adjusted to the revaluation surplus of the land, and recognised in the OCI.
According to IAS 36 (para. 39), the revaluation increase of buildings is to be recognised in OCI under
‘Revaluation surplus—buildings’ in the P&L and OCI.
For the purposes of this module, ignore any tax effects of revaluations as this topic is not dealt with until
Module 4. Therefore, assume the $80 000 is net of tax.
Question 2.7
(a) Refer to the P&L and OCI prepared in answering Question 2.6. Explain whether the revaluation
loss included in OCI could result in a ‘reclassification adjustment’ in future reporting periods.
(b) Where the financial statements of a foreign operation are translated for inclusion in the
financial statements of a reporting entity, the exchange differences arising from the translation
are initially recognised in OCI and accumulated in equity. On the disposal of the investment in
the foreign operation, the total foreign currency exchange difference accumulated in equity
over the life of the foreign operation is recognised in the profit or loss.
Assume that, at the date of disposal of an investment in a foreign operation, an entity had
recognised accumulated exchange difference gains net of tax through OCI of $7000 (pre-tax
of $10 000). Of the accumulated exchange difference gains, $2800 (pre-tax of $4000) related
to the current reporting period.
Using the net of tax approach, illustrate how the preceding information would be disclosed in
the P&L and OCI for the reporting period when the disposal of the investment in the foreign
operation occurred.
(a) As outlined in para. 96 of IAS 1, reclassification adjustments do not arise on changes in

revaluation surplus made in accordance with either IAS 16 Property, Plant and Equipment
or IAS 38 Intangible Assets. While such items are included in OCI, they are not reclassified
into the P&L in subsequent periods. Changes in revaluation surplus may be transferred to
retained earnings in subsequent periods as the asset is used or when it is derecognised.
(b) The disposal of the foreign operation would require the following items to be recognised in
the determination of profit or loss and other comprehensive income for the reporting period
during which the disposal took place.
Profit or loss $
Exchange difference on translating foreign operation 10 000
Income tax expense 3 000
Net exchange difference recognised in profit or loss 7 000
Other comprehensive income $

Exchange difference on translating foreign operation (net of tax)† 2 800
Reclassification adjustment (net of tax)‡ (7 000 )
Net exchange difference recognised in other comprehensive income (4 200 )
†
Of the accumulated exchange difference gains of $7000, $2800 (pre-tax of $4000) relates to the
current period. The exchange difference arising up to the date of disposal of the foreign operation
is initially included in other comprehensive income.
‡
The reclassification adjustment is for the accumulated exchange difference gains (net of tax) over
the total period that the foreign operation was in existence. As the foreign operation has been
disposed of, this exchange difference gain can now be recognised in profit or loss.
The impact on total comprehensive income for the current reporting period is net of tax
$2800. The disposal of the foreign operation gives rise to the realisation of an accumulated
exchange difference gain (net of tax) of $7000. Due to it being realised, it is to be recognised
in profit or loss. Prior to the disposal, however, the exchange difference gain in the current
period was unrealised and, as a result, was recognised in OCI. The unrealised exchange
difference gain was spread over several reporting periods, with $2800 being recognised in the
current reporting period in OCI (prior to it being realised) and the remaining $4200 recognised
in OCI of prior periods. Due to the reclassification of the exchange difference gain from OCI
(when it was unrealised) to profit or loss (upon becoming realised) a reclassification adjustment
net of tax of $7000 is recognised in OCI. This occurs in the current reporting period when the
realisation occurs. As the exchange difference gain of $2800 remains recognised in OCI in
the current reporting period, the net exchange difference recognised in OCI in the current
reporting period is ($4200) (being $2800 – $7000). This amount offsets the exchange difference
gain recognised in OCI of prior periods, so that the total impact of the foreign operation on
OCI is $nil.
The following table illustrates what has been recognised in the P&L and OCI of the reporting
entity over the life of the foreign operation.
Prior Current Total impact
periods period over life
($) ($) ($)
Profit or loss (after tax) — 7 000 7 000
Other comprehensive income
Exchange difference on translating
foreign operation 4 200 2 800
Less: Reclassification adjustment (7 000 )
Other comprehensive income 4 200 (4 200 ) —
Total comprehensive income 4 200 2 800 7 000
Question 2.8
(a) Refer to Section 8 of the ‘Case study data’. Explain which items you would consider for
separate disclosure in the notes to the financial statements in accordance with para. 97 of
IAS 1.
(b) Refer to Section 8 of the ‘Case study data’. Prepare a single P&L and OCI for Webprod Ltd
in accordance with the presentation, disclosure and classification requirements of IAS 1.
Assume Webprod Ltd classifies expenses according to function.
(a) Paragraph 97 of IAS 1 indicates that when an item of income or expense is material, its nature
and amount must be separately disclosed. That is, it is a material item because it could
influence the decision-making of financial statement users. This depends on the size and
nature of the item in the context of circumstances involved.

The determination of such items is a matter of judgment. In the case of Webprod Ltd,
the items that shall be considered for separate disclosure are interest revenue calculated
using the effective interest method, the loss on write-down of inventory expense,
the damages expense and the advertising campaign for new product. The nature and
size of these items would be relevant to users’ understanding of the financial performance
of Webprod Ltd. These items can be disclosed separately in the P&L and OCI or in the notes
to the financial statements.
Note that it is acceptable you to have included other items based on your interpretation
of the information provided.
(b)
Webprod Ltd
Statement of profit or loss and other comprehensive income
for the year ended 30 June 20X7
Note $ Para./Std
Revenue 1 20 794 434 B87– 89/IFRS 15
Interest revenue using the effective interest method 12 283 82(a)/IAS 1
Cost of sales 5, 7 (12 046 232 ) 99/IAS 1
Gross profit 8 760 485 85/IAS 1
Other income 1 25 000
8 785 485
Expenses
Retailing expenses 2, 5, 7 (2 971 574 )(a) 99/IAS 1
Product expenses 3, 4, 5 (829 721 )(b) 99/IAS 1
Administrative expenses 7 (3 585 077 ) (c)
99/IAS 1
Other expenses 6 (5 400 )(d)
Finance expenses (103 654 ) 82(b)/IAS 1
Profit before income tax 1 290 059
Income tax expense (387 018 ) 82(d)/IAS 1
Profit for the year 903 041 81A(a)/IAS 1
Other comprehensive income (net of tax):
Revaluation Surplus 82A/IAS 1
Revaluation surplus—land (230 000 )
Revaluation surplus—buildings 150 000
Other comprehensive income for the year, net of tax (80 000 ) 81A(b)/IAS 1
Total comprehensive income for the year 823 041 81A(c)/IAS 1
Notes to the financial report

The following disclosure notes may include additional information regarding the nature of the
item that was not provided in the case study information. You are not expected to know this
information—it has been included for illustrative purposes only.
Note 1: Revenues and other income

(a) Revenue $ Para./Std
Sales revenue 19 194 434 B87–89/IFRS 15
Telecommunications project service revenue 600 000 B87–89/IFRS 15
Grant revenue 1 000 000
20 794 434
(b) Other income
Profit on sale of factory plant 25 000
Note 2: Advertising campaign—new product 97/IAS 1

Included in the retail expenses is $380 000 paid for an advertising campaign to launch
Webprod Ltd’s new high-speed modem.
Note 3: Write-down of inventory 97/IAS 1

Because of rapid changes in the computer industry, two lines of software and one line of
hardware will have to be sold at substantial discounts. As a result, these inventory items have
to be carried at net realisable value at 30 June. This has resulted in an inventory write-down
of $24 921.

Note 4: Damages—lawsuit 97/IAS 1

On 15 January 20X7, Webprod Ltd was sued for infringement of a patent right.
On 20 August 20X7, Webprod Ltd settled the lawsuit for $620 000. A liability for damages
has been recognised in the statement of financial position.
Note 5: Depreciation and amortisation 104/IAS 1

Amortisation of patent rights 85 000
Depreciation of non-current assets 232 116 †
Depreciation of retail fixtures and fittings $10 254 + Depreciation of factory and plant $221 862
†
(see Section 3.2 of ‘Case study data’).
Note 6: Bad and doubtful debts

During the 20X7 financial year, Webprod Ltd incurred a doubtful debt expense of $5400.
Note 7: Employee benefits 104/IAS 1

During the 20X7 financial year, Webprod Ltd incurred employee benefit expenses
of $3 272 000 (see Section 4 of ‘Case study data’).
Calculations $
(a) Retailing expenses
Employee benefits—retail 166 320
Depreciation expense—retail fixtures and fittings 10 254
Advertising campaign new product 380 000
Other selling expenses 2 415 000
2 971 574
(b) Product expenses $

Write-down of inventory 24 921
Under-applied overhead 87 500
Amortisation of patent rights 85 000
Damages expense 620 000
Warranty expense 12 300
829 721
(c) Administrative expenses

Audit fees 25 000
Consulting services—auditor 30 000
Other administrative expenses 3 530 077
3 585 077
(d) Other expenses (from ordinary activities)

Doubtful debts 5 400
Question 2.9
Refer to Sections 1 and 8 of the ‘Case study data’. Prepare a statement of changes in equity in
accordance with paras 106 and 107 of IAS 1 in the column format that reconciles the opening and
closing balances of each component of equity as illustrated in the ‘Guidance on implementing
IAS 1 Presentation of Financial Statements’ (in Part B of the Red Book).
Webprod Ltd
Statement of changes in equity for the year ended 30 June 20X7
Share Revaluation Retained

capital ($) surplus ($) earnings ($) Total ($) IAS 1
Balance 1 July 20X6
†
1 050 000 700 000 843 240 2 593 240 106(d)
Comprehensive income‡ (80 000 ) 903 041 823 041 106(a)
Dividends paid or declared§ (450 000 ) (450 000 ) 106(d)(iii)
Balance 1 July 20X7 1 050 000 620 000 1 296 281 2 966 281 106(d)
†
See Case study data Section 1 for the closing balance of shareholders’ equity for the prior reporting
period (i.e. the opening balance as at 1 July 20X6).
Shareholders’ equity As at 30 June 20X6

Share capital 1 050 000
Revaluation surplus 700 000
Retained earnings 843 240
Total shareholders’ equity 2 593 240

‡
Comprehensive income for 20X7 (see the Suggested answer to Question 2.6).
Comprehensive income items for the year ended 30 June 20X7

Profit for the year 903 041
Other comprehensive income (net of tax) (80 000 )
Total comprehensive income 823 041
§
Dividends paid or declared (see Case study data Section 8).
Dividends paid or declared for the year ended 30 June 2017

Interim dividend 200 000
Final dividend 250 000
Total dividends paid or declared 450 000
Dividend per share $0.30 ($450 000/number of ordinary shares,
being 1 500 000 as per Case data Section 1)
Question 2.10
Refer to Section 8 of the ‘Case study data’.
Prepare a statement of financial position for Webprod Ltd. You may want to refer to para. 54 of
IAS 1 if you need to review the required line items. In addition, prepare notes to the statement
of financial position that:
• illustrate the composition of the items disclosed in the statement of financial position
• satisfy any relevant disclosure requirements. If you need to review the requirements, refer to
para. 79 of IAS 1.
Statement of financial position for Webprod Ltd as at 30 June 20X7
Note $ IAS 1
Current assets
Cash and cash equivalents 1 192 173 54(i)
Trade and other receivables 2 984 010 54(h)
Inventories 3 812 837 54(g)
Other current assets 4 63 350
Total current assets 2 052 370
Non-current assets
Trade and other receivables 2 50 000 54(h)
Financial assets 5 99 103 54(d)
Property, plant and equipment 6 4 099 730 54(a)
Intangible assets 7 465 000 54(c)
Total non-current assets 4 713 833
Total assets
6 766 203
Current liabilities
Trade and other payables 8 505 500 54(k)
Current tax payable 387 018 54(n)
Final dividend payable 250 000
Borrowings 9 100 000 54(m)
Provisions 10 741 000 54(l)
Total current liabilities 1 983 518
Non-current liabilities
Borrowings 9 1 535 000 54(m)
Provisions 10 281 404 54(l)
Total non-current liabilities 1 816 404
Total liabilities
3 799 922
Net assets
2 966 281
Shareholders’ equity
Issued capital 11 1 050 000 54(r)
Reserves 12 620 000 54(r)
Retained earnings 1 296 281 54(r)
Total shareholders’ equity 2 966 281
Note: As explained in the module notes, para. 77 requires further subclassification of the line
items, presented in a manner appropriate to the entity’s operations.
The following subclassifications illustrate the composition of the items in the statement
of financial position.
Extracts from notes to accounts

1. Cash and cash equivalent $
Cash at bank and on hand 192 173
2. Trade and other receivables $

Current
Trade receivables 723 210
Less: Allowance for doubtful debts (17 200 )
706 010
Grant receivable 250 000
Secured loan to director 28 000
984 010
Non-current
Secured loan to director 50 000
3. Inventories $
Raw materials—at cost 53 820
Work in process—at cost 132 540
Manufactured finished goods—at cost 437 800
Retail inventory—at cost 213 598
Less: Allowance for inventory write-drown (24 921 )
812 837
4. Other current assets $

Prepaid borrowing costs 4 550
Other prepayments 58 800
63 350
5. Financial assets $
Investment in debentures 100 000
Unamortised debenture discount (897 )
99 103
6. Property, plant and equipment

Land and buildings $
Land—independent valuation 20X7 970 000
Factory buildings—independent valuation 20X7 1 650 000
2 620 000
Factory plant and equipment (at cost) 1 790 246

Accumulated depreciation (352 862 )
1 437 384
Fixtures and fittings—retail outlets (at cost) 76 300

Accumulated depreciation (33 954 )
42 346
Total property, plant and equipment 4 099 730
Webprod Ltd adopted a policy of revaluing both its land and factory buildings annually to fair
value, in accordance with the revaluation model under IAS 16.
I. Virgo, FAIV, an independent valuer, carried out the revaluation as at 30 June 20X7 on the basis
of the fair value of the land and buildings from their existing use (being the highest and best
use under IFRS 13 Fair Value Measurement). Virgo determined that the value of the land and
buildings was as follows:
$
Land 970 000
Buildings 1 650 000
7. Intangibles $
Patent rights (at cost) 200 000
Accumulated amortisation (115 000 )
85 000
Product development costs (R&D) 380 000
465 000
8. Trade and other payables $

Trade payables 342 500
Accruals 163 000
505 500
9. Borrowings
Current $
Bank loan—secured 100 000
Non-current
Bank loan—secured 800 000
Promissory notes 235 000
Loan—Finance Ltd 400 000
Preference shares 100 000
1 535 000
10. Provisions
Current $
Employee benefits 110 000
Warranties 11 000
Damages—lawsuit 620 000
741 000
Non-current
Employee benefits 243 404
Warranties 38 000
281 404
11. Issued capital

$ IAS 1
Issued and fully paid capital
1 500 000 fully paid ordinary shares (no par value) 1 050 000 79(a)(ii)(iii)
The company had 1 500 000 ordinary shares outstanding at the beginning and end of the year
ending 30 June 20X7 (79(a)(iv))
12. Reserves
$ IAS 1
Revaluation surplus† 620 000 79(b)
†
See suggested answer to Question 2.6.
Question 2.11
It is important to complete all previous case study questions before attempting this question.
Refer to sections 1–5, 7 and 8 of the ‘Case study data’.
Prepare a statement of cash flows and disclosures for Webprod Ltd for the year ended
30 June 20X7, using the direct method in accordance with para. 18(a) of IAS 7. In addition,
prepare a reconciliation between the profit for the period and the cash from operating
activities (the indirect method).
Note: Question 2.11 is a comprehensive question that combines many of the concepts discussed
in this section of the module. You can expect to take several hours to complete the set tasks.
Tip: Calculate the cash flows for each of the following activities (preferably in this order).
Cash flows from operating activities 1. Cash received from customers

2. Cash received from grants
3. Cash paid to suppliers
4. Cash paid to employees
5. Borrowing costs
6. Warranties paid
7. Income tax paid
Cash flows from investing activities 8. Interest received

9. Proceeds from sale of factory plant and
equipment
10. Purchase of factory plant and equipment
11. Loan to director
12. Cash paid for product development costs
Cash flows from financing activities 13. Proceeds from funds borrowed
14. Dividends paid
15. Payment of bank loan
16. Payment of promissory notes
Cash flows from operating activities

1. Cash received from customers: $19 534 264
In order to determine the amount of receipts from customers, the following formula may be used:
Opening balance of + Sales revenue − Bad debts − Closing balance of

trade receivables written off † trade receivables
†
To determine the amount of bad debts written off, the following formula is relevant:
Opening balance of + Doubtful debts expense − Closing balance of

allowance for doubtful debts (from P&L) allowance for doubtful debts
The amount of receipts from customers is calculated as follows:

$
Opening balance of trade receivables 467 840
Plus: Sales revenue 19 194 434
Plus: Telecommunications project revenue 600 000
20 262 274
Less: Bad debts written off (see calculation below‡) (3 800 )
20 258 474
Less: Closing balance of trade receivables (723 210 )
Receipts from customers 19 535 264
This represents a cash inflow from operating activities.

‡
Bad debts written off are determined as follows:
Opening balance of allowance for doubtful debts 15 600

Plus: Doubtful debts expense 5 400
21 000
Less: Closing balance of allowance for doubtful debts (17 200 )
Bad debts written off 3 800
2. Cash received from grants: $750 000

In order to determine the amount of grants received, the following formula may be used:
Opening balance of + Grants revenue − Closing balance of

grants receivable grants receivable
The amount of receipts from grants is calculated as follows:

$
Opening balance of grants receivable —
Plus: Grants revenue 1 000 000
1 000 000
Less: Closing balance of grants receivable (250 000 )
Grants received 750 000
This represents a cash inflow from operating activities.
3. Cash paid to suppliers: $15 216 421

There are several steps in determining the amount of payment to suppliers and employees.
Step 1: Purchase of raw materials on credit

The first step involves determining the amount paid to purchase inventories—namely,
raw materials—on credit.
Section 2.2.1 of the ‘Case study data: Webprod Ltd’ indicates that the company purchased raw
materials totalling $5 423 500.
Alternatively, this amount may have been calculated using the following formula:
Closing balance of + Cost of raw materials − Opening balance of

raw materials allocated to work in progress raw materials
The amount of raw materials purchased is calculated as follows:

$
Closing balance of raw materials 53 820
Plus: Raw materials allocated to work in process (given in question) 5 432 180
5 486 000
Less: Opening balance of raw materials (62 500 )
Raw materials purchased 5 423 500
Step 2: Purchase of retail inventories on credit

The second step involves determining the amount paid to purchase inventories—namely,
retail inventories—on credit.
We are told in Section 2.1 of the case study that the company purchased retail inventories
totalling $2 563 200.
Alternatively, this amount may have been calculated with the following formula:
Closing balance of + COGS − Opening balance of

retail inventories retail inventories
The amount of retail inventories purchased is calculated as follows:

$
Closing balance of retail inventories at cost 213 598
Plus: COGS (see Section 2 note 2.1) 2 544 602
2 758 200
Less: Opening balance of retail inventories (195 000 )
Retail inventories purchased 2 563 200
Step 3: Determining the amount of cash paid to the suppliers of inventories

To determine the amount of inventories purchased for cash, it is necessary to adjust for the
opening and closing balances of trade payable. The Case study has assumed that trade payable
relates solely to the suppliers of raw materials and retail inventories.
The following formula may be used:
Opening balance of + Inventories purchased on − Closing balance of

trade payable credit (from above) trade payables
The amount of cash purchases of inventories is calculated as follows:

$
Opening balance of trade payables 340 000
Plus: Inventories purchased on credit† 7 986 700
8 326 700
Less: Closing balance of trade payables (342 500 )
Cash paid to the suppliers of inventories 7 984 200

†
Inventories purchased are $7 986 700 (raw materials $5 423 500 + retail inventories $2 563 200).
Step 4: Determining the amount of operating expenses paid

The next step is to determine the amount of operating expenses paid during the current
reporting period. To do this is a two-step process.
First, exclude non-cash expenses and expenses relating to investing and financing activities
that appear in the P&L and OCI.

Non-cash expenses include:
$
Damages expense (provision) 620 000
Employee benefits—retail (provision) 166 320
Loss on inventory write-down 24 921
Under-applied overhead expense 87 500
Warranty expense (provision) 12 300
Total non-cash expenses: 1 006 295
Borrowing costs (expenses relating to investing and financing activities) 103 654
The remaining expenses include:

$
Audit fees 25 000
Consulting fees 30 000
Advertising campaign 380 000
Selling and marketing expenses 2 415 000
Other expenses 3 530 077
Total remaining expenses: 6 380 077
Second, determine the amount of the remaining operating expenses for which cash has been
paid, given some of the operating expenses may have been incurred but have not been paid in
full. To determine the amount of operating expenses paid during the current reporting period,
it is necessary to adjust for the opening and closing balances of accruals.
The following formula may be used:
Opening balance + Operating expenses − Closing balance

of accruals incurred (from above) of accruals
The amount of cash expenses is calculated as follows:

$
Opening balance of accruals 124 000
Plus: Operating expenses incurred (from above) 6 380 077
6 504 077
Less: Closing balance of accruals ($163 000 − $30 000)† (133 000 )
Operating expenses paid 6 371 077
†
We are told in the question that during the 20X7 reporting period, Webprod Ltd purchased $1 084 846
of factory plant and equipment of which $30 000 of this amount is included in the accruals liability.
Of the closing accruals balance of $163 000 shown in the statement of financial position, $30 000 relates
to the purchase of factory plant and equipment. This $30 000 accrual will be reflected in the cash flows
from investing section of the statement of cash flows. For this reason, the $30 000 accrual is excluded
from the $163 000 closing balance.
Step 5: Increase in prepayments

In some instances, an entity will also prepay operating expenses. This will be reflected in
the prepayments account in the current asset section in the statement of financial position.
Examples include prepaid rent and prepaid insurance. While they are reflected as current
assets, these prepayments relate to payments of operating expenses and, as such, need to
be included as part of the payments to suppliers figure in the net cash flows from operating
activities in the statement of cash flows.
If the amount of prepayments increases during the reporting period, then the increase needs
to be reflected as an additional cash outflow in the statement of cash flows.
It will be observed that there was an increase in the prepayments balance in the statement
of financial position from $22 500 (see Case study data Section 1) to $58 800 (see Case study
data Section 8). An increase in prepayments indicates that the payments of operating expenses
exceed the amount of operating expenses incurred in the P&L and OCI. This increase of $36 300
needs to be included in determining the payments to suppliers.
Step 6: Determining under-applied overhead expense paid in cash

The final step is to determine the amount of cash paid in relation to under-applied overhead.
The amount of overhead allocated to work in process totalled $1 624 487 (see Section 2.2.2 of
Case study data. The under-applied overhead expense as shown in Case study data Section 8 is
$87 500. This gives a sub-total of $1 711 987 ($1 624 487 + $87 500).
Those expenses included in this sub-total of overheads that were non-cash expenses must be
excluded. In this particular case study, there are two non-cash expenses that are included in
overhead expenses that must be excluded, namely:
$
• employee benefits (refer Section 4 of ‘Case study data’) 665 281
• depreciation expense of factory and plant† 221 862
Total: 887 143
†
Refer to Section 3.2 of ‘Case study data’ (depreciation of factory buildings $100 000 + depreciation of
factory plant and equipment $121 862).
Therefore, the total cash expenses related to under-applied overhead is $824 844 ($1 711 987 –
$887 143).
Putting it all together:
The total amount of payments to suppliers of $15 216 421 comprises:

$
Cash paid to the suppliers of inventories 7 984 200 †
Operating expenses paid 6 371 077 ‡
Increase in prepayments 36 300 §
Under-applied overhead expense 824 844 #
Total: 15 216 421
†
See step 3: Determining the amount of cash paid to the suppliers of inventories.
‡
See step 4: Determining the amount of operating expenses paid.
§
See step 5: Increase in prepayments.
#
See Step 6: Determining under-applied overhead expense paid in cash.
This represents a cash outflow from operating activities.
4. Cash paid to employees: $3 272 000

Refer to Section 4 of the ‘Case study data’, which states that:
During the 20X7 financial year, the total payments for wages and salaries, including annual leave,
totalled $3 250 000. Long service leave paid during the same period amounted to $22 000.
Therefore, total employee benefits paid were $3 272 000.
5. Borrowing costs: $118 350

In determining the total cash paid for borrowing cost, apart from the amount noted in the expense
item, it is also important to take into consideration the items noted in the statement of financial
position such as the movement in prepaid borrowing costs and capitalised borrowing costs.
(a) Borrowing cost paid: $108 204

In order to determine the amount of borrowing costs paid, the following formula may be used:
Closing balance of + Borrowing cost − Opening balance of

prepaid borrowing costs expenses prepaid borrowing costs
The amount of borrowing costs paid is calculated as follows:

$
Closing balance of prepaid borrowing costs† 4 550
Plus: Borrowing cost expenses‡ 103 654
(108 204 )
Less: Opening balance of prepaid borrowing costs —
Borrowing cost expenses paid 108 204
†
See Section 5 of the Case study data.
‡
See Section 5 of the Case study data.

(b) Capitalised borrowing costs paid: $10 146

In addition to the borrowing cost payments identified above, Webprod Ltd included $10 146
(see Section 5 of the Case study data) of borrowing costs as part of plant under construction
during the 20X7 reporting period. This represented a change in accounting policy.
This $10 146 capitalised borrowing costs paid is added to the borrowing cost paid of $108 204
calculated above to give total borrowing costs paid of $118 350.
6. Warranties paid: $8800

In order to determine the amount of warranties paid, the following formula may be used:
Opening balance of + Warranties − Closing balance of

provision for warranties expense provision for warranties
The amount of warranty payments is calculated as follows:

$
Opening balance of provision for warranties† 45 500
Plus: Warranty expense‡ 12 300
57 800
Less: Closing balance of provision for warranties§ (49 000 )
Warranties paid 8 800
†
Provision for warranties: current $10 500 and non-current $35 000 (see Section 1 of Case study data).
‡
See Section 8 of Case study data.
§
Provision for warranties: current $11 000 and non-current $38 000 (see Section 8 of Case study data).
7. Income tax paid: $120 000

Where there are no temporary differences (i.e. no DTAs and/or DTLs), then the opening balance
of current tax payable is usually the amount of income tax paid during the current period.
In order to determine the amount of income tax paid, the following formula may be used:
Opening balance of + Income tax − Closing balance of

current tax payable expense current tax payable
The amount of income tax paid is calculated as follows:

$
Opening balance of current tax payable† 120 000
Plus: Income tax expense‡ 387 018
507 018
Less: Closing balance of current tax payable§ (387 018 )
Income tax paid 120 000
†
‡

Cash flows from investing activities

8. Interest received: $11 467
In order to determine the amount of interest received, the following formula may be used:
Closing balance of + Interest revenue − Opening balance of

unamortised debenture unamortised debenture
discount discount
The amount of interest received is calculated as follows:

$
Closing balance of unamortised debenture discount 897
Plus: Interest revenue 12 283
13 180
Less: Opening balance of unamortised debenture discount (1 713 )
Interest received 11 467
This represents a cash inflow from investing activities.
9. Proceeds from sale of factory plant and equipment: $88 000

Refer to Section 3.1 of the ‘Case study data’, which states that:
On 1 December 20X6, factory plant and equipment with a carrying amount of $63 000
(cost $160 000) was sold for $88 000. The profit or loss on sale is based on the carrying amount
of the plant at the start of the reporting period.
The gain on the sale of $25 000 is shown in the P&L and OCI. However, this is a non-cash gain.
The proceeds from the sale of factory plant and equipment totalled $88 000. This represents
a cash inflow from investing activities.
10. Purchase of factory plant and equipment: $1 052 700

Refer to Section 3.1 of the ‘Case study data’, which states that during the 20X7 financial year:
• On 20 August 20X6, retail fixtures and fittings were purchased at a cost of $8000.
• During the 20X7 reporting period, Webprod Ltd purchased $1 084 846 of factory plant and
equipment; $30 000 of this amount is included in the liability for accruals.
Purchase of factory plant and equipment ($) $ $

Retail fixtures and fittings† 8 000
Factory plant and equipment† 1 084 846
Subtotal 1 092 846
Less
Accruals† 30 000
Capitalised borrowing costs‡ 10 146
Cash payment for factory plant and equipment 1 052 700

†
See Section 3.1 of Case study data.

‡
Moreover, $10 146 worth of capitalised borrowing costs paid has already been included as an
operating cash outflow and, to avoid double counting, cannot be included as an investing cash
outflow. This represents a cash outflow from investing activities.
11. Loan to director: $6000

In order to determine the amount of the loan to the director, the following formula may be used:
Closing balance of − Opening balance of

director loan director loan
(asset) (asset)
The amount of the loan to the director is calculated as follows:

$
Closing balance of director loan account (asset) 78 000
Less: Opening balance of director loan account (asset) (72 000 )
Loan made to director 6 000
This represents a cash outflow from investing activities.
12. Cash paid for product development costs (R&D expenditure): $380 000
The product development costs of $380 000 that were capitalised as an intangible asset
(that form part of R&D expenditure. As per Note 7 of the 20X7 Trial Balance, $380 000 was
paid already) in the statement of financial position is shown separately as a cash outflow from
investing activities.
In order to determine the amount of monies spent on capitalised product development costs,
the following formula may be used:

product development product development
costs costs
The amount of monies spent on capitalised product development costs is calculated as follows:
$
Closing balance of product development costs 380 000
Less: Opening balance of product development costs —
Payment for product development costs 380 000
This represents a cash outflow from investing activities.
Cash flows from financing activities

13. Proceeds from funds borrowed: $400 000
In order to determine the amount of funds borrowed, the following formula may be used:

loan—Finance Ltd loan—Finance Ltd
The amount of funds borrowed is calculated as follows:

$
Closing balance of loan—Finance Ltd 400 000
Less: Opening balance of loan—Finance Ltd —
Funds borrowed 400 000
This represents a cash inflow from financing activities.
14. Dividends paid: $260 000

In order to determine the amount of dividends paid, the following formula may be used:
Opening balance of + Interim + Final − Closing balance of

final dividend dividend dividend final dividend
payable (liability) payable (liability)
The amount of dividends paid is calculated as follows:

$
Opening balance of final dividend payable (liability)† 60 000
Plus: Interim dividend‡ 200 000
Plus: Final dividend‡ 250 000
510 000
Less: Closing balance of final dividend payable (liability)‡ (250 000 )
Dividends paid 260 000

†

‡
Interim dividend $200 000, final dividend $250 000 and final dividend payable $250 000 (see Section 8
of Case study data).
This represents a cash outflow from financing activities.
15. Repayment of bank loan: $100 000

In order to determine the amount of the repayment of the bank loan, the following formula
may be used:
Opening balance of − Closing balance of

bank loan—secured bank loan—secured
The amount of the repayment of the bank loan is calculated as follows:

$
Opening balance of bank loan† 1 000 000
Less: Closing balance of bank loan‡ (900 000 )
Payment of bank loan 100 000

†
Opening balance of bank loan $1 000 000 (current liability $100 000 + non-current liability $900 000,
as per Section 1 of Case study data)

‡
Closing balance of bank load loan $900 000 (current liability $100 000 + non-current liability $800 000,
as per Section 8 of Case study data)

16. Payment of promissory notes: $65 000

In order to determine the amount of the repayment of promissory notes, the following formula
may be used:
Opening balance of − Closing balance of

promissory notes promissory notes
The amount of the repayment of promissory notes is calculated as follows:

$
Opening balance of promissory notes 300 000
Less: Closing balance of promissory notes (235 000 )
Payment of promissory notes 65 000
Webprod Ltd
Statement of cash flows for the reporting period ended 30 June 20X7
$
Note Inflows
(Outflows)
Cash flows from operating activities (IAS 7, paras 10, 14, 18)
Cash received from customers 19 535 264
Cash received from grants 750 000
Cash paid to suppliers (15 216 421 )
Cash paid to employees (3 272 000 )
Borrowing costs paid (IAS 7, para. 31) (118 350 )
Warranties paid (8 800 )
Income tax paid (IAS 7, para. 35) (120 000 )
Net cash flows from operating activities 4 1 549 693
Cash flows used in investing activities (IAS 7, paras 10, 16, 21)
Interest received (IAS 7, para. 31) 11 467
Proceeds from sale of factory plant 88 000
Purchase of factory plant and retail fixtures and fittings (1 052 700 )
Loan to director (6 000 )
Cash paid for product development costs (380 000 )
Net cash used in investing activities (1 339 233 )
Cash flows from financing activities (IAS 7, paras 10, 17, 21)
Proceeds from funds borrowed 400 000
Dividends paid (IAS 7, para. 31) (260 000 )
Payment of bank loan (100 000 )
Payment of promissory notes (65 000 )
Net cash flows used in financing activities 5 (25 000 )
Net increase in cash and cash equivalents 185 460

Cash and cash equivalents at the beginning of the period 6 713
Cash and cash equivalents at the end of the period 1 192 173
Notes to the statement of cash flows:

1. Components of cash and cash equivalents (IAS 7, para. 45)
For the purpose of the statement of cash flows, cash includes cash on hand and at banks and
short-term deposits at call, net of outstanding bank overdrafts (IAS 7, para. 46). Cash and
cash equivalents at the end of the financial year, as shown in the statement of cash flows,
are reconciled to the related items in the statement of financial position as follows:
Cash at bank: $192 173
2. Non-cash financing and investing activities (IAS 7, para. 43)
There were no non-cash financing and investing activities during the current period.
3. Financing facilities (IAS 7, para. 50) (see notes at the end of Section 1 of the Case study data).
Bank overdrafts
The company has access to bank overdrafts to a maximum of $200 000, which is secured by
a first mortgage over Webprod Ltd land and buildings. The bank overdraft has not been used
by Webprod Ltd during 20X7. The overdraft bears an interest rate of 8 per cent.
Bank term loan

Webprod Ltd has a 10-year bank loan secured by a first mortgage over the land and buildings
of Webprod Ltd. The bank loan has an effective interest rate of 7 per cent.
Credit standby arrangements

A bank standby facility of $200 000 is available to Webprod Ltd. This bank standby facility
bears interest at 9 per cent.
4. Reconciliation of net profit for the period to the net cash provided by operating activities:
$
Net profit after tax for the period 903 041
Non-cash adjustments
Depreciation included in overhead 221 862
Write-down of inventory 24 921
Profit—factory plant (25 000 )
Non-operating activity adjustments

Interest revenue (12 283 )
Borrowing costs capitalised (10 146 )
Add/Less: $
Increase in net trade receivables (255 370 )
Increase in grant receivable (250 000 )
Increase in work in process (24 140 )
Increase in finished goods (25 700 )
Increase in retail inventory (18 598 )
Increase in prepaid borrowing costs (4 550 )
Increase in prepayments (36 300 )
Increase in allowance for doubtful debts 1 600
Decrease in raw materials 8 680
Increase in trade payables 2 500
Increase in accruals 9 000 †
Increase in employee benefits 54 404
Increase in warranty provision 3 500
Increase in provision for damages 620 000
Increase in tax payable 267 018
Net cash provided by operating activities 1 549 693
†
Excludes increase in accruals from construction of factory plant $30 000 because this amount has
also been excluded in the calculation of operating expenses in Part 3, Item 4.
5. Reconciliation of liabilities arising from financing activities (IAS 7 44A–E)
(Note that you may want to refer to Section 1 Case study data for the closing balance of
liabilities related to financing activities as at 30 June 20X6, the cash flows from financing
activities in answer to Question 2.11 and the solution to Question 2.10 Statement of financial
position for Webprod Ltd as at 30 June 20X7.)
Reconciliation of liabilities arising from financing activities
Non-cash
01.07.X6 Cash flows changes 30.06.X7
Current liabilities—financing activities
Final dividend payable 60 000 (260 000) 450 000 250 000
Bank loan—secured 100 000 — — 100 000
Non-current liabilities—financing activities

Bank loan—secured 900 000 (100 000) — 800 000
Promissory note 300 000 (65 000) 235 000
Loan—Finance Ltd — 400 000 400 000
Preference shares 100 000 — — 100 000
Total 1 460 000 (25 000) 450 000 1 885 000
6. Cash not available for use (IAS 7, para. 48)
There were no restrictions on use of cash held as at 30 June 20X7.

Question 3.1
Consider whether the following constitutes a contract with a customer under IFRS 15, and explain
why it does or does not:
• A construction company enters into a three-year agreement with a property developer for
the construction of a shopping centre. After 12 months, the property developer experiences
significant financial difficulties and is unlikely to meet future commitments.
At the agreement’s inception, the construction company will apply the requirements of IFRS 15 to
the agreement to construct the shopping centre. This is because there is a contract (the three‑year
agreement) with a customer (the property developer) that appears to possess all the attributes
outlined in para. 9 of IFRS 15.
After 12 months, however, there is a significant change in facts and circumstances. The property
developer is experiencing significant financial difficulties. This significant change in the customer’s
circumstances requires the construction company to reassess whether the agreement contains all
the attributes in para. 9 of IFRS 15. As it is no longer probable that the construction company will
collect the consideration, IFRS 15 no longer applies to the agreement. The construction company
can continually reassess the agreement to determine whether all attributes are present again.
Question 3.2
A software developer enters into a contract with a customer to transfer a software licence,
provide an installation service, and provide software updates and technical support for a three-
year period. The entity also sells each of these components separately. Although unique to
each customer, the installation service does not significantly modify the software. The software
functions without the updates and the technical support.
Identify the performance obligation(s) within this contract.
Source: Based on IFRS Foundation 2017, IFRS 15 Revenue from Contracts with Customers,
in 2017 IFRS Standards, IFRS Foundation, London, pp. B1737–41.
First, because the software is delivered before the other goods and services, and it functions
without the updates and technical support, the customer can benefit from each of the goods and
services on their own or together with the other goods and services. As such, each of the goods
and services satisfies the criterion in para. 27(a) of IFRS 15.
Second, the promise to transfer each good and service to the customer is separately identifiable
from each of the other promises. As indicators of this, the entity is not providing a significant
service of integrating the software and services into a combined output, given the software
functions without the updates and technical support and each can be sold separately. Moreover,
the promised goods or services do not significantly modify or customise each other, as the
installation service does not significantly modify the software itself. Finally, the software
and services are not highly interdependent or highly interrelated as the software functions
independently of the updates and technical support (see IFRS 15, para. 29). Thus, each of the
goods and services satisfies the criterion in para. 27(b) of IFRS 15.
As both paras 27(a) and (b) are satisfied for each of the goods and services provided under the
contract, each constitutes a distinct good or service. Each distinct good or service gives rise to
a separate performance obligation. On this basis, the software developer would identify four
performance obligations:
1. the software licence
2. installation service
3. software updates
4. technical support.
Question 3.3
Consider whether the following performance payments constitute consideration of a fixed amount,
variable amount or a combination of both and justify your answer:
• A construction company enters into a contract with a customer to build an office block. The
consideration promised by the customer is $1 500 000 with a $350 000 performance bonus
if the office block is completed within 18 months.
• A construction company enters into a contract with a customer to build a warehouse for
$500 000. The contract specifies that the warehouse is to be completed by 30 June 20X6,
and that if it is not completed by 31 August 20X6, the construction company incurs a
$50 000 penalty.
Contract for construction of office block

The consideration promised under this contract is a combination of both fixed and variable
amounts. The $1 500 000 represents fixed consideration, as the construction company is entitled
to this amount on completion of the office block independent of the timeliness of completion.
The $350 000 is variable consideration, as it is a performance bonus in accordance with para.
50 of IFRS 15. The construction company is only entitled to the $350 000 if the office block is
completed within 18 months. If not, the construction company does not receive this amount.
As such, whether the construction company receives $350 000 varies according to the timeliness
of completion.
Contract for construction of warehouse

The consideration promised under this contract is a combination of both fixed and variable
amounts. The amount of $450 000 ($500 000 – $50 000) is fixed, as the entity is entitled to this
amount irrespective of whether the penalty is imposed. The $50 000 arising from the penalty
is variable in accordance with para. 50 of IFRS 15, as it is dependent on whether construction is
completed by 31 August 20X6.
Question 3.4
A consulting services entity wins a tender process to provide consulting services to a new
customer. The contract is for two years with an option for the entity to extend the contract for
another year. The entity intends on exercising this option. The entity incurs the following costs
to obtain the contract:
$
Legal fees to lodge tender 25 000
Travel costs to deliver proposal 20 000
Sales commission to employees for obtaining the contract 12 500
Total costs incurred 57 500
As part of the agreement with the lawyer involved in preparing the tender, $10 000 is payable
regardless of whether the tender is successful. The remaining $15 000 in legal fees becomes
payable on the success of the tender. All legal fees are borne by the entity and not recoverable
from the customer. What amount should the entity recognise as an asset for the incremental
costs of obtaining the contract?
Source: Based on IFRS Foundation 2017, IFRS 15 Revenue from Contracts with Customers,
in 2017 IFRS Standards, IFRS Foundation, London, p. B1766.
In accordance with para. 91 of IFRS 15, the entity recognises an asset for $12 500 as the
incremental costs of obtaining the contract. This amount relates to the commissions to sales
employees for obtaining the contract, which would not have been incurred if the contract had
not been obtained. Further, the entity expects to recover those costs through future fees for
the consulting services. As the contract is for three years, the amortisation period is longer than
one year.
The travel costs to deliver the proposal ($20 000) and the portion of legal fees payable irrespective
of the success of the tender ($10 000) are not incremental and cannot be recognised as an asset.
In relation to the $15 000 legal fees payable on the tender being successful, although incremental,
the entity would not expect to recover these costs either directly or indirectly. As such, these costs
would be expensed as incurred.
Question 3.5
With reference to the scope of IAS 37 and the definition of a provision, identify which of the
following is likely to be a provision within the scope of IAS 37, and which is likely to be another
form of liability and explain why.
• An obligation to repair or replace goods sold if they are determined to be faulty
• A warranty provided for a television sold by a retailer
• Annual leave
An obligation to repair or replace goods sold if they are determined to be faulty

An obligation to repair or replace goods sold is likely to be a provision within the scope of IAS 37.
As a result of a past obligating event (i.e. the sale of the goods), this is a present obligation that
is probable for an uncertain portion of the goods returned.
A warranty provided for a television sold by a retailer

An obligation relating to a warranty provided on the sale of a television is likely to be a provision
within the scope of IAS 37. A warranty generally involves the retailer (or manufacturer) warranting
to make good, either by repair or replacement, any defects to the goods sold within a specified
period. As a result of a past obligating event (i.e. the sale of the television with the warranty),
this is a present obligation that is probable for an uncertain amount, depending on how many
televisions require repair or replacement.
Annual leave
Annual leave payable to employees is an example of a liability covered by another standard
and, therefore, not within the scope of IAS 37. The requirements for recognising provisions for
annual leave are dealt with as a short-term compensated absence in IAS 19 Employee Benefits.
Question 3.6
A manufacturer gives warranties at the time of sale to purchasers of its product. Under the
terms of the contract for sale, the manufacturer undertakes to remedy, by repair or replacement,
manufacturing defects that become apparent within three years from the date of sale. As this
is the first year that the warranty has been available, there is no data from the firm to indicate
whether there will be claims under the warranties. However, industry research suggests that it
is likely that such claims will be forthcoming.
Should the manufacturer recognise a provision in accordance with the requirements of IAS 37?
Why or why not?
For a provision to be recognised, IAS 37 requires that:

(a) an entity has a present obligation (legal or constructive) as a result of a past event;
(b) it is probable that an outflow of resources embodying economic benefits will be required to
settle the obligation; and
(c) a reliable estimate can be made of the amount of the obligation (IAS 37, para. 14).
In this example, the manufacturer has a present legal obligation. The obligating event is the
sale of the product with a warranty.
IAS 37 outlines that the future sacrifice of economic benefits is probable when it is more likely
than less likely that the future sacrifice of economic benefits will be required. In this example,
the probability that settlement will be required will be determined by considering the class of
obligation (warranties) as a whole (IAS 37, para. 24). In accordance with para. 24, it is more likely
than less likely that a future sacrifice of economic benefits will be required to settle the class of
obligations as a whole.
The final criterion in para. 14(c) of IAS 37 must be met before a provision can be recognised.
If a reliable estimate can be made the provision can be measured reliably. Past data can provide
reliable measures, even if the data is not firm-specific but rather industry-based. Paragraph
25 of IAS 37 notes that only in ‘extremely rare cases’ can a reliable measure of a provision not
be obtained. Difficulty in estimating the amount of a provision under conditions of significant
uncertainty does not justify non-recognition of the provision.
Conclusion
The manufacturer should recognise a provision based on the best estimate of the consideration
required to settle the present obligation as at the reporting date.
Question 3.7
Refer to the background material in Question 3.6.
The firm has now been operating its warranty for five years, and reliable data exists to suggest
the following:
• If minor defects occur in all products sold, repair costs of $2 million would result.
• If major defects are detected in all products, costs of $5 million would result.
• The manufacturer’s past experience and future expectations indicate that each year
80 per cent of the goods sold will have no defects, 15 per cent of the goods sold will have
minor defects, and 5 per cent of the goods sold will have major defects.
Calculate the expected value of the cost of repairs in accordance with the requirements of IAS 37.
Ignore both income tax and the effect of discounting.
The expected value of the cost of repairs in accordance with IAS 37 is:
(80% × nil) + (15% × $2m) + (5% × $5m) = 300 000 + 250 000 = 550 000
Question 3.8
Review Note 15 ‘Provisions’ of the Techworks Ltd financial statements. Focusing on the Provision
for warranties class of provisions, highlight how Techworks Ltd has complied with the requirements
of para. 85 of IAS 37 in this disclosure.
Provision for warranties—Techworks Ltd’s compliance with IAS 37
Disclosure in Techworks Ltd’s 2016 financial statements

IAS 37 para. 85 requirement (Note 15 ‘Provisions’)
A brief description of the nature ‘Provision is made for estimated warranty claims in respect of
of the obligation products sold which are still under warranty at the end of the
reporting period.’
The expected timing of any ‘These claims are expected to be settled in the next financial year.’
resulting outflows of economic
benefits
An indication of the uncertainties ‘Management estimates the provision based on historical warranty
about the amount or timing of claim information and any recent trends that may suggest future
those outflows. Where necessary claims could differ from historical amounts.’
to provide adequate information,
an entity shall disclose the major
assumptions made concerning
future events, as addressed in
para. 48 of IAS 37
The amount of any expected Techworks Ltd provides no disclosure in relation to any reimbursement.
reimbursement, stating the As such, it may be assumed that no such reimbursement is expected,
amount of any asset that has or if any is expected, it is immaterial to the financial statements.
been recognised for that
expected reimbursement
Source: CPA Australia 2016.

Question 3.9
Consider the following quote:
At present, banks create provisions to meet the costs of … restructuring. When analysts
analyse these, they classify them as significant items so that they appear below the
operating profit line; this ensures the cost of these provisions disappears from their
calculations of the operating profit. By over-provisioning with below-the-line significant
items in a good year, the company can use the over-provisions during a bad year when
there are additional write-offs. The write-offs do not appear in the operating profit
(Washington 2002, p. 74).
Explain how the disclosure requirements contained in IAS 37 reduce the ability of entities to engage
in earnings management through the increase and then subsequent write-back of provisions.
Earnings management could be decreased due to the increased transparency of the movement
in provisions. As a result of the increased disclosure requirements, users are able to determine:
• the carrying amount of provisions at the beginning of the reporting period;
• additional provisions made during the reporting period; and
• amounts used (i.e. incurred and charged against the provision) during the period
(IAS 37, para. 84).
Therefore, users are able to establish the increase and decrease in provisions, including the
subsequent write-back of provisions.
Question 3.10
Identify two further examples of contingent assets. For each example, explain why the item
would be a contingent asset rather than being recognised as an asset. Do you believe that the
reporting of contingent assets affects the decisions of equity investors or other finance providers?
Why or why not?
You could have included a range of examples of contingent assets from your own knowledge
and experience. One example is an application by the entity for damages or compensation in
a court of law; if successful, the entity will receive a cash payment. This would be a contingent
asset because the future economic benefit will be confirmed only by the decision of the court.
Another example of a contingent asset is when an entity is expecting to receive future economic
benefits from an estate, but the amount to be received is uncertain at the reporting date.
The reporting of contingent assets may have an effect on the decisions of equity investors or
other finance providers, who make their assessment based on the likelihood of a contingent
asset becoming the entity’s asset. If the asset does crystallise, it is likely to have an effect on
performance ratios, such as leverage, and may assist the entity in meeting its debt covenants.
Question 4.1
Calculate the tax base for the following assets:
(a) An item of inventory was purchased during the year for $250. The cost of the inventory for
both accounting and tax purposes is $250. The tax cost of the inventory will be included
in the determination of taxable profit (tax loss) as a deduction when the inventory is sold.
The income from the sale of inventory is taxable when the inventory is sold (i.e. on a cash basis).
(b) Trade receivables have a gross carrying amount of $250 and an allowance for doubtful debts
of $50 (i.e. the net trade receivable is $200). The related revenue has already been included
in taxable profit (tax loss). Doubtful debts will be deductible for tax purposes when the debt
is written off.
(a)
Future
Tax base Carrying Future taxable
= + deductible –
of an asset amount amounts
amounts
250 = 250 + 250 – 250
The carrying amount of the inventory in the financial statements is $250, as provided in the
facts to the question.
The future deductible amounts are equal to the tax cost of the inventory, $250. When the
inventory is sold, the tax cost of the inventory (as provided in the facts to the question) will be
included as a deduction against the taxable proceeds on sale of the inventory.
The future taxable amounts reflect the future taxable economic benefits of the asset. That is,
when the entity sells the inventory, it generates revenue and so recovers the carrying amount
of the item. In this example the income on sale of inventory is taxable, so future taxable
amounts associated with the asset are equal to the carrying amount of $250. Therefore,
the tax base is $250.
(b)
250 = 200 + 50 – nil
For accounting purposes, the reduced amount of $200 is used, as this reflects the expected
amount that will be recovered in the future. However, for tax purposes, the total of $250 is
recognised until the doubtful debt is written off. This highlights the difference between the
accounting position and the tax position on this item. The formula can be applied to this
as follows:
–– The carrying amount of the accounts receivable in the accounting records is calculated
as gross carrying amount ($250) less allowance for doubtful debts ($50), which is equal
to $200.
–– The future deductible amount is the allowance for doubtful debts ($50). When the
doubtful debt is written off as not recoverable, the amount currently included in the
allowance for doubtful debts will be included as a deduction for tax purposes.
–– There are no future taxable amounts as the related revenue associated with the
accounts receivable has already been included in taxable profit (tax loss). Therefore,
the tax base is $250.
Question 4.2
Calculate the tax base for the following liabilities:
(a) Employee benefits have a carrying amount of $100. The employee benefits are deductible
on a cash basis (i.e. when paid).
(b) A loan payable has a carrying amount of $250. The repayment of the loan will have no tax
consequences.
(c) Revenue received in advance has a carrying amount of $400. The amount was taxed on a
cash basis (i.e. when received).
The first step is to determine whether the liability is either:

• a liability that is not revenue received in advance, or
• a liability that is revenue received in advance.
(a)
Tax base of a
Future
liability that is not Carrying Future taxable
= – deductible +
revenue received amount amounts
amounts
in advance
nil = 100 – 100 + nil
The carrying amount of the employee benefits is $100.
The employee benefits will be deductible when paid; therefore, the future deductible
amount is $100.
There are no future taxable amounts because there is no revenue associated with the
payment of employee benefits to be included in taxable profit (tax loss). Therefore, the tax
base is $nil.
(b)
250 = 250 – nil + nil
The carrying amount of the loan is $250.
The loan repayment has no tax consequences; therefore, there are no future deductible or
taxable amounts. Therefore, the tax base is $250.
(c)
Tax base Amount of
of revenue Carrying revenue not
= –
received amount taxable
in advance in the future
nil = 400 – 400
The carrying amount of the revenue received in advance is $400.
The revenue received in advance has already been taxed; therefore, the amount not taxable
in the future is $400. Therefore, the tax base is $nil.
Question 4.3
Refer to IAS 12, para. 7, Example 3.
Assume that the carrying amount of the trade receivables in the example is $80. The $80 is net
of expected doubtful debts of $20.
(a) Use the fundamental principle from para. 10 of IAS 12 to explain why a deferred tax asset
arises for this transaction.
(b) What is the amount of the temporary difference implied by your answer to Part (a) of this
question?
(c) Apply the formulas for the tax base and a temporary difference to determine these amounts.
(d) Explain which cell of Table 4.6 this amended example falls into.
(a) According to para. 10 of IAS 12, an entity shall, with certain limited exceptions, recognise a
deferred tax liability (asset) whenever recovery or settlement of the carrying amount of the
asset or liability will make future tax payments larger (smaller) than they would be if such
recovery or settlement were to have no tax consequences.
In this scenario, the tax base is $100 and the carrying amount is $80. A deferred tax asset
arises from a deductible temporary difference because the carrying amount is less than the
tax base. It is expected that only $80 of the trade receivable will be recovered (the remaining
$20 is doubtful). If only $80 is recovered, a tax deduction of $20 for the bad debt will arise.
The tax deduction will cause future tax payments to be smaller than they would have been
in the absence of the tax consequence. Therefore, in accordance with para. 10 of IAS 12,
a deferred tax asset arises.
(b) The amount of the deductible temporary difference implied by the answer to Part (a) of this
question is $20.
(c) The relevant formulas are:
Future
= + deductible –
amounts
100 = 80 + 20 – 0
Temporary Carrying
= – Tax base
difference amount
20 = 80 – 100
There are no future taxable amounts, as the related revenue (sales) has already been included
in taxable profit (tax loss).
(d) This modified example falls into cell 2 of Table 4.6 since the relationship between the carrying
amount of the asset and the tax base is:
Carrying amount of asset < tax base of asset
This confirms that the recovery of the receivable gives rise to a deferred tax asset.
Before leaving this modification to Example 3 of IAS 12, para. 7, it is helpful to note that deferred
tax assets are defined as amounts of income taxes recoverable in future periods. Recall that
the $100 of revenue has already been included in taxable income and tax on this amount has
previously been paid. The deferred tax asset of $6 is that portion of the tax previously paid that
will be recovered when the debt is written off and the $20 is deducted from taxable profit.
Question 4.4
Part A (adapted from Part A of the Illustrative Examples to IAS 12)
(a) Using the basic principles from para. 10 of IAS 12, explain why a deferred tax liability should
be recognised in relation to the following scenarios:
Development costs
Development costs of $1000 that are recognised as an asset (i.e. capitalised) and will
be amortised to the P&L and OCI. The costs were deducted in determining taxable
profit when they were incurred (i.e. when the cash was paid).
Prepaid expenses
Prepaid expenses (recognised as an asset for accounting purposes) of $1000 that
have already been deducted on a cash basis (i.e. when paid) in determining the
taxable profit in a previous period.
(b) Using the relevant formulas, determine the tax base and the temporary difference associated
with the items in Part A.
Part B
A liability that was to be settled in units of a foreign currency was recognised in the reporting
currency financial statements of an entity at $100. Due to movements in the exchange rate
between the reporting currency and the foreign currency, the liability was remeasured by
$20 to $120.
The increase in the carrying amount of the liability was taken into account as a foreign exchange
loss when measuring accounting profit before tax for the current year. However, the loss is not
deductible against taxable profit until foreign currency is acquired to settle the liability in future.
(a) Use the fundamental principle from para. 10 of IAS 12 to explain why a deferred tax asset
arises for this transaction.
(b) What is the amount of the temporary difference implied by your answer to Part (a) of this
question?
(c) Use your answer to Part (b) of this question to derive the amount of the tax base.
(d) Apply the relevant formulas to derive the tax base and the temporary difference.
Part A
(a) The explanations are as follows.
Development costs
When the carrying amount of the development costs is recovered by using the asset,
the entity will generate assessable income. Since the whole of the development expenditure
has already been deducted for tax purposes, there will be no amount deductible against
the assessable amount. Consequently, tax will become payable on the revenue earned.
Therefore, the entity should recognise a deferred tax liability for the additional tax payable
of $1000 × 30% = $300.
Prepaid expenses
The reasoning for this item is the same as that for development costs. To recover the carrying
amount of the asset, the entity generates taxable revenue of an amount equal to the carrying
amount of the prepaid expenses. However, there will be no amount deductible against the
revenue earned, the amount already having been deducted for tax purposes. Therefore,
tax will be payable on the whole of the economic benefits recovered. The entity should
recognise a deferred tax liability for the future tax payments of $1000 × 30% = $300.
(b) The following formulas are applicable for both items.
Future
= + deductible –
amounts
0 = 1000 + 0 – 1000
Temporary Carrying
= – Tax base
difference amount
1000 = 1000 – 0

Part B
(a) The $20 difference between the carrying amount of the liability and the tax base is a deductible
temporary difference. When the liability is settled in a later period, an additional $20 will be
required to purchase the foreign currency needed to settle the liability. This extra amount will
be deductible for tax purposes. When the amount is deducted, taxable profit will be reduced
by $20 and tax payments will be reduced by $6 ($20 × 30%). Therefore, the entity recognises
a deferred tax asset of $6.
(b) The amount of the deductible temporary difference implied by the answer to Part (a) of
this question is $20, which is the amount by which the carrying amount of the liability has
been adjusted.
(c) As the temporary difference is $20, the tax base must be $100; $20 less than the $120 carrying
amount of the liability.
(d)
Tax base of a Future
= – deductible +
amounts
in advance
100 = 120 – 20 + 0
Temporary Carrying
= – Tax base
difference amount
20 = 120 – 100

Question 4.5
(a) Using the data and analysis in Example 4.8, present the income tax journal entries for
31 December 20X9.
(b) Assume that the tax legislation allows for the carrying back of tax losses for deduction from
taxable income of the three years before the year of the tax loss. Explain whether or not
you would recognise the full amount of the deferred tax asset as at 31 December 20X9.
(a) The analysis of the data for Example 4.8 indicates that the entity should recognise the
following deferred tax balances that originated during 20X9:
Deferred tax asset $13 500 ($45 000 × 30%)

Deferred tax liability $30 000 ($100 000 × 30%)
There were no other transactions during 20X9, so these are the net movements in
the deferred tax balances for the period. Therefore, the related deferred tax expense
and deferred tax income are:
Deferred tax income† $13 500

Deferred tax expense $30 000

†
It is acceptable to recognise this as a reduction in the deferred tax expense account instead
of an increase in deferred tax income.
Also note that taxable profit for the year ended 31 December 20X9 was $nil. Therefore,
current tax is $nil by definition (IAS 12, para. 5). Tax expense (income) is the aggregate
of current tax expense (income) and deferred tax expense (income) (IAS 12, para. 6).
Hence, tax expense for the period is:
$ $
Current tax expense 0
Deferred tax expense 30 000
Less: Deferred tax income (13 500 ) 16 500
Tax expense 16 500
Therefore, the income tax journal entry is:
31 December $ $
20X9
Deferred tax expense (net) 16 500
Deferred tax asset 13 500
Deferred tax liability 30 000
(b) Since the tax loss can be carried back for three years, the expected loss in 20Y0 would
be available for offset against the taxable income of 20X9 and the two preceding years.
Taxable income for 20X9 was $nil. Therefore, recognition of the balance of the deferred tax
asset, $4500, is contingent on there being sufficient taxable profit in 20X8 and 20X7.
Question 4.6
Lowsales Ltd has the following extract from its statement of financial position as at 30 June 20X1:
$
Cash assets 97 000
Accounts receivable (net) 234 000
Prepaid rent 4 000
Inventory 228 000
Equipment (net) 48 000
Total assets 611 000
Accounts payable 67 000

Revenue received in advance 18 000
Bank loan 100 000
Foreign currency loan payable 32 000
Employee benefits liability 65 000
Total liabilities 282 000
The following information is relevant for Lowsales Ltd:
1. Revenue received in advance is recognised in the statement of financial position of Lowsales
Ltd and will be recognised in the P&L and OCI in a later reporting period (i.e. as the revenue
is earned). It is included in taxable profit in 20X1 (i.e. it is taxed on a cash basis).
2. The employee benefits liability increases with additional employee expenses and decreases
when the liability is paid. Lowsales Ltd receives a tax deduction when employee benefits
are paid.
3. For tax purposes, deductions can only be claimed for bad debts written off. At 30 June 20X1,
the allowance for doubtful debts was $11 000 and the allowance had increased by $5000.
The revenue relating to the accounts receivable has already been taxed.
4. The equipment was originally purchased four years ago for $80 000. The equipment is being
depreciated for tax purposes over eight years and for accounting purposes over 10 years.
5. The foreign currency loan payable was originally drawn down at $33 000. The $1000 foreign
exchange gain included in the statement of P&L and OCI is not included in taxable profit
until the loan is settled.
6. Prepaid rent has increased by $2000 during the year. This additional outlay can be claimed
as a tax deduction as incurred (i.e. when it is paid).
7. There are no future tax consequences associated with the cash, accounts payable or inventory
assets.
Assume that Lowsales has an opening deferred tax asset balance of $16 200 and opening deferred
tax liability balance of $2400. Lowsales’ taxable profit for the financial year ending 30 June 20X1
is $331 000. Assume a tax rate of 30 per cent.
(a) Calculate the relevant tax bases for assets and liabilities for Lowsales for the financial year
ended 30 June 20X1.
(b) Prepare the deferred tax worksheet (deferred tax assets, liabilities and expense) for Lowsales
for the financial year ended 30 June 20X1.
(c) Prepare the income tax journal entry for Lowsales for the financial year ended 30 June 20X1.
(The format of the deferred tax worksheet used in Question 4.6 is an adaptation of the deferred
tax worksheet in Part B of IAS 12.)
Future
= + deductible –
amounts
(a) Using the above formula, the tax bases of the assets of Lowsales Ltd as at 30 June 20X1 are:
Future Future
Carrying deductible taxable
amount amounts amounts Tax base
Asset $ $ $ $
Cash assets 97 000 0 0 97 000
Accounts receivable (net)† 234 000 11 000 0 245 000
Prepaid rent‡ 4 000 0 4 000 0
Inventory 228 000 228 000 228 000 228 000
Equipment (net)§ 48 000 40 000 48 000 40 000
†

Revenue, which led to accounts receivable, is included in taxable profit in the same year, but the
allowance for doubtful debts will be deductible in the future when the debt becomes bad.
‡
When the prepaid rent is recovered in the future, there will be a taxable amount of $4000.
However, there will be no future deductible amounts, as the prepaid rent has already been
claimed as a deduction (i.e. when it was paid).
§
The future deductible amounts for equipment will be the cost of the equipment ($80 000)
less tax accumulated depreciation as at 30 June 20X1 ($40 000).
Tax base of a
Future
= – deductible +
amounts
in advance

Future Future
Carrying deductible taxable
Liability—not revenue amount amounts amounts Tax base
received in advance $ $ $ $
Accounts payable 67 000 0 0 67 000
Bank loan 100 000 0 0 100 000
Foreign currency loan payable† 32 000 0 1 000 33 000
Provision for employee benefits liability‡ 65 000 65 000 0 0
†
When the foreign currency liability is settled in a later period, $1000 less will be required to
purchase the foreign currency needed to settle the liability. This $1000 difference will be taxable.
‡
The settlement of the employee benefits liability will result in future tax deductions.
Tax base for a liability Future non-taxable

Carrying
that is revenue received = – amount of revenue
amount
in advanced

For the revenue received in advance by Lowsales Ltd, the tax base is equal to the carrying
amount of the liability ($18 000) less the amount already included in taxable profit and
therefore non-taxable in the future ($18 000), which equals $0.
(b) The format of the following deferred tax worksheet is an adaptation of the deferred tax
worksheet in the Illustrative Examples, ‘Illustrative computations and presentation’, of IAS 12.
Deferred tax worksheet for Lowsales Ltd as at 30 June 20X1:
Taxable Deductible
Carrying temporary temporary
amount Tax base differences differences
$ $ $ $
Cash assets 97 000 97 000
Accounts receivable (net) 234 000 245 000 11 000
Prepaid rent 4 000 0 4 000
Inventory 228 000 228 000
Equipment (net) 48 000 40 000 8 000
Total assets 611 000 610 000
Accounts payable 67 000 67 000

Revenue received in advance 18 000 0 18 000
Bank loan 100 000 100 000
Foreign currency loan payable 32 000 33 000 1 000
Employee benefits liability 65 000 0 65 000
Total liabilities 282 000 200 000
13 000 94 000
Deferred tax liability 3 900 †
Deferred tax asset 28 200 ‡
Less: Opening deferred tax liability/asset§ (2 400 ) (16 200 )
Movement in deferred tax liability/asset 1 500 Cr 12 000 Dr
Deferred tax expense 1 500 Dr 12 000 Cr
†
Total taxable temporary difference $13 000 × 30%.
‡
Total deductible temporary difference $94 000 × 30%.
§
As the deferred tax asset and liability are likely to be offset (refer to Part D of the module for
discussion of offsetting), the worksheet could have also been prepared on a net deferred tax asset
basis. In that case, there would be an opening net deferred tax asset of $13 800 ($16 200 – $2400)
and a closing deferred tax asset of $24 300 ($28 200 – $3900), a net increase of $10 500.
(c) Now that current tax expense and deferred tax expense have been determined for
Lowsales Ltd, the following income taxes journal entry would be prepared:
30 June 20X1 $ $
Deferred tax liability 1 500 †
Deferred tax asset 12 000 ‡

Current tax expense 99 300

Current tax payable 99 300 §
Total tax expense is $99 300 – $12 000 + $1500 = $88 800.
†
Movement in the deferred tax liability for the year (calculated in the deferred tax worksheet in
Part (b)).
‡
Movement in the deferred tax asset for the year (calculated in the deferred tax worksheet
in Part (b)).
§
Calculated as taxable profit of $331 000 × 30% = $99 300. The taxable profit was provided in
the facts of the question.
Question 4.7
Note to candidates: This is a very challenging question. It is recommended that you have a good
understanding of the concepts discussed earlier in this module before attempting this question.
Using the following data, prepare tax-effect journal entries for Bayside Ltd for each of the years
ended 30 June 20X9, 30 June 20Y0 and 30 June 20Y1.
Prior to the beginning of the 20X9 financial year, Bayside Ltd had recognised a deferred tax liability
of $600 relating to a taxable temporary difference of $2000. The taxable temporary difference
is the cumulative difference between the amounts of accelerated depreciation deducted for tax
purposes and the amounts of straight-line depreciation expense for accounting purposes.
Summary of key amounts for the years ended 30 June 20X9 – 30 June 20Y1:
Year ended Year ended Year ended
30 June 30 June 30 June
20X9 20Y0 20Y1
$ $ $
(1 ) (2 ) (3 )
1. Accounting profit (loss) before income tax (6 000 ) 2 800 7 700
2. Deduct additional tax depreciation (1 000 ) (800 ) (700 )
3. Taxable profit (loss) before utilising
unused tax losses (7 000 ) 2 000 7 000
4. Less tax losses recouped this period 0 2 000 5 000
5. Taxable profit (loss) (7 000 ) 0 2 000
6. Current tax payable 0 0 600
The following key items are provided in the table:
• Bayside Ltd incurred a tax loss of $7000 during the period ended 30 June 20X9 (row 3 of
column 1).
• The differences between accounting profit (loss) before income tax and taxable profit (loss)
arise from using accelerated depreciation for tax purposes and straight-line depreciation for
accounting purposes. The extra amounts of tax depreciation allowed each year are deducted
in row 2.
• Row 3 of column 2 shows that for the year ended 30 June 20Y0, taxable profit, before utilising
unused tax losses, was $2000. The corresponding amount for the year ended 30 June 20Y1
was $7000.
• The taxable temporary differences that arose from the additional tax depreciation, shown in
row 2 for each of the three years, were expected to reverse before the end of the seven-year
tax loss carry-forward period that commenced on 30 June 20X9.
For 30 June 20X9 and 30 June 20Y0, Bayside was unable to establish that it was probable that
there would be future taxable profits in excess of taxable profits from the reversal of taxable
temporary differences.
The taxation legislation does not provide for the carry-back of tax losses.
The tax rate is 30 per cent.

Bayside Ltd incurred a tax loss of $7000 during the period ended 30 June 20X9. During the loss
year, the excess of tax depreciation over accounting depreciation was $1000, causing the related
temporary difference to increase by the same amount. This movement in the taxable temporary
difference caused the entity to recognise an increment in the deferred tax liability of $300,
increasing the item from the opening balance of $600 to $900.
The tax loss for the period was $7000, giving rise to a deferred tax asset of $2100. However,
the probable future taxable profit arising from the reversal of taxable temporary differences
(via depreciation) at 30 June 20X9 was only $3000 (opening $2000 + additional tax depreciation
$1000). As at 30 June 20X9, the entity was unable to establish that it was probable there would
be future taxable profits in excess of the reversal of this taxable temporary difference of $3000.
Therefore, the entity recognises only $900 of the total tax deferred tax asset, using the benefit
of only $3000 ($900 / 30%) of the total tax losses of $7000.
The journal entries are, therefore, now described.
The first entry recognises the $900 deferred tax asset that results from the tax losses that the
entity believes will be recovered from the reversal of taxable temporary differences.
30 June
20X9 $ $
Deferred tax asset 900
Current tax income 900
The second entry relates to the increase in the deferred tax liability as a result of the additional
tax depreciation during the 20X9 financial year.
Deferred tax expense 300

Deferred tax liability 300
As at 30 June 20X9, tax losses for which no deferred tax income had been recognised were $4000.
Year ended 30 June 20Y0

During the year ended 30 June 20Y0, the excess of tax depreciation over accounting depreciation
was $800, causing the related taxable temporary difference to increase by the same amount.
This movement in the taxable temporary difference causes the entity to recognise an additional
$240 to the deferred tax liability.
Recognising an increase in the deferred tax liability implies that it is probable that there will
be a further $800 ($240 / 30%) of taxable profit against which an additional $800 of unrecognised
tax losses can be offset. As a consequence, the entity recognises an extra deferred tax asset
of $240.
For the year ended 30 June 20Y0, the taxable profit before utilising tax losses was $2000.
Therefore, tax losses of $2000 may be recouped (recovered) for this period. When tax losses
are recouped, the benefit from the recoupment is first allocated to tax losses for which no
deferred tax asset was previously recognised, and then to tax losses for which a deferred tax
asset was previously recognised.
Recall that, in the previous period, deferred tax assets were recognised with respect to only
$3000 of the tax losses arising during the year ended 30 June 20X9. Therefore, there were
unrecognised benefits associated with $4000 of tax losses (unrecognised tax losses) as at
30 June 20X9. A consequence of recognising an additional $240 to the deferred tax asset is
that unrecognised tax losses are reduced by a further $800 ($240 / 30%), leaving a balance
of unrecognised tax losses of $3200.
Therefore, the whole of the benefit of the $2000 of tax losses recouped during the year
ended 30 June 20Y0 is attributed to tax losses for which no benefit was previously recognised.
This reduces unrecognised tax losses to $1200.
The applicable journal entry is:
30 June
20Y0 $ $

Recognition of additional deferred tax liability and deferred tax asset ($800 × 30%)

Recoupment of tax losses not previously recognised ($2000 × 30%)
Year ended 30 June 20Y1

During the year ended 30 June 20Y1, the excess of tax depreciation over accounting depreciation
was $700, causing the related taxable temporary difference to increase by the same amount.
This movement in the taxable temporary difference causes the entity to recognise an additional
$210 to the deferred tax liability.
During the previous reporting period, tax losses of $2000 were recouped, leaving a $5000
balance of tax losses yet to be recouped. For the year ended 30 June 20Y1, taxable profit before
using tax losses was $7000. This is sufficient to absorb the balance of the unrecouped tax losses.
The benefit of the losses recouped is allocated in the order discussed earlier.
As at 30 June 20Y0, tax losses for which no deferred tax income had yet been recognised
(unrecognised tax losses) were $1200 and those for which a benefit had been recognised were
$3800. Therefore, the benefit of the first $1200 of tax losses recouped is allocated to the first
category of tax losses. The remainder is allocated to the $3800 of tax losses for which a deferred
tax asset had been recognised.
The journal entry is:
30 June
20Y1 $ $
Recoupment of tax losses not previously recognised ($1200 × 30%)

Recoupment of tax losses previously recognised: reversal of DTA that had been
created for $3800 of tax losses (20X9 $900, 20Y0 $240)
$ $
Deferred tax liability resulting from additional tax depreciation of $700
Current tax expense 600

Current tax payable 600
Recognition of tax liability on taxable profit of $2000
Unrecognised tax losses†

Year ended Year ended Year ended
30 June 30 June 30 June
20X9 20Y0 20Y1
$ $ $
(1) (2) (3)
1. Unrecognised tax losses at beginning — 4 000 1 200
2. Add tax losses incurred this period 7 000 — —
7 000 4 000 1 200
3. Tax losses for which deferred tax asset
recognised this period (3 000 ) (800 ) —
4. Unrecognised tax losses recouped
this period — (2 000 ) (1 200 )
5. Unrecognised tax loss at end 4 000 1 200 —
6. Tax losses for which deferred tax asset
recognised at end 3 000 3 800 —
†
‘Unrecognised tax losses’ refers to tax losses for which no deferred tax asset has been previously
recognised.
Question 4.8
An entity is finalising its financial statements for the year ended 30 June 20Y0. Before 30 June
20Y0, the government announced that the tax rate was to be amended from 40 per cent to
45 per cent of taxable profit from 30 September 20Y0.
The legislation to amend the tax rate has not yet been approved by the legislature. However,
the government has a significant majority and it is usual, in the tax jurisdiction concerned,
to regard an announcement of a change in the tax rate as having the substantive effect of actual
enactment (i.e. it is substantively enacted).
After performing the income tax calculations at the rate of 40 per cent, the entity has the following
temporary differences and deferred tax asset and deferred tax liability balances:
Aggregate deductible temporary differences $200 000
Deferred tax asset $80 000
Aggregate taxable temporary differences $150 000
Deferred tax liability $60 000
Of the deferred tax asset balance, $28 000 related to a temporary difference of $70 000
($70 000 × 40%). This deferred tax asset had previously been recognised in OCI and accumulated
in equity as a revaluation surplus.
The entity reviewed the carrying amount of the asset in accordance with para. 56 of IAS 12 and
determined that it was probable that sufficient taxable profit to allow utilisation of the deferred
tax asset would be available in the future.
Present the journal entries necessary to give effect to para. 60 of IAS 12.
The adjusted balances of the deferred tax accounts under the new tax rate are:
Deferred tax asset

$
Previously credited to OCI—equity $70 000 × 0.45 = 31 500
Previously recognised as income $130 000 × 0.45 = 58 500
90 000
Deferred tax liability

Previously recognised as expense $150 000 × 0.45 = 67 500
The net adjustment to deferred tax expense is a reduction of $2500. Of this amount $3500
is recognised in OCI and $1000 is charged to P&L.
The amounts are calculated as follows:

Increase
Carrying Carrying (decrease) in
amount amount deferred tax
at 45% at 40% expense
$ $ $
Deferred tax asset
Previously credited to OCI—equity 31 500 28 000 (3 500 )†
Previously recognised as income 58 500 52 000 (6 500 )‡
90 000 80 000 (10 000 )
Previously recognised as expense 67 500 60 000 7 500 §
Net adjustment (2 500 )
Notes: $
†
An alternative method of calculation is: $70 000 × (0.45 – 0.40) = 3 500
‡
§
The journal entry is:

$ $
OCI—revaluation surplus 3 500


The previous journal entries can be combined as follows:

$ $
Deferred tax expense† 1 000
OCI—revaluation surplus 3 500
$
†
Increase in deferred tax liability previously recognised as expense 7 500
Less: Increase in deferred tax asset previously recognised as revenue 6 500
Net deferred tax expense 1 000
Question 4.9
Using the same facts as Example 4.13, assume that in the tax jurisdiction concerned the amount
of the tax deduction is not altered in response to a revaluation. Therefore, the tax base is not
adjusted and remains at $100.
Calculate the taxable temporary difference immediately before and after the revaluation.
As illustrated below, the temporary difference after the revaluation is a taxable amount of $80.
Before revaluation After revaluation

$ $
Carrying amount 100 180
Tax base 100 100
Temporary difference Nil 80
In future periods when the entity recovers the $180 carrying amount of the asset by use or by
sale, the amount deductible in determining taxable profit is $100. Therefore, the net taxable
amount is $80, giving rise to a deferred tax liability of $24 ($80 × 30%).
Question 4.10
Present the journal entry required to recognise the deferred tax liability applicable to the
revaluation recognised in Example 4.14, under the assumption that the revaluation increase was
credited to OCI and accumulated in equity as a revaluation surplus, if:
(a) the carrying amount of the asset was recovered by using the asset to the end of its useful life
(b) the carrying amount of the asset was recovered by selling the asset and capital gains tax
is applicable.
(a) Carrying amount recovered by using the asset

$ $
Other comprehensive income—revaluation surplus 21
To recognise additional deferred tax as an adjustment
to OCI accumulated in the revaluation surplus (i.e. $24 – $3)
(b) Carrying amount recovered by selling the asset

Other comprehensive income—revaluation surplus 15
To recognise additional deferred tax as an adjustment
to OCI accumulated in the revaluation surplus (i.e. $18 – $3)
Note: full details of the calculations are provided in Example 4.14.

Question 4.11
Assume that the carrying amount and the recoverable amount through sale is $45 000 as at
31 December 20X2. Using the information in Table 4.17 as at 31 December 20X2, outline how
the calculations would differ if:
(a) The asset was expected to be recovered through sale and capital gains tax was not applicable.
(b) The asset was expected to be recovered through sale and capital gains tax was applicable.
(a) Capital gains tax not applicable

In a regime in which there is no capital gains tax, if the asset is sold for the recoverable
amount of $45 000, the capital gain of $5000 (the excess of the sale proceeds $45 000
over initial cost of $40 000) is exempt from income tax. However, this is a depreciable asset
and any tax depreciation recouped from the sale of the asset is taxable. Tax depreciation
recouped is equal to any remaining proceeds of sale, after capital gains, in excess of the tax
written-down amount of the asset.
Therefore, as shown below, there is a taxable temporary difference of $30 000 associated
with the recovery of the asset:
Recovery by sale $ $
Sales proceeds 45 000
Less: Capital gain (5 000 )
Cost (Balance of sale proceeds) 40 000
Less: Tax written-down cost
Cost 40 000
Depreciation (30 000 ) (10 000 )
Taxable temporary difference 30 000
Because there is no capital gains tax applicable, the depreciation recouped is equal to the
taxable temporary difference. The deferred tax liability is $30 000 × 30% = $9000.
(b) Capital gains tax applicable

In a regime in which capital gains tax applies, if the asset is sold for the recoverable amount
of $45 000, the capital gain of $5000 (the excess of the sale proceeds $45 000 over initial
cost of $40 000) is taxable. As noted above, in addition to the capital gain, because this is a
depreciable asset, any tax depreciation recouped from the sale of the asset is also taxable.
Tax depreciation recouped is equal to any remaining proceeds of sale, after capital gains,
in excess of the tax written down amount of the asset.
As shown below, there is a taxable temporary difference of $35 000 associated with the
recovery of the asset. The taxable temporary difference can be disaggregated between
the $5000 capital gain and $30 000 recoupment of depreciation:
Recovery by sale $ $
Sales proceeds (recovery of cost of
$40 000 plus $5000 capital gain) 45 000
Less: Tax written-down cost
Cost 40 000
Depreciation (30 000 ) (10 000 )
Taxable temporary difference 35 000
The deferred tax liability is $35 000 × 30% = $10 500.

Question 4.12
Part A
Construct a table identifying all taxable and deductible temporary differences for AAA Ltd for
the year ending 31 December 20X1, and a table identifying all taxable and deductible temporary
differences for AAA Ltd for the year ending 31 December 20X2.
The tables should include the carrying amounts of the assets and liabilities, their corresponding
tax bases and the two types of temporary differences: taxable and deductible. The bottom section
of the table should illustrate the calculation of the deferred tax asset and liability for the year.
Part B
How would the answer for the year ended 31 December 20X2 differ if the tax rate changed from
30 per cent to 25 per cent in 20X2?
Part A
Taxable Deductible
amount Tax base difference difference
20X1 $ $ $ $
Receivable 55 000 — 55 000
Inventory 2 000 2 000
Investments 33 000 33 000
Buildings 24 000 20 000 4 000
Plant and equipment 10 000 10 000
Warranty obligations 10 000 — 10 000
Goodwill 10 000 10 000
Long-term debt 20 000 20 000
Total 59 000 10 000
Deferred tax liability (× 30% tax rate) 17 700
Deferred tax asset (× 30% tax rate) 3 000
Taxable Deductible
amount Tax base difference difference
20X2 $ $ $ $
Receivable — —
Inventory 2 000 2 000
Investments 33 000 33 000
Buildings (refer to Table 4.17) 36 000 10 000 26 000
Plant and equipment 10 000 10 000
Warranty obligations — —
Goodwill 10 000 10 000
Long-term debt 20 000 20 000
Total 26 000 0
Deferred tax liability (× 30% tax rate) 7 800
Deferred tax asset (× 30% tax rate) 0
Part B
Current tax liabilities (assets) are to be recognised at each reporting date at the amounts that are
expected to be paid to (recovered from) the taxation authorities. The tax rates and tax laws to be
applied are those that have been enacted or substantively enacted by the end of the reporting
period (IAS 12, para. 46).
Deferred tax assets and liabilities are to be measured at the tax rates expected to apply on
realisation or settlement of the deferred tax assets and deferred tax liabilities, respectively.
The expected tax rates and the tax laws to be applied are those that have been enacted or
substantively enacted by the end of the reporting period (IAS 12, para. 47).
Therefore, AAA Ltd should measure the deferred tax assets and deferred tax liabilities using
the new tax rate of 25 per cent. The deferred tax liability would be $26 000 × 0.25 = $6500.
Question 4.13
How would the answer for the year ended 31 December 20X0 in Table 4.19 differ if the entity
had a history of losses?
If an entity has a history of losses, special consideration should be given to establishing whether
or not sufficient taxable profit will be available against which the deductible temporary difference
can be utilised. In this case, IAS 12 requires that the guidance provided in paras 35 and 36 be
considered (IAS 12, para. 31). This guidance requires that, when utilisation of a deferred tax asset
is dependent on future taxable profit in excess of the taxable profit arising from the reversal of
existing taxable temporary differences, the probability recognition criterion will be satisfied only
if there is convincing other evidence that such taxable profits will be available.
Question 5.1
Indicate which of the following acquisitions represent a business combination
Select one or more options from

the following list. Justify your answer for each option.
(a) A Ltd acquires inventory

from B Ltd on a regular
basis.
(b) A Ltd acquires plant and

equipment from B Ltd as a
one-off transaction.
(c) A Ltd acquires some

inventory from B Ltd that
it then sells to C Ltd and
some plant and equipment
that it then sells to D Ltd.
(d) A Ltd acquires a bundle

of assets from B Ltd
that includes, among
others, cash, inventories,
a brand name, plant and
equipment, land and
buildings that are used
together to produce and
market a blood pressure
monitor.
(e) A Ltd acquires the entire

share capital of B Ltd from
its old shareholders.
Only situations (d) and (e) represent business combinations. Situations (a) and (b) represent
acquisition of individual assets that do not constitute a business. The regularity of those kind of
asset acquisitions has no impact on this assessment. The asset acquisitions on a regular basis
may indicate strong relationships between the parties involved, but that does not necessarily
indicate that one entity has control over the other.
Situation (c) describes the acquisition of a bundle of assets that will not be used together to
generate output; as such, this bundle does not satisfy the definition of a business and therefore
the acquisition cannot be recognised as a business combination. Situation (d), on the other hand,
describes a business combination, as the bundle of assets acquired represents a business.
Situation (e) is again a business combination, but the form is different from situation (d). While
situation (d) describes a direct acquisition, situation (e) represents an indirect acquisition. In both
these cases, the form of the transaction does not matter; it is the substance of acquiring control
of other businesses that makes them business combinations.
Question 5.2
Refer to the following business combinations and discuss the factors that need to be taken into
account when determining the acquirers in the combinations.
(a)
A Ltd B Ltd
A Ltd acquired 90%

of the shares and
voting rights in
B Ltd for cash.
(b)
D Ltd
100% 100% 100%
A Ltd B Ltd C Ltd
A new entity, D Ltd, was formed and acquired all

the shares in A Ltd, B Ltd and C Ltd by issuing
shares in D Ltd.
(c) 100%
A Ltd B Ltd
Prior to the acquisition of shares in B Ltd, A Ltd had 500 000 shares on issue
(fair value of $5) and B Ltd had 400 000 on issue (fair value of $10).
To acquire the shares in B Ltd, A Ltd issued 800 000 shares to the shareholders of B Ltd.
(a) A Ltd would be the acquirer in this combination. This conclusion is supported as follows:
–– With 90 per cent of the voting rights, A Ltd would have the power over the investee
to affect the amount of the returns it would receive from B Ltd as the holders of the
other 10 per cent of the voting rights would not have the ability to out-vote A Ltd when
decisions about relevant activities of B Ltd need to be made.
–– A Ltd would be able to appoint the directors of B Ltd, who could direct the activities
of the company to provide a return to A Ltd via its performance.
–– A Ltd provided consideration as it gave up cash to acquire the ordinary shares of B Ltd
(IFRS 3, para. B14).
(b) D Ltd was formed to facilitate the business combination and issued shares in D Ltd for all of
the shares in A Ltd, B Ltd and C Ltd to their former owners/shareholders. In such situations,
one of the combining entities that existed before the combination is identified as the acquirer.
One must determine whether A Ltd, B Ltd or C Ltd is exposed, or has the rights, to variable
returns from its involvement with the other entities and has the ability to affect those returns
through its power over the entities, that is, which entity has control over the other entities in
the combination.
In some circumstances, this may be an arbitrary decision. It is essential to focus on the

substance and not the form of the transaction. IFRS 3 indicates that it is important to consider
factors such as which entity initiated the combination, the relative size of the combining entities
(IFRS 3, para. B17) and those indicators listed in IFRS 3, para. B15. For example, the acquirer
is likely to be the entity that has a significantly greater fair value than the other entities, or
the entity that has a management that will dominate the selection of the combining entity’s
management. Without further information about the combining entities, it is difficult to
nominate which one would be the acquirer.
(c) Even though A Ltd acquired the shares of B Ltd, the combination could be a reverse acquisition
where B Ltd is in fact the acquirer. After the combination, the original shareholders of B Ltd will
hold 800 000 shares in the combined entity (via shares in A Ltd), while the original shareholders
in A Ltd will hold only 500 000 shares in the combined entity. Hence, the original shareholders
in B Ltd may now be able to replace (or appoint the majority of) the directors of A Ltd. In such
circumstances, B Ltd would have the rights to variable returns from A Ltd (via dividends) and
the ability to affect those returns through its power over A Ltd (IFRS 10, para. 6). Hence, B Ltd
would be considered to be the acquirer in the combination. As with all combinations, all of the
circumstances involved would have to be considered.
Question 5.3
The managing director of a company subject to a takeover offer argued that the price offered
by the potential acquirer was inadequate because it did not reflect the value of some items such
as the company’s brands, competitive position and market strength.
Which of these items could be recognised as an identifiable asset and which would form part of
‘goodwill’ in accordance with IFRS 3?
Goodwill represents the future economic benefits from unidentifiable assets. Identifiable assets are
those assets capable of being individually identified and recognised in the financial statements.
IAS 38 defines an intangible asset as identifiable if it meets either the separability criterion or
the contractual–legal criterion. If one criterion is satisfied, the identifiable intangible asset of the
acquiree can be recognised if its fair value is capable of reliable measurement (IAS 38, para. 35).
The question mentions three items:

1. brands
2. competitive position
3. market strength.
‘Competitive position’ and ‘market strength’ are typical of items not recognised as identifiable
assets in the statement of financial position. Such items do not satisfy the identifiability criteria
in IAS 38, as they cannot be separated from the entity and sold, rented, transferred, licensed
or exchanged (the separability criterion), nor do they arise from contractual or legal rights
(the contractual–legal criterion). Even though an acquirer would be willing to pay for such items,
they would be regarded as unidentifiable assets and, hence, form part of goodwill.
Many entities separately recognise their brand names as intangible assets. The illustrative
examples in IFRS 3 (Part B of the Red Book) include ‘Examples of items acquired in a business
combination that meet the definition of an intangible asset’. IFRS 3, paras IE19−21 deal with
trademarks, trade names and other intangibles that are often synonymous with brand names.
As trademarks are usually registered, IFRS 3 regards this as satisfying the contractual−legal
criterion of IAS 38—that is, future benefits can be derived from legal rights. A trademark is also
likely to satisfy the separability criterion because it can be sold. Finally, where a brand name is
regarded as an identifiable intangible asset because it satisfies the criteria of IAS 38, it can be
recognised and its fair value can be reliably measured (IAS 38, para. 35).
In conclusion, even though there are three items mentioned by the managing director, only the
brand name could possibly be regarded as an identifiable asset. The other two items would be
regarded as components of goodwill.
Question 5.4
Would all identifiable assets and liabilities recognised by an acquirer be included in the statement
of financial position of the acquiree prior to acquisition?
No, some identifiable assets and liabilities may not have been recognised in the acquiree’s
statement of financial position prior to acquisition. As noted in IFRS 3, para. 13, the acquirer
may obtain control over identifiable assets and liabilities that were not previously included
in the statement of financial position of the acquiree (e.g. identifiable intangible assets
generated internally, like brand names and trademarks; or contingent assets and liabilities).
This may be because the items did not satisfy the applicable recognition criteria prior
to acquisition.
Question 5.5
Provide examples of unidentifiable assets that may contribute to the goodwill of a business.
Examples of unidentifiable assets that may form part of goodwill include market penetration,
good industrial relations, strategic location, superior management, good credit rating, excellent
training programs, specialised skills and community standing. Each of these would provide future
economic benefits to the entity, but would not be recognised because it would not be possible
to reliably measure their fair value. Also, they may not satisfy the identifiability criteria in IAS 38,
as they normally cannot be separated from the entity and sold, rented, transferred, licensed
or exchanged (the separability criterion), nor do they arise from contractual or legal rights
(the contractual–legal criterion).
Question 5.6
(a) If an entity has an acquisitions department, would the costs associated with running
the department be included in the cost of a business combination?
(b) On 1 April 20X5, Investor Ltd (Investor) signed an agreement to acquire all the shares of
Investee Ltd and, in return, to issue 100 000 of its own shares. The terms of the agreement
were fulfilled on 30 June 20X5, when the shares were transferred. Consulting fees relating
to the combination were $10 000. These costs were paid by Investor.
The last sale of Investor shares took place in December 20X4 at a price of $4.50 per share.
The estimated fair value of the shares at 30 June 20X5 was $5.00 per share.
(i) Calculate the consideration transferred for the investment acquired by Investor, explaining
your reasoning.
(ii) Provide pro forma journal entries for Investor to account for the acquisition of the
investment and the payment of the costs attributable to the investment.
Dr Cr
$000 $000
(a) No, the costs associated with running an acquisitions department would not be included in
the cost of a business combination. General administrative costs associated with maintaining
an acquisitions department for a particular business combination are not considered part
of the cost of the business combination and should be expensed as incurred. They may be
acquisition-related costs, but the general principle is that those costs are expensed in the
periods in which they are incurred (IFRS 3, para. 53).
(b) (i) The consideration transferred should be determined as at the acquisition date, the date
when the risks and rights to future benefits associated with the investment pass to Investor.
This is not 1 April 20X5, which is the date when the agreement was signed, but 30 June
20X5, which is when the terms of the agreement were fulfilled.
The consideration transferred should be measured by reference to the fair value of what
was given up at the acquisition date (being 30 June 20X5, as discussed), not what was
received. Investor gave up 100 000 shares and their fair value at 30 June 20X5 was $5.00
per share, making the fair value of the total consideration transferred equal to $500 000.
Consulting fees cannot be included as part of the consideration transferred, as

acquisition-related costs are expensed in the periods in which the costs are incurred
(IFRS 3, para. 53).
(ii) The pro forma journal entries prepared by Investor to account for the acquisition of the
investment and the payment of acquisition-related costs are as follows:
Dr Cr
$000 $000
Investment in Investee 500
Issued capital 500
Issue of shares to acquire the investment
Consulting fees (expense) 10

Bank 10
Acquisition costs recognised in P&L
Question 5.7
Using the same data as in Example 5.6 and assuming that a contingent liability exists in the notes
of B as suggested in Example 5.3 (A measures it at the fair value of $1 000 000), prepare and
explain the journal entry posted by A to recognise the acquisition of the assets and liabilities of
B. Assume no tax effect.
The fair value of the identifiable net assets in B is calculated as:
Fair value of total identifiable assets recorded by B $10 000 000

Add: Fair value of identifiable assets not previously recorded by B $1 000 000
Less: Fair value of total identifiable liabilities recorded in B ($5 000 000 )
Less: Fair value of contingent liability not previously recorded in B ($1 000 000 )
Fair value of total identifiable net assets of B $5 000 000
Therefore, the goodwill on acquisition is:

Fair value of consideration transferred by acquirer $8 000 000
Less: Fair value of identifiable net assets in B ($5 000 000 )
Goodwill $3 000 000
The journal entry posted by A in its own records to recognise the acquisition of all the assets
and liabilities of B is as follows:
Dr Cr
$ $
Account receivable 400 000
Inventory 600 000
Plant and equipment 2 000 000
Land and buildings 7 000 000
Trademark 1 000 000
Goodwill 3 000 000
Account payable 500 000
Bank loan 4 500 000
Provision for damages 1 000 000
Bank 8 000 000
Question 5.8
Refer to the journal entries posted in Examples 5.6 and 5.7. Discuss the impact of those entries
of the individual accounts of A and identify which one provides more information to the users
interested in B.
In Example 5.6, the acquirer acquired all the assets and liabilities of a business that it now fully
owns. This acquisition is a direct acquisition and, as such the assets are transferred to the acquirer’s
accounts, which recognise them as assets of the entity, together with the previous assets it owned
prior to the acquisition. Liabilities are only directly transferred into the acquirer’s records.
On the other hand, in Example 5.7, the acquirer acquired only the shares issued by the
business that it now fully owns, but the acquiree retains legal ownership of its assets and a
legal responsibility to settle its liabilities. As such, the treatment of this acquisition recognises
that the acquirer purchases just one single asset that it needs to recognise in its own accounts.
Shareholders in the acquirer will not be able to easily identify by looking at the financial
statements of the acquirer what assets and liabilities were acquired unless they are provided
with a detailed description of the business combination.
To make it easier to understand the financial impact and the risks and opportunities facing
the acquirer as a result of this business combination via purchase of shares, IFRS 10 requires the
acquirer in these instances to prepare consolidated financial statements that will include the assets
and liabilities of all the entities within the group.
Question 5.9
Prepare a pro forma general journal entry to reflect the acquisition of Small’s assets and liabilities
by Large, based on the data in Example 5.8.
Dr Cr
$000 $000
Notes:
The pro forma journal entry at acquisition date to reflect the acquisition of Small’s assets and
liabilities by Large is as follows:
Dr Cr
$000 $000
Trade receivables 95
Inventory 200
Land and buildings 700
Goodwill 60
Bank overdraft 30
Trade payables and loans 400
Bank† 400
Issued capital‡ 225

†
Payment of consideration in cash.
‡
Issue of shares as part of the consideration transferred.
Notes
1. The identifiable assets and liabilities acquired by Large are recorded at their fair values
at acquisition date in accordance with IFRS 3, para. 18. The amounts recorded for these
assets and liabilities in Small are not relevant to this type of business combination,
which is structured as a direct acquisition.
2. There is no deferred tax asset or deferred tax liability recognised by Large as the assets
and liabilities acquired are of such a type that their amounts recorded by Large also
establish their tax base.
3. The difference between the fair value of the consideration transferred (made out of cash
and shares) and the fair value of the identifiable assets and liabilities acquired is equal
to the goodwill, which is recognised as an asset in accordance with IFRS 3, para. 32.
Question 5.10
Based on the data in Example 5.9, prepare a pro forma journal entry for High to reflect the
acquisition of Low’s assets and liabilities.
Dr Cr
$000 $000
Notes:
The pro forma journal entry at acquisition date to reflect the acquisition of Low’s assets and
liabilities by High is as follows:
Dr Cr
$000 $000
Accounts receivable 200
Inventory 850
Plant and equipment 2 600
Goodwill 350
Trade payables 100
Loans 890
Contingent liability 300
Bank †
2 800

†
Payment of consideration in cash.
Notes
1. The identifiable assets and liabilities acquired by High are recorded at their fair values
at acquisition date in accordance with IFRS 3, para. 18. This includes the contingent
liability because it is a present obligation and its fair value can be reliably measured at
acquisition date.
2. The recognition of the contingent liability has given rise to a deferred tax asset.
3. The difference between the fair value of consideration transferred and the fair value of
the identifiable assets and liabilities acquired is equal to the goodwill, which is recognised
as an asset in accordance with IFRS 3, para. 32.
Question 5.11
(a) ‘X Ltd (X) owns 60 per cent of the share capital of Y Ltd (Y). Thus, Y is a subsidiary of X.’
Explain whether you agree with this statement, providing reasons for your answer.
(b) ‘X has 44 per cent of the voting rights in Y. The other 56 per cent of voting rights in Y are held
by several hundred shareholders who are geographically dispersed. No other shareholder
owns more than 1 per cent of the voting rights in Y. In general, few of the other shareholders
attend annual general meetings. There are no arrangements between shareholders for making
collective decisions.’
Explain whether X is likely to control Y.
(c) Would it make any difference to your answer to (b), if, apart from X, there were only two
other shareholders in Y, each with a 28 per cent shareholding interest?
(d) Provide two examples of where an investor could have the majority of voting rights but
no power.
(a) The degree of equity ownership is not the overriding consideration in determining the
existence of control, but the existence of voting rights attached to the shares that constitute
the equity ownership would be a factor (remember that not all classes of shares have
voting rights attached). Whether Y is a subsidiary of X will depend on whether X controls Y
(IFRS 10, para. 5). X will only have control over Y if all of the following criteria are satisfied:
–– X has power over Y through having existing rights to direct Y’s relevant activities.
–– X is exposed, or has rights, to variable returns from its involvement with Y.
–– X has the ability to use its power over Y to affect the amount of its returns
–– (IFRS 10, paras 6 and 7).
Determination of whether X has control will rely on judgments being made based on the
substance of the case. Given no other relevant factors, and assuming that X has 60 per cent of
the voting rights in Y, it would be expected that X has the power to direct the relevant activities
of Y. This power would derive from an ability to use its voting power to appoint the majority
of directors of X who direct the relevant activities of the company, including the operating
(e.g. selling goods or services, buying assets) and financing activities (e.g. obtaining funding)
of the company (IFRS 10, paras B11, B35).
X would also be exposed to, or have a right to, variable returns based on the performance
of Y. As a shareholder, X would expect to receive a return via dividends and changes in
the value of its investment. These returns could be positive or negative depending on Y’s
profitability. It does not matter that the other shareholders’ (who hold 40%) share in the
returns of Y (IFRS 10, paras 15 and 16). X may also be able to include a right to receive returns
from factors such as securing a supply of services, economies of scale or remuneration from
providing services (IFRS 10, para. B57).
Finally, it would be expected that X could use its power over Y to affect the returns it received
from the company. That is, X could use its power to increase the returns it received from Y
or reduce any potential losses.
(b) Even though X does not hold the majority of shares in Y, it can still have control of Y.
The critical issue is whether X has the power to direct the relevant activities of Y. IFRS 10,
para. B42 and Example 4 of Appendix B both suggest that it is likely that X would satisfy
the power criterion of control. This stems from both X’s absolute and relative voting rights
compared with other shareholders (IFRS 10, para. B42(a)). To outvote X, other shareholders
with a combined interest of a least 45 per cent of the shares need to act together. This would
involve hundreds of shareholders. As few of these shareholders attend annual meetings
and there is no agreement between shareholders to make collective decisions, this is
highly unlikely.
In addition to X having the power to direct the relevant activities of Y, the company must
also satisfy the other criteria for control (IFRS 10, paras 6 and 7). As a shareholder in Y, X is
exposed to returns from the company, which will vary depending on the performance of Y.
Finally, X can use its power to affect the returns from Y. As the dominant shareholder, X would
be able to influence the appointment of Y’s directors and hence the financial and operating
decisions of the company, which in turn will impact on X’s returns from Y.
(c) As with Part (b), the critical criterion of control in this situation is whether X has power over
Y. In accordance with IFRS 10, para. B42(a) and the discussion in IFRS 10, Example 6 of
Appendix B, X would not satisfy the power criterion of control. The central factor preventing
X from having power over Y is that the two other shareholders have combined voting rights of
56 per cent. Hence, these two shareholders can work together to prevent X from directing the
relevant activities of Y. Therefore, in this case, X is not likely to control Y.
(d) IFRS 10, paras B36 and B37 discuss the situation in which an investor can have the majority
of voting rights but no power. One example of where this could occur is when another entity
has a contractual right to direct the relevant activities of the investee and is not an agent
of the investor. In such a situation, the investor does not have power over the investee.
Another example is where the voting rights are not substantive as the investor does not
have the practical ability to exercise their rights (IFRS 10, para. B22). This could occur where
the relevant activities of the investee are subject to direction of other parties, such as the
government, a court administrator or a liquidator.
Question 5.12
Using the data from Example 5.12:
(a) Calculate the fair value of the consideration transferred.
(b) Provide a pro forma journal entry for Holding to account for the acquisition of Subsidiary’s
shares.
Dr Cr
$000 $000
(c) Provide a pro forma journal entry for Subsidiary for the revaluation of its non-current assets
to fair value and a consolidation journal entry for the revaluation of the current assets of
Subsidiary to fair value.
Dr Cr
$000 $000
(d) Explain whether the group has purchased goodwill and, if so, calculate the amount
of purchased goodwill.
(a) The fair value of the consideration transferred is the aggregate of the fair value of share
capital issued as consideration. The fair value of the shares issued by Holding, at 30 June
20X3, was $5.00 per share. Hence, the fair value of consideration transferred is calculated as:
Fair value of shares issued (30 000 shares† @ $5.00) = $

150 000
†
Subsidiary has an issued capital of 12 000 shares. Holding offered five of its shares for every two of
Subsidiary and therefore issued 12 000 / 2 × 5 = 6000 × 5 = 30 000 shares as part of consideration.

(b) The pro forma journal entry for Holding to account for the acquisition of the Subsidiary’s
shares is as follows:
Dr Cr
$000 $000
Investment in Subsidiary 150
Issued capital 150
(Issue of shares to acquire shares in Subsidiary)
(c) The recognition of the identifiable net assets of Subsidiary at fair value as part of the business
combination leads to the recognition of a deferred tax liability. The amount of the deferred
tax liability is calculated as follows:
$000
Fair value of identifiable net assets 125
Less: Tax base of identifiable net assets acquired (95 )
Taxable temporary difference 30
Therefore, a deferred tax liability of $9000 ($30 000 × 30%) arises on acquisition.
Note: The deferred tax liability only arises in this situation due to the difference between the

fair value of the identifiable assets and their tax base.
The pro forma journal entry for the revaluation of Subsidiary’s non-current assets to fair value
in the consolidation worksheet is as follows:
Dr Cr
$000 $000
Non-current assets 20
Revaluation surplus 14
The consolidation journal entry for the revaluation of the identifiable current assets of
Subsidiary to fair value on consolidation is as follows:
Dr Cr
$000 $000
Current assets 10
Asset revaluation surplus 7
(d) The group has purchased goodwill as the fair value of the consideration transferred
is larger than the fair value of the identifiable net assets acquired (IFRS 3, para. 32).
As Holding acquired the entire issued capital of Subsidiary, there is no non-controlling
interest or previous equity interest.
The fair value of the identifiable net assets acquired by Holding is calculated as follows:
$000
Fair value of identifiable net assets before deferred tax liability 125
Less: Deferred tax liability arising on revaluation
of identifiable net assets to fair value (9 )
Fair value of identifiable net assets acquired 116
Therefore, the goodwill to be recognised by the group is determined as follows:
$000
Fair value of consideration transferred (refer to Part (a)) 150
Less: Fair value of identifiable net assets acquired (116 )
Goodwill 34
Question 5.13
Using the information in Case study 5.1 and Example 5.10, prepare a consolidation worksheet
adjusting entry as at the acquisition date to record the elimination of the investment account and
of the pre-acquisition equity of the subsidiary. Explain the rationale for your entries.
The pre-acquisition consolidation elimination entries as at the acquisition date should:

1. revalue the plant acquired to its fair value and recognise a business combination reserve
(considered part of pre-acquisition equity of Subsidiary) for the after-tax increase in value
and a deferred tax liability for the tax effect
2. eliminate the investment account appearing in the financial statements of Parent, together
with the parent entity’s share of the pre-acquisition equity of Subsidiary that includes the
business combination reserve recognised on revaluation of plant and recognise any goodwill.
1. Revaluation of plant
Remember that it is the group that has acquired the business (including goodwill) of the subsidiary.
Therefore, the requirements of IFRS 3 in terms of using the acquisition method for this business
combination are applicable in the consolidated financial statements. As such, as long as the plant
wasn’t revalued in the subsidiary’s accounts, it has to be recognised at fair value on consolidation,
just like all the other identifiable net assets.
At the acquisition date (1 July 20X0):

• The financial statements of Subsidiary recorded plant at cost of $100 000, less accumulated
depreciation of $40 000. See point 3 of Case study 5.1.
• Parent considered that the plant owned by Subsidiary had a fair value of $80 000. In accordance
with IFRS 3, the plant must be initially measured at $80 000 (i.e. fair value) in the consolidated
financial statements. See point 3 of Case study 5.1.
Therefore, the consolidation worksheet entry must decrease the gross carrying value of the plant
by $20 000 (i.e. from $100 000 down to $80 000) and decrease accumulated depreciation by
$40 000 (i.e. from $40 000 down to $nil). This is reflected in the consolidation worksheet entry as a
debit to accumulated depreciation of $40 000 and a credit to the gross carrying value of plant of
$20 000. After these adjustments, the plant is valued at fair value (an increase of $20 000 over the
old carrying amount in the records of Subsidiary), but the tax base is not affected and therefore a
taxable temporary difference is created, for which a deferred tax liability of $6 000 (assuming a tax
rate of 30%) needs to be recognised. Similar to the case of the revaluation of plant in individual
accounts, for the after-tax increase in value, a revaluation reserve has to be recognised. In this
module, the term used for the reserve created on the revaluation of the subsidiary’s assets and
liabilities to fair value in the consolidation worksheet entry is the ‘business combination reserve’.
This term is not specified by IFRS 3, and other names could be used.
The journal entry will be posted in the consolidation worksheet as follows:
Dr Cr
$ $
Plant 20 000
Business combination reserve 14 000
From the group’s perspective, the plant was acquired at a fair value of $80 000 and this is
reflected in this worksheet.
Note: Items of plant and equipment may be shown in a worksheet ‘net of accumulated
depreciation’ and hence the consolidation entry is a single adjustment to that line item. That is,
for this example, if there was no detail concerning accumulated depreciation, the $60 000 net of
accumulated depreciation amount for plant would be simply adjusted by a debit of $20 000 to
arrive at the $80 000 consolidated amount net of accumulated depreciation.
2. Elimination of the investment in the subsidiary and the pre-acquisition equity and
recognition of goodwill
Dr Cr
$ $
Issued capital 100 000
Goodwill 36 000
Investment in Subsidiary 230 000
This entry relates to the elimination of the pre-acquisition equity and the investment in the
subsidiary and the recognition of goodwill. Business combination reserve is considered a part
of pre-acquisition equity of the subsidiary because it reflects the after-tax profit-making potential
of the asset. In effect, these are pre-acquisition benefits of the plant.
The two preceding entries could be combined as follows:
Dr Cr
$ $
Goodwill 36 000
Plant 20 000
As a result of these entries, the consolidated financial statements would then:

(i) include the net assets of Subsidiary recorded at fair value
(ii) recognise the deferred tax liability arising from the business combination in accordance with
IAS 12 and IFRS 3
(iii) exclude the asset ‘Investment in Subsidiary’ because the group cannot have an investment
in itself
(iv) have a shareholders’ equity that includes the issued capital of the parent (the issued capital of
Subsidiary is owned by Parent, not shareholders external to the group) and retained earnings
of Parent (the retained earnings of Subsidiary are obtained prior to the formation of the
group and, therefore, do not belong to the group and have been eliminated).
Question 5.14
(a) Using points 3 and 4 of Case study 5.1 and the information from Example 5.10, prepare
a consolidation worksheet adjusting entry for the year ended 30 June 20X2. Explain the
rationale for account(s) that differ(s) from the 30 June 20X1 entry discussed previously.
(b) Refer to point 5 of Case study 5.1, which relates to the sale of the plant. Prepare a consolidation
adjusting entry for the year ending 30 June 20X3. Explain the rationale for accounts debited
and credited that differ from (a).
(c) Provide the consolidation adjusting entry that would be necessary in years subsequent to
the year ended 30 June 20X3. Explain the rationale for accounts debited and credited that
differ from (b).
(a) For the year ended 30 June 20X2, Subsidiary would process the following depreciation entry:
Dr Cr
$ $

As point 4 of Case study 5.1 indicates, the remaining useful life of the plant as of 1 July 20X0
is five years with a scrap value of $0. Given the carrying amount of the plant is $60 000 (see
point 3 of Case study 5.1), depreciation expense per annum in the financial statements of
Subsidiary is $12 000 (($60 000 – $0) / 5 years). This amount is annual depreciation expense for
each year subsequent to the acquisition date, including the year ended 30 June 20X2.
As discussed in Example 5.10, the P&L and OCI of the group should include depreciation
expense for the plant of $16 000. This is because the plant had a fair value of $80 000 at
the acquisition date, giving rise to annual depreciation expense of $16 000 (($80 000 – $0) /
5 years). A comparison of the statement of financial position of Subsidiary with what should
be reported in the statement of financial position of the group would reveal the following
information in relation to the plant:
Subsidiary Group
$ $
Plant 100 000 80 000
Less: Accumulated depreciation (64 000 )† (32 000 )‡
Carrying amount 36 000 48 000

†

Accumulated depreciation at acquisition date ($40 000) plus depreciation for the years ended 30 June 20X1
and 30 June 20X2 ($12 000 + $12 000) from the point of view of Subsidiary.
‡
Depreciation for the years ended 30 June 20X1 and 30 June 20X2 ($16 000 + $16 000) from the point of
view of the group.
Consolidation entries on 30 June 20X2
1. Revaluation of plant to fair value

Dr Cr
$ $
Plant 20 000
2. Depreciation entry and associated tax effect

Dr Cr
$ $
(opening balance—prior year adj.)
Depreciation expense (current year adj.) 4 000
Accumulated depreciation must be adjusted for two years’ depreciation adjustments

(20X1 and 20X2)—hence, the credit of $8000 (2 × $4000), where the depreciation adjustment
reflects the difference in annual depreciation expense between the group and Subsidiary
($16 000 – $12 000 = $4000). The debit to the retained earnings account of $4000 relates to
increased depreciation in the prior accounting period (i.e. 20X1). As an alternative explanation,
the $4000 debit to the opening retained earnings account could be considered from the point of
view of the depreciation charges made in the financial statements of the group in the preceding
period. To illustrate, in the year ended 30 June 20X1, an additional $4000 of depreciation
expense was recognised in the P&L and OCI of the group, as compared to that of Parent plus
Subsidiary. These higher depreciation charges would have reduced the profits and, in turn,
the retained earnings of the group, as compared to the profits and retained earnings reported
in the financial statements of Parent plus Subsidiary. As a result, in the 20X2 financial year,
the opening retained earnings account of the group had to be reduced by $4000.
Dr Cr
$ $
Retained earnings (opening balance) 1 200
The higher group depreciation expense in 20X1 reduces the group profit before tax, which requires
the 20X1 tax expense of the group to be reduced by $1200 ($4000 × 30%). This reduction in group
tax expense by $1200 is reflected in the credit entry to the opening retained earnings account,
as it relates to increased group profit after tax from a prior period. Hence, in the 20X2 financial
year, the opening retained earnings account of the group increased by $1200. The net effect of the
impact of the 20X1 depreciation adjustment net of tax was to reduce (debit) the opening retained
earnings of the group by $2800 ($4000 – $1200). The higher group depreciation expense in 20X2
also reduces the group profit before tax, requiring the 20X2 tax expense of the group to also be
reduced by $1200, which is reflected in the credit entry to income tax expense.
The deferred tax liability of the group after the entries above is $3600 ($6000 – $2400), as the
temporary difference relating to the plant at 30 June 20X2 is $12 000. That is, at 30 June 20X2,
the carrying amount of the plant for the group is $48 000 (see above), while its tax base is
$36 000. The tax base corresponds with the carrying amount of the plant to the Subsidiary
because the plant was not revalued for tax purposes and the tax and accounting depreciation
calculations are consistent.
3. Pre-acquisition elimination entry

Dr Cr
$ $
Goodwill 36 000
The preceding three entries could be combined as follows:
Dr Cr
$ $
Goodwill 36 000
Plant 20 000
Accumulated depreciation must be adjusted for two years’ depreciation adjustments

(20X1 and 20X2)—hence, the debit of only $32 000 ($40 000 – (2 × $4000)), which reflects the
combined debit and credit entries to accumulated depreciation from consolidation entries 1
and 2. This entry to accumulated depreciation for $32 000 can also be confirmed by referring
to the statement of financial position extract, which illustrates that Subsidiary would have
recorded accumulated depreciation at 30 June 20X2 of $64 000, while the group should report
accumulated depreciation of $32 000.
The other entry to be explained is the debit to the retained earnings account of $82 800.
In effect, this comprises two entries: the elimination of the original pre-acquisition earnings
($80 000); and an entry relating to increased depreciation expense (net of tax) in the prior
accounting period ($4000 – $1200 = $2800). The latter reflects the fact that the parent entity
recognised the profit-making potential of the asset and was prepared to pay $20 000 more
than the carrying amount of plant. In effect, these are pre-acquisition benefits of the plant.
This is easier to see if one recalls that the revaluation of the plant entry (entry (1)) has resulted
in a credit to the business combination reserve. Of course, this is clearly a component of the
pre-acquisition equity acquired. As the asset is used, this pre-acquisition equity is reflected
over subsequent accounting periods via higher depreciation charges and lower group profits.
(b) Point 5 of Case study 5.1 states that the plant held by Subsidiary was sold on 1 July 20X2
to an external party. Therefore, Subsidiary would not need to record any depreciation for
the financial year ending 30 June 20X3. Instead, at 1 July 20X2, Subsidiary would process the
following entry to account for the sale of plant:
Dr Cr
$ $
Bank 40 000
Plant 100 000
Profit on sale of plant 4 000
Consolidation pre-acquisition elimination entry on 30 June 20X3

Dr Cr
$ $
Goodwill 36 000

The debit to opening retained earnings of $85 600 has two components: the elimination of
the original pre-acquisition profit of $80 000; and an entry relating to the two prior years’
depreciation adjustments net of tax (2 × $2800 = $5600). The rationale for the adjustment to
opening retained earnings for prior years depreciation adjustments was explained in Part (a).
Subsidiary has recorded a profit on the sale of the plant of $4000, being the difference
between the amount received for the plant ($40 000) and the carrying amount of the plant in
Subsidiary’s accounts ($100 000 – $64 000 = $36 000). From the group’s point of view, however,
a loss of $8000 should be recorded for the sale of plant (sale price $40 000, less carrying
amount $48 000†).

†
Refer to the statement of financial position extract in the answer to Question 5.14, Part (a).
The debit to the Profit on sale of plant account for $12 000 in the P&L and OCI converts the
‘profit’ of $4000 (credit) recorded by Subsidiary to a ‘loss’ of $8000 (debit) for the group in
the consolidated P&L and OCI.
Again this reflects the fact that, at the acquisition date, the group treated the difference
between the book value and the fair value of the plant ($20 000) as pre-acquisition equity.
The group has already recognised $8000 of this amount in previous periods via depreciation
charges (refer to the debit to the retained earnings account—gross adjustment of $8000 less
tax effect of $2400, giving a net adjustment of $5600). The remaining $12 000 is treated as
pre-acquisition equity on the sale of the plant. Hence, the group will not recognise the $4000
profit in Subsidiary’s P&L and OCI, but an $8000 loss.
The reduction of the profit on the sale of the plant by the group by $12 000 compared
with Parent and Subsidiary requires the tax expense of the group to be reduced by $3600
($12 000 × 30%). As such, it is recorded entirely to income tax expense.
(c) Dr Cr
$ $
Goodwill 36 000
The $94 000 debit to retained earnings is made up two components: the elimination of
the original pre-acquisition earnings of $80 000; and the $14 000 reduction in retained
earnings via the depreciation and profit on sale adjustments, net of the tax effects of
previous reporting periods. That is, the 20X1 and 20X2 depreciation adjustments net
of tax (2 × ($4000 – $1200) = $5600) plus the adjustment for the sale of plant net of tax
($12 000 – $3600 = $8400).
The $14 000 also reflects the amount that was debited to the business combination reserve
at the acquisition date, as it involved pre-acquisition equity. This component of pre-
acquisition equity is now reflected in retained earnings, and its effects will be carried over
to every subsequent reporting period because retained earnings will always be $14 000
less than the sum of the retained earnings of Parent and Subsidiary.
Question 5.15
(a) Refer to Case study 5.2 and use assumption 1. Prepare pro forma consolidation worksheet
entries for the year ended 30 June 20X4. Explain the rationale for your entries.
(b) Refer to Case study 5.2 and use assumption 2. Prepare pro forma consolidation worksheet
entries for the year ended 30 June 20X4. Explain the rationale for your entries.
(c) Assume that on 1 July 20X2, a subsidiary sold to its parent entity an item of plant for
$50 000. The plant had cost the subsidiary $100 000 and had a carrying amount of $40 000.
While the subsidiary had depreciated the plant using the reducing-balance method at a rate
of 30 per cent, the parent entity is depreciating the plant on a straight-line basis over five
years with a zero scrap value at the end of its useful life.
Prepare pro forma consolidation worksheet entries for the financial years ending 30 June
20X3 and 30 June 20X4 to account for this transaction from the group’s point of view. Assume
a tax rate of 30 per cent and explain the rationale for your pro forma entries. (Hint: First
think about the entries that would be processed in the accounting records of the parent and
subsidiary as a result of the transaction.)
(a) Question 5.15(a) assumes that all of the inventory held by the subsidiary as at 30 June 20X3
was sold in July 20X3 for $50 000 to parties external to the group.
The following pro forma consolidation worksheet entries would be processed:
Dr Cr
$ $
Retained earnings
(opening balance) 10 000
Cost of goods sold 10 000

Retained earnings
Eliminations
adjustments
Parent Subsidiary Dr Cr Consolidated
$000 $000 $000 $000 $000
Sales 50 50
Less: Cost of goods sold (40) 10 (30)
Gross profit 10 20
Profit before tax 10 20

Income tax expense (3) 3 (6)
Retained earnings 7 10 3 —
(opening balance)†
†
Refer to ‘Profit for the year’ of Parent in the Example 5.14 worksheet.
Group profit before tax for the year ended 30 June 20X3 (the prior year) was $10 000 less than
the sum of the profit before tax for individual entities in the group as the inventory transferred
intra-group on 1 June 20X3 was still on hand with the subsidiary and therefore the intra-group
profit was not yet realised from the group’s perspective. As that unrealised profit was not
eliminated from the parent’s accounts, the opening retained earnings at 1 July 20X3 of the
parent includes that profit. On consolidation, that has to be eliminated. Hence, the opening
retained earnings for the financial year ended 30 June 20X4 has to be reduced by $10 000
(a debit entry).
In the current financial year, the inventory has been sold to parties external to the group.
Hence, the profit on the sale should be recognised by the group. The sale would be included
in the total sales of the subsidiary, the reporting entity that held the inventory after the ‘internal’
sale. However, the cost of goods recorded in the financial statements of the subsidiary
would be overstated from the point of view of the group as it is based on the inventory
value recognised by the subsidiary—that was overstated from the perspective of the group
at 30 June 20X3 as it was recorded based on the price paid intra-group that included the
unrealised profit. Therefore, in the 20X4 financial year when the inventory is sold the cost
of goods sold has to be remeasured (reduced) to reflect the cost to the group. The credit
entry to the cost of goods sold achieves this reduction. After processing this worksheet entry,
the consolidated profit before tax will be $10 000 greater than the combined profit before tax
of the parent and the subsidiary (refer to the consolidation worksheet extract to confirm this).
In essence, the profit recognised by the parent in the previous period is transferred to the
current period when it should be recognised by the group.
Thus, the profit on the sale of the inventory has been correctly included in the 20X4
financial year, the period during which it was sold to parties external to the group.
As the profit on the sale of the inventory has now been recognised by the group,
a corresponding increase in the income tax expense of the group should be recognised—
hence, the debit to the income tax expense.
In the 20X3 financial year, the income tax expense of the group was reduced by $3000
on the elimination of $10 000 profit. The effect of this reduction in income tax expense
‘flowed through’ the worksheet, resulting in an increase in the closing retained earnings of
the group compared with that of the parent entity plus subsidiary. Thus, the 20X4 opening
balance of the retained earnings of the group needs to be increased. This is achieved via
a credit entry in the worksheet.
Another way of viewing the two entries that adjust the opening balance of retained earnings
is that in the 20X3 financial year, the unrealised profit after tax of the group was $7000.
The elimination of this unrealised profit after tax has resulted in a lower closing balance
of retained earnings. Hence, to obtain the same result, the 20X4 consolidated opening
retained earnings has to be reduced by $7000 (the debit of $10 000 and the credit of $3000).
Finally, it should be noted that in the 20X3 consolidated financial statements, a deferred
tax asset of $3000 was recognised. During the 20X4 financial year, the profit on the sale of
the inventory was recognised in the consolidated financial statements. However, as the tax
relating to this profit has already been paid in 20X3 by the parent, no tax is payable on the
recognition of this profit by the group. In this instance, the 20X3 deferred tax asset has been
used by the group in the 20X4 financial year. Therefore, no accounting entries are required
to reinstate the deferred tax asset account.
(b) Question 5.15(b) assumes that half of the inventory held by the subsidiary as at 30 June 20X3
was sold by 30 June 20X4 for $25 000 to parties external to the group. The consolidation
elimination entries at 30 June 20X4 would include the following:
Dr Cr
$ $
Retained earnings
Inventory 5 000

Retained earnings
Consolidation worksheet after the consolidation elimination entries
Elimination
adjustments
Parent Subsidiary Dr Cr Consolidated
$000 $000 $000 $000 $000
Sales 25 25
Less: Cost of goods sold (20) 5 (15)
Gross profit 5 10

Income tax expense (1.5) 1.5 (3)
Profit for the year 3.5 7
Retained earnings 7 10 3
(opening balance)†
Statement of financial position
Inventory 20 5 15
Deferred tax asset 1.5 1.5
†
Refer to ‘Profit for the year’ of Parent in Example 5.14 worksheet.
The rationale for the debit and credit entries to the retained earnings (opening balance) is
the same as the adjustments to the retained earnings (opening balance) explained in (a).
In the financial year ended 30 June 20X4, only half of the inventory that had previously
been sold within the group was sold for $25 000 to parties external to the group. Both the
consolidated cost of goods sold and consolidated asset ‘inventory’ should be recognised
at $15 000. This amount represents half of the cost of the inventory to the group, which the
parent purchased for $30 000. Therefore, the cost of goods sold recognised by the subsidiary
of $20 000 overstates the cost of goods sold of the group by $5000 (half of the $10 000).
The remaining half of the inventory on hand is still reflected in the inventory of the subsidiary
as $20 000, but its value is also overstated from the group’s perspective. Both the cost of
goods sold and the inventory remaining need to be re-measured (reduced) to reflect only
the effect of the external transactions of the group.
As the group has recognised half ($5000) of the intra-group profit previously eliminated
(refer to the consolidation worksheet extract to confirm this), the income tax expense of the
group has to be increased by $1500 (debit tax expense—30% of $5000). However, given that
the tax on the full intra-group profit was already paid, this tax expense recognised for the
group now essentially means that the group has used half ($1500) of the deferred tax asset
recognised in the 20X3 financial year. Hence, the consolidated statement of financial position
should only include the remaining deferred tax asset of $1500 for the remaining unrealised
intra-group profit.
(c) The entries processed by the subsidiary and parent for the year ended 30 June 20X3 would be:
Subsidiary
Dr Cr
$ $
Bank 50 000
Plant 100 000
Parent
Dr Cr
$ $
Plant 50 000
Bank 50 000


The following pro forma consolidation worksheet entries would be processed for the financial
year ended 30 June 20X3:
Dr Cr
$ $
Plant 10 000

Income tax expense 600
Notes
• Debit ‘Profit on sale of plant’—$10 000
In the 20X3 financial year, the financial statements of the subsidiary would include $10 000
profit on the sale of the plant to the parent entity. From the perspective of the group,
this profit should be eliminated.
• Debit ‘Deferred tax asset’ and credit ‘Income tax expense’—$3000
If the profit on the sale is eliminated, the income tax expense recognised by the subsidiary
should also be eliminated. A deferred tax asset also needs to be recognised by the group.
In future accounting periods, the group will recognise the profit on sale of the plant but will
not pay tax because the subsidiary has paid it in 20X3. Alternatively, the consolidated tax asset
of $3000 can be explained by the fact that the tax base of the plant ($50 000) is greater than
its carrying amount to the group ($40 000) and, hence, the group has a deductible temporary
difference of $10 000 and therefore a deferred tax asset.
• Credit ‘Plant’—$10 000
The Plant account has to be reduced, as it is overstated from the group’s point of view.
It is measured in the statement of financial position of the parent entity at $50 000. However,
the cost of the plant to the group was $40 000.
• Debit ‘Accumulated depreciation’ and credit ‘Depreciation expense’—$2000
The plant is being depreciated by the parent entity based on the cost to that entity
($50 000). In preparing the consolidated financial statements, the depreciation should
be measured using the cost to the group ($40 000). Both the parent entity and the group
are depreciating the plant on a straight-line basis over the remaining useful life of the
asset (five years). To relate the depreciation to the cost to the group requires a decrease
in depreciation expense of $2000 each financial year.
Note: The group should depreciate a depreciable non-current asset using the same
depreciation method and rate applied by the member of the group using the item. That is,
the group is using up the service potential of the depreciable item at the same rate as
the member of the group that controls it. In this case, when the plant was held by the
subsidiary prior to 1 July 20X2, the group would have used the reducing-balance method
of depreciation. However, since the plant was sold to the parent, it has been used in a
different manner such that its service potential is being used up evenly. As a result, both the
parent and the group should use the straight-line basis of depreciation. The difference in
the amount of depreciation recorded by the parent entity versus the group derives from
the different cost of the plant to each entity, not from the depreciation rate being used.
• Debit ‘Income tax expense’, credit ‘Deferred tax asset’—$600
This entry is the tax effect of the preceding entry. As the group uses the plant, the intra-group
profit is recognised via depreciation charges. Hence, the income tax expense of the group
must be increased as the deferred tax asset created in 20X3 is used. That is, the group is
including the profit, but the tax has already been paid by the subsidiary when the plant was
sold to the parent entity.
After the preceding entries, the consolidated deferred tax asset is $2400. This reflects the
fact that the tax base of the plant to the group at 30 June 20X3 is $40 000 (carrying amount
in financial statements of parent entity), which is $8000 greater than its carrying
amount of $32 000 in the consolidated financial statements, and therefore a deductible
temporary difference.
Pro forma consolidation worksheet entries for the financial year ended 30 June 20X4
Dr Cr
$ $
Plant 10 000

Notes: First entry

• Debit ‘Retained earnings’—$5600
This entry reflects the net adjustment to the retained earnings account as a result of the
eliminations at 30 June 20X3 of all the effects of the intra-group transaction from 1 July 20X2.
Note that the retained earnings account always recognises after-tax profit. The decrease in
the retained earnings of $5600 needs to be recognised because of:
$
Elimination of the after-tax profit from the intra-group transaction (7 000 )
Recognition of after-tax profit realised via depreciation 1 400
Net effect on 20X3 closing consolidated retained earnings (5 600 )
In essence, the net effect on 20X3 closing consolidated retained earnings is a decrease by
the remaining intra-group profit still unrealised from the group’s perspective at 30 June 20X3.
As the retained earnings account closing balance needs to be reduced by $5600 in 20X3,
the opening balance for 20X4 must be similarly reduced.
• Debit ‘Deferred tax asset’—$2400
This entry is related to the adjustment to the retained earnings account above in that it
represents the tax effect of considering that some intra-group profit is still unrealised as of
30 June 20X3, meaning that there are still tax benefits to be enjoyed by the group as the
tax of the remaining unrealised profit was already paid.
• Debit ‘Accumulated depreciation’—$2000
Reinstatement of reduction in 20X3 accumulated depreciation.
• Credit ‘Plant’—$10 000
Remeasurement of plant to the cost to the group.
Notes: Second entry

• Debit ‘Accumulated depreciation’, credit ‘Depreciation expense’—$2000

Remeasurement of the depreciation expense of the plant from that recorded in the parent
entity to the basis required in the consolidated financial statements.
• Debit ‘Income tax expense’, Credit ‘Deferred tax asset’—$600

Tax effect of the preceding entry. As the group uses the plant, the profit on ‘Internal sale’
is recognised via lower depreciation charges.
Question 5.16
To extend Example 5.15, assume that:
• during the 20X3 financial year, Parent and Subsidiary recorded profits of $100 000 and
$50 000 respectively
• neither company paid, or declared, a dividend during the 20X3 financial year—the increase
in each company’s retained earnings during this year is equal to its 20X3 profit.
Complete the following consolidation worksheet.
Elimination Non- Parent

adjustments controlling equity
Parent Subsidiary Dr Cr Consolidated interest interest
Account $000 $000 $000 $000 $000 $000 $000
600 250
Other net assets 440 250
Investment in 160
Subsidiary
Goodwill
600 250
Elimination Non- Parent

adjustments controlling equity
Parent Subsidiary Dr Cr Consolidated interest interest
Account $000 $000 $000 $000 $000 $000 $000
Issued capital 300 100 70 330 30 300
Retained earnings 300 150 70 380 45 335
600 250 710 75 635
Other net assets 440 250 690

Investment in Subsidiary 160 160 —
Goodwill 20 20
600 250 160 160 710
The increase in the consolidated net assets during the 20X3 financial year reflects the profits
recorded by Parent ($100 000) and Subsidiary ($50 000). Compared with Example 5.15, the increase
in the non-controlling interest from $60 000 to $75 000 represents the non‑controlling interest
in the profit earned by Subsidiary during 20X3 (30% of $50 000) (IFRS 10, para. B94). Moreover,
the increase in the parent equity interest of $135 000 ($635 000 – $500 000) reflects the profit
earned by Parent, $100 000, plus its share of post‑acquisition profits of Subsidiary, $35 000
(70% of $50 000).
The items recorded in the adjustments column are the pre-acquisition elimination entries.
Recall from Example 5.15 that 70 per cent of the shares were purchased for $160 000.
Therefore, the pre-acquisition elimination entry eliminates the parent entity’s 70 per cent share
of the equity in the subsidiary at the acquisition date. At the acquisition date, the issued capital
of Subsidiary was $100 000 and retained earnings was also $100 000. Therefore, the parent
entity’s share to be eliminated is $70 000 from issued capital (70% × $100 000) and $70 000
from retained earnings (70% × $100 000), as recorded in the adjustments column. As a result
of the transaction giving rise to these pre-acquisition elimination entries, $20 000 goodwill
was recognised by the group. The pre-acquisition elimination entry is repeated each year that
the consolidation worksheet is prepared and every year it eliminates the parent’s share of the
subsidiary’s pre‑acquisition equity only. The profit earned by the subsidiary after acquisition date
is post‑acquisition and, as such, increases the consolidated equity. The parent’s share of these
profits should not be eliminated as it reflects the return earned by the group after the acquisition.
Question 5.17
Refer to Case study 5.3 in Appendix 5.1. Using data for the year ended 30 June 20X5,
measure the non-controlling interest in the following: opening retained earnings, profit and
closing retained earnings.
Non-controlling interest—30 June 20X5:

Non-controlling interest in opening retained earnings account = $33 600 (according to non-
controlling interest in closing retained earnings calculation of previous year in Example 5.16).
During the year ended 30 June 20X5, the inventory originally sold intra-group during the year
ended 30 June 20X4 was on-sold to external parties. Hence, the group would recognise the
previously unrealised profit as part of the 20X5 consolidated profit. The non-controlling interest
will be entitled to its share of this profit after tax.
Non-controlling interest in the current profit:

= 30% of (Current after-tax profit in financial statements of Subsidiary – (+) Current period
unrealised after-tax profits (losses) made by Subsidiary + (–) Current period realised after-tax
profits (losses) of the group that were originally made by Subsidiary in a prior period)
= 30% of (Current after-tax profit in financial statements of Subsidiary + Current period realised
profit on sale of inventory – Tax effect on the current period realised profit)
= 30% of ($100 000 + $40 000 – $12 000)
= 30% of $128 000
= $38 400
Note that the profit of Subsidiary for both 20X4 and 20X5 totals $300 000 ($200 000 + $100 000).
The non-controlling interest’s share of this amount is $90 000 (30% of $300 000). The non-controlling
interest in the consolidated profit for 20X4 and 20X5 is also $90 000. This consists of the $51 600
from Example 5.16 and the $38 400 calculated in this question. However, it must be stressed that
while the non-controlling interest has received over the two years its share of the profits recorded
by Subsidiary, it has only received it when the profit was included in the consolidated P&L and OCI.
In general, if the non-controlling interest is calculated over a number of periods during

which intra-group transactions take place followed by external transactions involving all the
assets originally transferred intra-group, the non-controlling interest in the profits over those
periods can simply be calculated as its share of Subsidiary’s profits. On the other hand, if the
non-controlling interest is calculated over a number of periods during which intra-group
transactions take place followed by external transactions involving only some of the assets
originally transferred intra-group, the non-controlling interest in the profits over those periods
is calculated as its share of Subsidiary’s after-tax profits excluding the unrealised profits related
to the assets still on hand. If the retained earnings account is capturing those unrealised profits
over a number of periods, this discussion is relevant to the calculation of the non-controlling
interest in the retained earnings.
In this question, the non-controlling interest in closing retained earnings account will be
calculated as follows:
= 30% of (Closing retained earnings account of Subsidiary – Unrealised after-tax profits
of Subsidiary)
= 30% of Closing retained earnings account of Subsidiary†
= 30% of $190 000
= $57 000

†
The previously unrealised profit has now been realised by the group and there are no unrealised
profits to carry forward.
An alternative way of reconciling the non-controlling interest in the closing retained earnings
is by using the individual items making up the balance:
= Non-controlling interest in opening retained earnings + Non-controlling interest in profit –
Non-controlling interest in dividends
= $33 600 + $38 400 – $15 000 (30% of $50 000)
= $57 000
Note that it is important to understand the principles involved in measuring the non-controlling
interest and not just learn a formula. The principles have to be applied to different circumstances.
Question 5.18
Question 5.18 extends Example 5.17. One year later, on 30 June 20X2, the following information
and worksheet data were available for Parent and Subsidiary:
Required:
(a) Complete the consolidation worksheet.
Note: Remember to use any relevant information relating to the 20X1 year from the
comprehensive example (Example 5.17).
(b) Explain how the non-controlling interest was arrived at.
Additional information:
1. During the financial year ended 30 June 20X2, half of the inventory sold by Parent  to
Subsidiary in the previous financial year was sold to parties external to the group. On 15 June
20X2, Subsidiary sold inventory to Parent for $8000 that had cost $4000. Parent still had
this inventory on hand at the end of the financial year.
2. Over the financial year, Parent had charged Subsidiary $4000 for services rendered; $1000
of the services had not been paid for by the end of the financial year.
3. The plant sold by Subsidiary to Parent on 30 June 20X1 was depreciated by $7000 in the
financial statements of Parent during the 20X2 financial year. That is, a straight-line basis of
depreciation was adopted.
4. During the financial year, Subsidiary paid an interim dividend of $10 000. On 30 June 20X2,
Subsidiary declared a final dividend of  $10 000. Parent  recognises dividend income when
it is receivable.
5. The directors of Parent and Subsidiary decided to transfer $20 000 and $10 000 respectively
from their respective pre-acquisition retained earnings to a general reserve.
6. Assume a tax rate of 30 per cent.
Eliminations Non- Parent

adjustments Consoli- controlling equity
Parent Subsidiary Dr Cr dated interest interest
Consolidation worksheet $000 $000 $000 $000 $000 $000 $000
Sales 400 150

Less: Cost of goods sold (210) (70)

Gross profit 190 80
Less: Expenses (88) (30)
102 50
Dividend income 14 —
Other income 4 —
Less: Income tax expense (36) (15)


Retained earnings 1 July
270 68
20X1
354 103
Less:
Interim dividend (10) (10)
Final dividend (20) (10)
Transfer to general reserve (20) (10)

Retained earnings
304 73
30 June 20X2
General reserve 20 10
Total equity 724 183
Liabilities
Other 79 52
Total equity and liabilities 848 260
Current assets
Dividend receivable 7
Inventory 65 22
Other 171 60
Non-current assets
Plant (net) 230 90
Other 215 70
Investment in Subsidiary 120
Goodwill
Deferred tax asset
Total assets 848 260

(a) Completion of the consolidation worksheet

Sales 400 150 8(3a) 542
Less: Cost of goods sold (210) (70) 2(2a) (274)
4(3a)
Gross profit 190 80 268
Less: Expenses (88) (30) 2(7a) 4(4) (116)
102 50 152
Dividend income 14 — 14(8) —

Other income 4 — 4(4) —
Profit before tax 120 50 152

Less: Income tax expense (36) (15) 0.6(2b) 0.6(7b) (49.8)
1.2(3b)
Profit for the year 84 35 102.2 9.24 92.96
Retained earnings 1 July 20X1 270 68 4(2a) 1.2(2b) 303 21.24 281.76
354 103 35(1) 4(6a) 405.2 30.48 374.72
1.2(6b)
Less:
Interim dividend (10) (10) 7(8) (13) (3) (10)
Final dividend (20) (10) 7(8) (23) (3) (20)
Transfer to general reserve (20) (10) 7(1) (23) (3) (20)

Retained earnings 30 June 20X2 304 73 346.2 21.48 324.72
Issued capital 400 100 70(1) 430 30 400

General reserve 20 10 7(1) 23 3 20
Total equity 724 183 799.2 54.48 744.72
Liabilities
Trade payables 25 15 1(5) 39
Final dividend payable 20 10 7(9) 23
Other 79 52 131
Deferred tax liability 0.6(7b) 1.2(6b) 0.6
Total equity and liabilities 848 260 992.8
Current assets
Dividend receivable 7 7(9)
Trade receivables 40 18 1(5) 57
Inventory 65 22 2(2a) 81
4(3a)
Other 171 60 231
Non-current assets
Plant (net) 230 90 4(6a) 2(7a) 322
Other 215 70 285
Investment in Subsidiary 120 120(1)
Goodwill 15 (1)
15
Deferred tax asset 0.6(2b)
1.2(3b) 1.8
Total assets 848 260 175.2 175.2 992.8
Entries:
1. Pre-acquisition elimination entries
The pre-acquisition elimination entries will be:

Dr Cr
$ $
Goodwill 15 000
This first entry is the same as the pre-acquisition elimination entry recorded in 20X1 (see pre-
acquisition elimination entry (1) in Example 5.17).
The next entry is explained as follows. The directors of Subsidiary transferred $10 000 from
pre acquisition retained earnings to a general reserve. As the transfer took place during 20X2,
the effect to the retained earnings is recognised as a movement during the year and does not
affect the opening balance. The journal entry posted by Subsidiary to recognise this transfer
would be:
Dr Cr
$ $
Retained earnings—transfer to general reserve 10 000

Considering that this transfer is from pre-acquisition equity, it will impact on the pre-acquisition
elimination entries prepared on consolidation at 30 June 20X2 as some of the pre-acquisition
equity that needs to be eliminated is now recognised as general reserve and a movement in
retained earnings. Thus, an additional entry is required to ensure that Parent’s share of the
entire pre-acquisition equity of Subsidiary is eliminated. In essence, the following entry simply
reverses the entry processed in the accounting records of Subsidiary, but only for Parent’s share.
Dr Cr
$ $
Retained earnings—transfer to general reserve 7 000
2a. Inventory sold in previous year from Parent to Subsidiary

Half of the inventory remained on hand as at 30 June 20X2.
Dr Cr
$ $
Inventory 2 000

In the previous financial year, the profit made by Parent from the sale of inventory to
Subsidiary was regarded as unrealised from the group’s point of view and it was eliminated
(see consolidation elimination entry (2a) from Example 5.17). The consolidation process
in 20X2, however, starts by adding together the amounts recognised in the individual
statements of Parent and Subsidiary, which are not affected by the previous consolidation
adjustments. Hence, the elimination needs to be repeated, but this time to the opening
retained earnings balance for the 20X2 financial year to reduce it by the unrealised profit of
the previous year (20X1).
Recall that Parent sold the inventory to Subsidiary in 20X1 for $9000. This amount ($9000)
will become the cost of goods sold for Subsidiary when all of this inventory is sold to
external parties. At 30 June 20X2, half has been sold, meaning cost of goods sold is $4500.
From the group’s perspective, when Subsidiary sold half of the inventory in 20X2, the cost
of goods sold (i.e. $4500 = half of $9000) included in the financial statements of that entity
would be overstated by $2000. That is, the group should record cost of goods sold upon
selling half of the inventory to external parties at $2500 (not $4500), which is half of the
original cost to the group of $5000. Also, the remaining inventory on hand at 30 June 20X2 is
overstated by $2000 (recorded as $4500 by Subsidiary when the cost to the group was $2500).
The credit entries correct both the cost of goods sold and the inventory to the cost to the
group. The credit to cost of goods sold results in an increase in the group’s profit for 20X2:
in essence, the group recognises $2000 of unrealised intra-group profit from 20X1 that is now
realised due to the sale to external parties.
2b. Tax effect of preceding entry

Dr Cr
$ $

The group’s $2000 of realised profit in 20X2 requires the related income tax expense to be
recognised. In addition, $2000 of profit is still unrealised given half of the inventory is still on
hand. As such, the group still has a deferred tax asset of $600 remaining. That is, in the future,
the group will recognise the profit when the inventory is sold to parties external to the group,
but the tax has already been paid by Parent in 20X1. An alternative explanation as to why
there is a deferred tax asset of $600 relates to the fact that while the inventory is recognised
by the group at $2500, it has a tax base of $4500 (the amount recorded in Subsidiary), and this
gives rise to a deductible temporary difference of $2000, which in turn generates the deferred
tax asset.

In 20X1, the income tax expense of the group was reduced by $1200 as a result of the
elimination of unrealised profit (see consolidation elimination entry (2b) from Example 5.17).
This further resulted in an increase in the closing retained earnings of the group as compared
to Parent plus Subsidiary. The credit entry in item 2b reflects the fact that the opening retained
earnings of the group in the 20X2 financial year must be increased by the same amount.
3a. Sale of inventory from Subsidiary to Parent

Subsidiary processed the following entry for the intra-group sale of the inventory:
Dr Cr
$ $
Bank 8 000
Sales 8 000
Inventory 4 000
Parent processed the following entry for the intra-group purchase of the inventory:
Dr Cr
$ $
Inventory 8 000
Bank 8 000

From the group’s perspective, the intra-group sales revenue and cost of goods sold must
be eliminated (which will result in the elimination of the intra-group profit on the sale)
and the inventory must be remeasured to the cost to the group. Therefore, the following
consolidation elimination entry (3a) is processed:
Dr Cr
$ $
Sales 8 000
Inventory 4 000
To explain each line of this entry, the debit to Sales eliminates the credit to Sales recorded
by Subsidiary upon the sale of inventory to Parent. Similarly, the credit to Cost of goods sold
eliminates the debit to Cost of goods sold previously recorded by Subsidiary at the time of
sale. The credit to Inventory of $4000 offsets the ‘net’ debit to Inventory recorded by both
Parent and Subsidiary at the time of sale (i.e. $8000 debit recorded by Parent minus $4000
credit recorded by Subsidiary equals $4000 ‘net’ debit). No entry is required for Bank as
the debit recorded by Subsidiary at the time of sale has already been offset by the credit
recorded by Parent.
3b. Tax effect of entry (3a)

The consolidation elimination entry for inventory requires the following tax effect entry (3b):
Dr Cr
$ $
As the group has eliminated $4000 of unrealised profit (i.e. Sales of $8000 minus Cost of
goods sold of $4000, as recorded by Subsidiary), the income tax expense of the group must
be reduced by $1200 (30% of $4000). In addition, the group must recognise a deferred tax
asset of $1200. That is, while the carrying amount of the inventory for the group is $4000,
it has a tax base of $8000 (based on the amount recognised by the holder of those assets
intra-group) and this gives rise to a deductible temporary difference of $4000.
4. and 5. Elimination of intra-group provision of services and intra-group debt resulting

from the provision of services
Parent processed the following entry for the services rendered:
Dr Cr
$ $
Bank 3 000
Other income 4 000
Subsidiary processed the following entry for the services received:
Dr Cr
$ $
Expenses 4 000
Bank 3 000

From the group’s perspective, these entries relate to parties within the group and should
be eliminated. Therefore, the following consolidation elimination entries (4 and 5)
must be processed:
Consolidation elimination entry 4

Dr Cr
$ $
Other income 4 000
Expenses 4 000
Consolidation elimination entry 5

Dr Cr
$ $

There won’t be any consolidation tax effect elimination entry as there is no net impact on
the profit recognised by the group. This is because the amount of Other income eliminated
equals the amount of Expenses eliminated, meaning that the effect of these elimination
entries on consolidated profit is nil. No entry is required for Bank as the debit recorded by
Parent is already offset by the credit recorded by Subsidiary.

6a. 20X2 adjustment for inter-company loss on sale of plant eliminated at 30 June 20X1
Recall that Subsidiary sold plant to Parent in the previous financial year (20X1) at a loss of
$4000. In 20X1, the loss made by Subsidiary was regarded as unrealised from the group’s point
of view and it was eliminated (see consolidation elimination entry (5a) from Example 5.17).
The consolidation process in 20X2, however, starts by adding together the amounts recognised
in the individual statements of Parent and Subsidiary, which are not affected by the previous
consolidation adjustments. Hence, the elimination needs to be repeated, but this time to the
opening retained earnings balance for the 20X2 financial year to increase it by the unrealised
loss of the previous year (20X1). Therefore, the following consolidation elimination entry (6a)
must be processed:
Dr Cr
$ $
Plant 4 000

During the 20X1 financial year, the elimination of the loss on the sale of the plant resulted
in an increase in the income tax expense of the group (see consolidation elimination entry
(5b) from Example 5.17) and, consequently, a decrease in consolidated profit. The decrease
in the 20X1 consolidated profit (due to the increase in income tax expense) had the effect of
decreasing the consolidated closing retained earnings at 30 June 20X1. As the elimination
needs to be repeated, consolidated retained earnings is to be decreased (debited), but this
time to the 20X2 consolidated opening retained earnings account. Therefore, the following
consolidation elimination entry (6b) must be processed:
Dr Cr
$ $
7a. Correction of group depreciation relating to plant sold on 30 June 20X1

Recall that the carrying amount of the plant in Subsidiary’s financial statements in 20X1 is
$20 000, which is the amount reported in the consolidated financial statements. The group
must, therefore, depreciate the plant at $9000 per year (($20 000 – $2000) / 2 years). Parent,
however, depreciates the plant based on the carrying amount of $16 000, resulting in
depreciation expense of $7000 recorded by Parent (($16 000 – $2000) / 2 years). Therefore,
the following consolidation elimination entry (7a) must be processed in 20X2 to reflect the
difference in annual depreciation recorded by Parent ($7000) and that which should be
recorded by the group ($9000):
Dr Cr
$ $

In the previous consolidation elimination entry, an increase in the depreciation expense was
recognised that decreases the group’s profit. In turn, this will result in a reduction in (credit to)
the income tax expense of the group that should be recognised on consolidation. However,
Parent pays additional tax (as it has more profit due to lower depreciation charges than the
group) and, hence, a part of the deferred tax liability recognised in consolidation elimination
entry (6b) needs to be reversed. The 30 June 20X2 consolidated deferred tax liability should
only be $600 to reflect the fact that the carrying amount of the plant to the group is $11 000
($20 000 – $9000), while its tax base, recognised based on the amount recorded by the holder
of the asset, is $9000 ($16 000 – $7000). The difference between the carrying amount and
tax base gives rise to a taxable temporary difference of $2000 and deferred tax liability of
$600 ($2000 × 30%). At the time of consolidation elimination entry 6b, deferred tax liability is
$1200. As the consolidated deferred tax liability should be $600 (and not $1200), deferred tax
liability is to be reduced (debited). Therefore, the following consolidation elimination entry
(7b) must be processed:
Dr Cr
$ $
8. and 9. Elimination of intra-group dividends

Note that the parent is entitled to 70 per cent of the interim (70% of $10 000) and final
(70% of $10 000) dividends (total = $14 000), while the remainder of the dividends is
paid to the non-controlling interest (a party external to the group). Therefore, the intra-
group dividends amount to only 70 per cent of all dividends and the effects of those
intra-group dividends will have to be eliminated on consolidation. That includes:
–– for interim dividends: 70 per cent of the interim dividend recognised by Subsidiary
and the related dividend income recognised by Parent
–– for final dividends: 70 per cent of both the declared dividend and dividend payable
recognised by Subsidiary and both the related dividend income and dividend
receivable recognised by Parent.
Therefore, the following consolidation elimination entries (8) and (9) must be processed:
Dr Cr
$ $
Dividend income 14 000 †
Final dividend (retained earnings) 7 000
Interim dividend (retained earnings) 7 000
Dividend receivable 7 000
†
$7000 dividend income recognised by Parent in relation to interim dividend plus $7000 dividend
income recognised by Parent on the final dividend declared.
(b) Calculation of non-controlling interest

Note: The non-controlling interest is entitled to its share of Subsidiary’s equity, as reflected
from the group’s perspective. That means that unrealised profits from intra-group transactions
that originate from Subsidiary will need to be eliminated from Subsidiary’s equity before non-
controlling interest is allocated a part of it. The intra-group sales from Parent to Subsidiary are
not relevant to non-controlling interest calculations, as it is Parent that profits from these sales.
–– Non-controlling interest in opening consolidated retained earnings:

= 30% of (Opening retained earnings balance in financial statements of Subsidiary – (+)
Unrealised after-tax profits (losses) made by Subsidiary in the previous period(s))
= 30% of (Opening retained earnings balance in financial statements of Subsidiary +
Unrealised after-tax loss on plant made by Subsidiary in the previous period)
= 30% of ($68 000 + ($4000 – $1200))
= 30% of ($68 000 + $2800)
= 30% of $70 800
= $21 240

This calculation is the same as the second approach used to calculate the non-controlling
interest in Subsidiary’s 20X1 closing retained earnings (see Example 5.17). Refer to the
relevant calculation presented under the heading ‘Calculations of non-controlling interest’
in the comprehensive example (Example 5.17).
–– N
on-controlling interest in Subsidiary’s profit after tax (adjusted for profit or loss on intra-
group transactions):
= 30% of (Profit in financial statements of Subsidiary – (+) Unrealised after-tax profits
(losses) made by the Subsidiary + (–) Realised after-tax profits (losses) of the group
that were originally made by the Subsidiary)
= 30% of (Profit in financial statements of Subsidiary – Unrealised after-tax profit on sale
of inventory– Realised after-tax loss on plant (via depreciation))
= 30% of ($35 000 – ($4000 – $1200) – ($2000 – $600)
= 30% of ($35 000 – $2800 – $1400)
= 30% of $30 800
= $9240
To determine the non-controlling interest in the 20X2 consolidated profit, there are two
adjustments for unrealised profits or losses resulting from the sale of assets from Subsidiary
to Parent.
irst, during 20X2 Subsidiary sold inventory to Parent for $8000. This inventory had an
F
original cost of $4000, giving rise to an intra-group profit of $4000, which is unrealised from
the group’s perspective as all of the inventory is still on hand at year-end. This unrealised
profit was eliminated in consolidation elimination entry (3a), with the tax effect of this
elimination being recognised in consolidation elimination entry (3b). The profit on inventory
($4000) and associated tax effect ($1200) give rise to an unrealised profit after tax of $2800
($4000 – $1200). As this has been included in the profit after tax in the financial statements
of Subsidiary, the non-controlling interest in the consolidated profit of the group needs to
be calculated after excluding this item from Subsidiary’s profit.

econd, another adjustment to the non-controlling interest calculation stems from the
S
20X1 unrealised loss on the sale of plant from Subsidiary to Parent. During 20X2, part of
this loss was realised by the group through the plant being used and producing goods or
services for sale to parties external to the group. Therefore, the group recognised $2000
of the loss (via depreciation) and an associated tax effect of $600. However, the 20X2 profit
after-tax of Subsidiary ($35 000) does not include the loss recognised by the group. Hence,
the non‑controlling interest in the consolidated profit of the group needs to consider
Subsidiary’s profit adjusted for this loss (and the related tax effect).
–– N
on-controlling interest in Subsidiary’s closing retained earnings.
This figure can be calculated in two ways.
(i) Using the calculations of the individual items making up the closing balance of the
retained earnings account:
= Non-controlling interest in Subsidiary’s opening retained earnings (as calculated
above) + Non-controlling interest in Subsidiary’s profit after tax adjusted for profit
or loss intra-group transactions (as calculated above) – Non-controlling interest
in Subsidiary’s dividends – Non-controlling interest in transfer by Subsidiary of
retained earnings to general reserve
= $21 240 + $9240 – (30% of $20 000) – (30% of $10 000)
= $21 240 + $9240 – $6000 – $3000
= $21 480
(ii) Using the closing balance of retained earnings of the Subsidiary – (+) Any after-tax
unrealised profits (losses) made by the Subsidiary:
= 30% of ($73 000 – Unrealised after-tax profit on inventory ($4000 – $1200) +
Remaining unrealised after-tax loss on sale of plant ($2000 – $600))
= 30% of $71 600
= $21 480
The closing balance of the retained earnings of Subsidiary ($73 000) includes both the
20X2 after-tax profit from the sale of inventory to Parent and the 20X1 after-tax loss from
the sale of plant to Parent. Therefore, to determine the non-controlling interest in the
closing retained earnings of the group starting with the closing balance retained earnings
of Subsidiary requires adjustments for: the unrealised inventory profit and the loss on the
plant yet to be realised by the group at the end of the 20X2 financial year. By the end
of 20X2, after one year of use, half of the unrealised loss is still to be realised through the
use of the asset. Both of these adjustments incorporate the tax effects involved.
–– Non-controlling interest in Subsidiary’s issued capital:

= 30% of $100 000
= $30 000
–– Non-controlling interest in statement of financial position:

= Non-controlling interest in Subsidiary’s issued capital (as calculated above) + Non-
controlling interest in Subsidiary’s closing retained earnings (as calculated above) +
Non-controlling interest in Subsidiary’s reserves (as calculated above)
= $30 000 + $21 480 + $3000
= $54 480
Question 5.19
Refer to the worksheet prepared in answering Question 5.18 and the information in Example 5.17
to prepare the following statements in accordance with the disclosure requirements of IAS 1:
(a) Prepare a consolidated P&L and OCI.
(b) Prepare a consolidated statement of changes in equity.
(c) Prepare a consolidated statement of financial position.
(a) Consolidated statement of profit or loss and other comprehensive income for the year
ended 30 June 20X2
$
Revenue 542 000
Less: Cost of goods sold (274 000 )
Gross profit 268 000
Less: Expenses (116 000 )
Profit† before tax 152 000
Less: Income tax expense (49 800 )
Other comprehensive income —
Total comprehensive income for the year 102 200

Profit attributable to:
Non-controlling interests 9 240
Owners of the parent 92 960
102 200

†
Refer to worksheet in Question 5.18.
(b) Consolidated statement of changes in equity for the year ended 30 June 20X2
Equity attributable to owners of Parent

Non-
Issued General Retained controlling Total
capital reserves earnings Total interest equity
$000 $000 $000 $000 $000 $000
Balance 30 June 20X1† 400 281.76 681.76 51.24 733
Total comprehensive
income for the year 92.96 92.96 9.24 102.2
Dividends (30) (30) (6) (36)
Transfers to general 20 (20) — — —
reserve
Balance 30 June 20X2 400 20 324.72 744.72 54.48 799.2

†
Refer to worksheet in the comprehensive example (Example 5.17).
(c) Consolidated statement of financial position as at 30 June 20X2
Equity $000 $000

Equity attributable to owners of the parent
Issued capital 400.0
Reserves 20.0
Retained earnings 324.72 744.72
Non-controlling interest 54.48
Total equity
799.2
Represented by:
Assets
Current assets
Trade receivables 57.0
Inventory 81.0
Other 231.0 369.0
Non-current assets
Plant (net) 322.0
Other 285.0
Deferred tax asset 1.8
Goodwill 15.0 623.8
Total assets 992.8
Less: Liabilities
Trade payables 39.0
Final dividend payable 23.0
Other liabilities 131.0
Deferred tax liability 0.6 193.6
Total net assets

799.2
Question 5.20
Comment on whether the following accounting policy is in accordance with IAS 28:
Associates are those entities in which the group has a shareholding between 20 per cent
and 50 per cent of the issued capital.
Equity accounting is applied where an investor has significant influence over an investee.
Significant influence normally stems from voting power, not ownership interest, which may or
may not reflect voting power. Whether the accounting policy is valid depends on the voting
rights attached to the securities, not the wording of the accounting policy (which refers
to a ‘shareholding between 20 per cent and 50 per cent of the issued capital’). Neither the
definition of ‘significant influence’ (IAS 28, para. 3) nor the discussion of significant influence
(IAS 28, paras 5–9) focuses on ownership interest.
The accounting policy focuses on the 20 per cent quantitative test. While this test leads to a
presumption of significant influence, all prevailing circumstances should be considered before
deciding an entity is an associate. Presumably, in arriving at the conclusion that a company
is an associate, the entity has considered evidence apart from voting power, such as board
representation, participation in policy-making, and interchange of managerial personnel
(IAS 28, para. 6).
Question 5.21
(a) Refer to the diagram below. The percentages included in the diagram represent the
percentage of shares held. What is the total ownership interest by Investor in Z Ltd (Z),
both direct and indirect?
Investor (W Ltd)
80% 30%
Subsidiary (X Ltd) Associate (Y Ltd)

5%
25% 10%
Associate (Z Ltd)
(b) Does the level of ownership interest you have calculated in (a) determine whether or not Z 
is an associate of Investor? Justify your answer.
(c) Will your answer to (b) be different if the percentages included in the diagram also represent
voting power? Justify your answer.
(a) Investor has the following ownership interest in Z (IAS 28, para. 27):
%
Direct interest held by investor/parent 5
Indirect interest
via subsidiary—X Ltd (80% of 25%) 20
25
In preparing equity-accounted information in the consolidated financial statements,

the investor (group) would use 25 per cent to calculate its share of items such as the
profit of the associate company Z. In accordance with IAS 28, para. 27, the holdings of
the investor’s other associate (Y) are ignored. However, it should be noted that where
an associate (Y) has an interest in an associate (Z), the group’s share of Y’s profit will be
based on a profit that includes a share of Z’s profit (IAS 28, para. 27). Therefore, in essence,
the group captures the indirect interest in Z through the associate Y.
(b) While voting power is important in determining whether significant influence exists
(IAS 28, paras 5–9), it is the investor’s ownership interest in the associate company that
must be determined when implementing the equity method (IAS 28, para. 27).
(c) If the percentages recognising the ownership interest are also denoting the voting power,
then Investor, directly and indirectly via a subsidiary, has enough voting power to claim that
is able to exercise significant influence over Z (i.e. the direct and indirect voting power is
larger than 20%, the cut-off considered as enough for significant influence to exist).
Question 5.22
Use the data from Example 5.19 to answer (a) and (b).
(a) Comment on the treatment of the goodwill, both at the time of the investment and in
subsequent accounting periods, under the equity method.
(b) Investee revalued its assets to their fair value at the acquisition date. What is the effect of this
revaluation on the equity-accounted investment immediately after acquisition (if prepared
at that time) and in subsequent accounting periods?
(a) The goodwill of $10 000 (refer to Example 5.19) will not be separately disclosed, but will
remain part of ‘Investment in associate’, both in the financial statements of Investor
and in any consolidated financial statements that include the investment based on the
equity method.

When applying the equity method in subsequent accounting periods, the goodwill remains
part of the investment and must not be amortised against the investor’s share of the
associate’s profits or losses (para. 32). In addition, when testing for impairment, the focus
is the entire carrying amount of the investor’s investment in the associate, not the goodwill
determined at acquisition (para. 42).
(b) The revaluation by Investee does not affect Investor’s cost of investment. In subsequent
reporting periods, Investee’s depreciation expense relating to depreciable assets will be
higher than in the absence of revaluation. This will be reflected in Investee’s P&L and OCI.
In turn, this will flow through to Investor’s ‘share of profits’ for equity accounting purposes.
Therefore, this particular revaluation of assets by Investee does not require Investor to
make any adjustments (when equity accounting).
If the associate did not revalue the assets in its own financial statements, its P&L and OCI
would include depreciation based on original carrying amount. This would necessitate an
adjustment to the investor’s share of the associate’s profits (an equity-accounting adjustment)
so that depreciation is based on the fair value of the assets as assessed by the investor at
the time of making the investment (IAS 28, para. 32). Similar consolidation adjustments were
seen when the net assets of the subsidiary were not recorded at fair value in the subsidiary’s
financial statements.
Question 5.23
Using the information in Example 5.20, prepare financial statements for Investor that comply
with the disclosure requirements of IAS 1.
After equity accounting for the investment, the following information would appear in the
consolidated financial statements of Investor:
Abridged consolidated statement of profit or loss and other comprehensive income

for Investor for the year ended 30 June 20X5
$000
Other income and expenses 300
Share of profit or loss of associate† 25.2
Profit before tax expense 325.2
Less: Income tax expense (90 )
Profit for the year 235.2
Other comprehensive income —
Total comprehensive income 235.2
†
IAS 1, para. 82(c)
Consolidated statement of financial position of Investor as at 30 June 20X5
$
Retained earnings† 195 200
Revaluation surplus 60 000
Liabilities 270 000
1 125 200
Investment in Investee Ltd‡ 65 200

Other assets 1 060 000
1 125 200
†
Retained earnings of Investor ($185 000) + Share of associate’s post-acquisition increase
in retained earnings ($10 200 = $25 200 – $15 000).
‡
IAS 1, para. 54(e).
Question 5.24
(a) Using the information in Example 5.21, prepare a single consolidated P&L and OCI for Investor
in accordance with IAS 1, paras 10A and 82.
(b) What difference would it make if the inventory was sold from Investee to Investor?
(c) Reconcile the equity-accounted investment in Investee of $69 100 to Investor’s share of the
net assets shown in the statement of financial position of Investee.
Abridged consolidated statement of profit or loss and other comprehensive income

(a)
for Investor for the year ended 30 June 20X5
$000
Other income and expenses 300
Share of profit or loss of associate† 23.1
Profit before tax expense 323.1
Less: Income tax expense (90 )
Profit for the year 233.1
Share of other comprehensive income of associates‡ 6
Total comprehensive income 239.1

†
IAS 1, para. 82(c).

‡
IAS 1, para. 82A.

Note: The total comprehensive income includes the profit for the year, which would be
included in retained earnings, and the share of other comprehensive income, which is
reflected in equity in the asset revaluation surplus.
(b) The same elimination entry is used, no matter whether the transaction is ‘upstream’
or ‘downstream’. Hence, the pro forma journal entry processed in Example 5.21 would
also be processed if the sale of inventory was from Investee to Investor.
(c) Net assets of Investee Ltd $204 000 †

†
$184 000 according to Example 5.20 + $20 000 for revaluation of land.
$
Investor Ltd’s share of carrying amount = 30% of $204 000 = 61 200
Less: Unrealised profit on inventory‡ (2 100 )
Investor Ltd’s share of net assets 59 100
Plus: Goodwill 10 000
Equity investment in Investee Ltd 69 100
As outlined in Example 5.21, the unrealised profit on inventory must be eliminated on a net basis.
‡
That is, the only accounts affected are ‘Investment in Investee’ and ‘Share of profit or loss of
associates’. The elimination reflects the investor’s ownership interest (30%) in the unrealised profit
after tax of $7000 ($10 000 × (1 – .30)). Note: The elimination is not against the individual accounts
affected as would be the case with a consolidation adjustment for unrealised profits or losses.
Question 5.25
On 1 July 20X6, the consolidated financial statements of Investor contained an asset, ‘Investment
in associate’, of $30 000. For the financial year ended 30 June 20X7 the associate incurred a
loss of $150 000, while for the 20X8 financial year it earned a profit of $80 000. Investor owns
30 per cent of the issued capital of the associate.
Ignoring income tax effects, prepare consolidation worksheet entries for the 20X7 and 20X8
financial years to equity-account for Investor’s share of profits and losses. Determine the amount
of the investment in the associate as at 30 June 20X7 and 30 June 20X8.
Dr Cr
30 June 20X7 $ $
Dr Cr
30 June 20X8 $ $
The following consolidation worksheet entries would be processed to account for Investor’s share
of profits and losses:
Dr Cr
30 June 20X7 $ $
Share of profit or loss of associate 30 000 †
Investment in associate 30 000
The total share of the associate’s losses is 30 per cent of $150 000 or $45 000. However, in accordance
†
with IAS 28, para. 39, the investment can only be written down to zero. Hence, before the investor’s
share of subsequent profits can be recognised, its share of losses not recognised ($15 000) must be
offset (IAS 28, para. 39). That is, the associate must earn a profit of $50 000 ($15 000 / 30%).
Note: In accordance with IFRS 12, para. 22(c), the notes to the financial statements of Investor
should disclose the amount of unrecognised losses, both for the period and cumulatively.
The amount of the unrecognised losses is $15 000.
Dr Cr
30 June 20X8 $ $
Investment in associate 9 000
Share of profit or loss of associate 9 000 ‡
The total share of the associate’s profits is 30 per cent of $80 000 or $24 000. However, as the share
‡
of the associate’s losses not recognised is $15 000, only $9000 of the investor’s share of profits will be
recognised during the 20X8 financial year.
After the preceding entry, the amount of the investment in the associate will be $9000.
This amount can be reconciled as follows:
$
Investment as at 1 July 20X6 30 000
Share of losses 20X7 (30% of $150 000) (45 000 )
(15 000 )
Share of profits 20X8 (30% of $80 000) 24 000
Investment as at 30 June 20X8 9 000
Question 6.1
Angel Investor Pty Ltd (the investor) enters into a contract with Easy Business Ltd (the borrower)
to provide a $100 000 loan. Because the investor expects the borrower’s business to grow
substantially, the investor requires the borrower to settle the instrument in five years with 10 000
of the borrower’s own equity instruments. Consider the following questions:
(a) Does this instrument meet the definition of a financial instrument? Explain your answer.
(b) If the instrument is a financial instrument, how would Angel Investor Pty Limited and
Easy Business Limited classify this instrument?
(a) The instrument meets the definition of a financial instrument because it creates a
financial asset for Angel Investor Pty Ltd, and a financial liability (or equity instrument)
of Easy Business Ltd.
(b) The instrument should be classified as an equity instrument because it meets the fixed
for fixed test. That test requires an instrument to be classified as equity if a fixed amount
of cash is settled with a fixed number of equity instruments. In this case, Angel Investor
Pty Ltd is exposed to the share price movements of those 10 000 shares because the total
value of what it receives in settlement of the instrument will depend on the market price of
Easy Business Ltd shares. For example, if the share price is $5, Angel Investor Pty Ltd will
receive shares to the total value of $50 000 (10 000 × $5), but if the share price is only $0.60,
the value of shares received by Angel Investor Pty Ltd would be $6000 (10 000 × $0.60).
Question 6.2
Compare and contrast how forward contracts and option contracts protect entities from price risk.
Which type of contract might an entity prefer to use to limit price risk?
A forward contract requires an entity to pay a fixed amount of cash in exchange for cash or
another asset. When used to reduce price risk, the forward contract will usually be settled net
in cash. The effect is that the price of the exposure is fixed at the amount agreed in the contract.
The entity would not be able to participate in any favourable price movements.
An option contract, on the other hand, provides the holder the right, but not the obligation,
to settle the contract at the agreed price. A singular option contract on its own can be used
to limit an entity from either favourable or unfavourable price movements. If an entity chooses
to protect itself from unfavourable price movements, it will be exposed to favourable price
movements, and vice versa. For this reason, some entities favour option contracts over forward
contracts because the option contract allows the entity to participate in favourable price
movements but be protected from unfavourable movements. In contrast, forward contracts
protect the entity from all movements, both favourable and unfavourable.
Question 6.3
MCL Pty Ltd (MCL) is a wholesaler of chemicals and a distributor of imported soaps and perfumes.
In the three financial years to 30 June 20X6, the company reported losses totalling $6.4 million.
These losses were largely due to the adverse effects of a devaluation of the AUD and the impact
of significantly increased price competition from the other chemical wholesalers in the region.
To sustain operations during this period, MCL had substantially increased its level of leverage to
a record high as at 30 June 20X6. However, continued trading difficulties throughout the 20X7
financial year necessitated a further inflow of borrowed funds to meet pressing commitments.
In May 20X7, after having increased leverage to a level equivalent to the debt-to-total-assets
covenant in the company’s debenture trust deed, it was apparent that MCL’s financial plight was
desperate. Although the January 20X7 purchases on credit had not been settled, it was evident
that no additional equity funds would be forthcoming, at least in the short term, owing to the
company’s recent results and precarious statement of financial position.
The chief executive of MCL was very anxious when approaching International Co-op Loans Centre
(‘International’), a newly established financial institution in the region. International had adopted
a high profile since launching its operations in February 20X7, and projected a ‘glossy’ image
in its marketing campaigns. After a series of meetings with International’s management in the
last week of May, an unusual arrangement was entered into by the two parties on 2 June 20X7:
• MCL sold 35 per cent ($500 000) of its trading stock to International for a $2 million immediate
cash settlement.
• MCL agreed to buy back the same stock in three months for $2.4 million.
• The trading stock sold to International was to remain in MCL’s warehouse. A monthly rental
fee of $200 was payable to MCL for the space made available for this purpose.
MCL’s statement of profit or loss and other comprehensive income (P&L and OCI) looked much
healthier for the 20X7 financial year, with a profit of $82 500 after including the $1.5 million gain
from the sale of trading stock to International.
Although MCL did not show a liability in respect to the transaction for the year ended 30 June
20X7, there was a footnote reference in the accounts to contracts entered into for the purchase
of trading stock.
How should MCL record the transaction on 2 June 20X7? Prepare the appropriate journal entry.
For the purposes of this exercise, ignore the rent received by MCL.
Dr Cr
$ $
Has MCL transferred substantially all the risks and rewards of ownership? The repurchase
agreement is part of the total transaction and it means, in substance, that MCL retains
substantially all the risks and rewards of ownership and should not treat the transaction as a sale.
Note: In this suggested answer the interest expense on the loan is recognised when the entity repurchases
the inventory due to the brief period of the loan. In practice, the entity would carry the loan at amortised
cost and recognise interest expense using the effective interest rate.
Therefore, MCL should record the transaction as:

Dr Cr
$ $
Cash at bank 2 000 000
Loan payable 2 000 000
The impact of the repurchase or repayment of the loan will result in an outflow of $2.4 million
and the removal of the loan.

Loan payable 2 000 000
Cash at bank 2 400 000
Question 6.4
(a) A bank agrees to accept shares in Won Ton Ltd (Won Ton) in settlement of an outstanding
loan. The loan amount outstanding is $235 000. Two hundred thousand shares in Won Ton
are issued to the bank. The fair value of the shares in Won Ton on the date of the agreement
is $1 for each share.
What is the journal entry in the books of Won Ton to record this transaction?
Dr Cr
$ $
(b) Shin Nee Ltd (Shin Nee) establishes a trust and transfers $1 million to the trust for the
purposes of servicing a $1.3 million loan to a bank.
Show how Shin Nee should record this transaction and explain your reasoning.
Dr Cr
$ $
(a) Dr Cr
$ $
Loan payable 235 000
Paid-up capital 200 000
Gain on settlement 35 000
(b) Paragraph B3.3.3 of IFRS 9 does not permit the derecognition of a financial liability simply
because funds have been transferred to a trust. There must be a legal release of the
obligation for the debtor.
Therefore, the entry would be:
Receivables from trust 1 000 000

Cash 1 000 000
Question 6.5
Determine whether the following instruments satisfy the sole payments of interest and principal
requirement in IFRS 9.
(a) A bond that is convertible into shares of the issuer and the return on the bond is linked to
the return on the issuer’s shares.
(b) A variable rate loan where the rate is reset every three months based on movements in the
CPI index.
(a) A bond that is convertible into shares of the issuer and the return on the bond is linked
to the return on the issuer’s shares:
This is an example of an instrument that has leverage, as the return to the bond holder is
not based on contractual terms that give rise on specified dates to cash flows that are solely
payments of principal and interest on the principal amount. Hence this instrument would be
classified at fair value.
A variable rate loan where the rate is reset every three months based on movements
(b)
in the CPI index:
This instrument is similar to instrument A in para. B4.1.13 in IFRS 9. The instrument does qualify
for amortised cost as the amounts payable on the loan are reset to the CPI index, which will
adjust the interest for movements in inflation and nothing more. If the reset of interest is linked
to some other measure, like the performance of the debtor, then it fails the test as there is no
certainty about the returns.
Question 6.6
Jolly Frog Ltd (Jolly Frog) has a portfolio of debt securities that it has been carrying at amortised
cost, as it met the rules in IFRS 9 based on its intent to hold the securities and collect the cash
flows over the terms of the debt securities. On 1 April 20X8, Jolly Frog acquired a financial
services section (Tadpole). Tadpole will have responsibility for managing the securities by selling
and buying based on price movements.
Required:
(a) Jolly Frog wants to apply fair value to the securities since the acquisition of Tadpole. Do you
think Jolly Frog meets the requirements in para. 4.4.1 of IFRS 9? Explain your answer.
(b) Assume Jolly Frog meets the requirement to change to fair value. Prepare the journal entry
for reclassification of the securities by Jolly Frog using the following data, explaining your
reasoning. For the purposes of this question the impairment requirements of IFRS 9 do
not apply.
$
Cost of securities at 1 January 20X7 100 000
Recoverable value of securities at
30 June 20X7 90 000
Allowance for impairment loss 10 000
Fair value of securities at
1 April 20X8 115 000
Dr Cr
$ $
(a) Yes, the securities will no longer be managed based on contractual cash flows but will
be managed by Tadpole on a fair value basis and Jolly Frog will be required to apply the
fair value measurement basis.
(b) The journal entry on 1 April 20X8 is:

Dr Cr
$ $
Securities 15 000
Allowance for impairment loss 10 000
P&L 25 000
At the time of the reclassification and change to fair value, the carrying amount of the securities
was $90 000 because an impairment loss had been recognised to reduce the carrying amount
from cost to the recoverable amount. The above entry reverses the allowance for impairment
account and increases the securities account. The gain of $25 000 is the increase from the former
carrying amount of $90 000 to the new carrying amount of $115 000.
Question 6.7
Should the following be considered hedged items under IFRS 9?
(a) A company has signed a contract to purchase goods from a supplier in South Korea in six
months. The company enters a forward exchange contract to buy wons (the currency of
South Korea) in six months.
(b) A company has a potential customer located in France who is considering the purchase of one
of its high-powered luxury ferries within the next six months. The company enters a forward
exchange contract to sell euros in six months.
(a) The contract to purchase goods is a firm commitment and would be a hedged item under
IFRS 9.
(b) Unless the potential transaction is a highly probable forecast transaction, the transaction
would not qualify as a hedged item under IFRS 9, para. 6.3.3, includes a highly probable
forecast transaction as an acceptable hedge item that can be hedged. Therefore, if the sale
to the customer in France was regarded as highly probable, it would be a qualifying hedged
item under IFRS 9.
Question 6.8
Discuss possible reasons for the required disclosures in para. 28 of IFRS 7.
The requirements in para. 28 of IFRS 7 are designed to ensure that entities do not exploit
possible differences between the fair value at the date of initial recognition and the amount
that would be determined using a valuation technique. At the very least, this difference must
be reported, allowing users to assess its impact on the entity’s performance for the period.
Question 6.9
Why are disclosures about transfers of financial assets that fail the derecognition criteria in IFRS 9
important to users of financial statements?
Transfers of financial assets that fail IFRS 9’s derecognition criteria are those that create new
liabilities for entities. Users of financial statements need to understand the relationship between
the assets that continue to be recognised and the newly recognised liabilities. These disclosures
will allow users to understand the cash flows of the entity and its financial position.
Question 7.1
Consider the situations below and comment on whether a formal estimate of the recoverable
amount of each entity’s assets is required. Explain your answer with reference to IAS 36.
(a) An asset of A Ltd has a history of profitable use within A Ltd’s operations and is currently
profitable. The most recent budgeted results of A Ltd show that the cash outflows related
to operating the asset are 20 per cent higher than originally budgeted.
(b) B Ltd manufactures computer chips for use in domestic appliances. One of B Ltd’s competitors
recently announced that it had developed a new generation of computer chips, which allows
the competitor to reduce its cost to manufacture chips by 15 per cent.
(c) C Ltd operates in the gaming industry. Recent government regulations are expected to
increase competition in the sector, resulting in a loss of market share. In anticipation of
this increased competition, C Ltd plans to diversify its operations into hospitality and
entertainment activities. This diversification is expected to compensate the entity for the
loss of its market share in the gaming sector.
(d) The ordinary shares of D Ltd are listed on the stock exchange. The market capitalisation of
D Ltd at its most recent reporting date was $50 million. The carrying amount of D Ltd’s net
assets at that date was $47 million.
(e) E Ltd has significant operations in Country X. Country X has recently been affected by a natural
disaster. Although the operations of E Ltd were not directly affected by the natural disaster,
many of its suppliers were significantly affected and have ceased operations indefinitely.
As a consequence, the plant of E Ltd can operate at only half its normal capacity for the next
three years.
(a) The asset has a history of profitable use within A Ltd’s operations and is currently profitable.
However, the evidence from internal reporting indicates the cash outflows are significantly
higher than those originally budgeted. According to para. 12(g) of IAS 36, this is an indication
that the asset may be impaired. Therefore, A Ltd should make a formal estimate of the
recoverable amount of the asset.
(b) The announcement by one of B Ltd’s competitors that it had developed a new generation
of computer chips, which would result in a 15 per cent reduction in the cost to manufacture
the chips, constitutes a significant adverse change in the technological environment in which
B Ltd operates. According to para. 12(b) of IAS 36, this is an indication that the assets of B Ltd
may be impaired. Therefore, B Ltd should make a formal estimate of the recoverable amount
of the assets used to manufacture computer chips for use in domestic appliances.
(c) C Ltd expects to be able to compensate for the loss of market share in the gaming industry by
diversifying into hospitality and entertainment activities. However, the assets of C Ltd that are
dedicated to gaming activities may potentially be impaired as a result of the recent government
regulations that will likely increase competition in the sector. According to para. 12(b) of IAS 36,
this is an indication that the assets of C Ltd may be impaired. Therefore, C Ltd should make a
formal estimate of the recoverable amount of the assets used in gaming activities.
(d) The market capitalisation (net worth) of D Ltd at its most recent reporting date ($50m)
exceeds the carrying amount of D Ltd’s net assets at this date ($47m). Therefore, on the
basis of market capitalisation, there is no need for D Ltd to make a formal estimate of
the recoverable amount of its assets.
(e) Although E Ltd was not directly affected by the natural disaster, many of its suppliers have
ceased operations indefinitely. As a result, E Ltd’s plant is operating at only half its capacity.
This indicates the economic performance of the asset would be worse than expected.
This is because the cash inflows from the use of the plant will be significantly lower than
expected. The assets of E Ltd may potentially be impaired as a result of this change. According
to para. 12(g) of IAS 36, this is an indication that the assets of B Ltd may be impaired. Therefore,
E Ltd should make a formal estimate of the recoverable amount of the assets in Country X.
Question 7.2
In developing IAS 36, the International Accounting Standards Committee (IASC)—the predecessor
to the current IASB—rejected a number of other proposals for the definition of ‘recoverable
amount’, including basing the definition on:
• the sum of undiscounted cash flows expected to be derived from an asset
• fair value
• value in use.
The basis for the IASC decision is set out in paras BCZ9–BCZ22 of IAS 36. What were the IASC’s
principal objections to these alternative definitions of ‘recoverable amount’?
The IASC primarily objected to the IAS 36 definition of ‘recoverable amount’ based on the sum
of undiscounted cash flows expected to be derived from an asset for the following reasons:
• It ignores the time value of money.
• Measurements that consider the time value of money are more relevant to resource allocation
decisions made by investors, other external users of financial statements and management.
• Discounting techniques are well understood by many entities.
• Discounting is already required for other financial statement items.
• Entities are better served if they are provided with timely information regarding whether their
assets will generate a return that at least compensates for the time value of money (IAS 36,
para. BCZ13).
The IASC primarily objected to a definition of ‘recoverable amount’ based on the fair value
of an asset for the following reasons:
• It refers to the market’s expectations of the recoverable amount of an asset rather than
to a reasonable estimate made by the entity itself. For example, in some cases, an entity
may have superior information than the market about the future cash flows expected to be
derived from an asset. Further, an entity may intend to use an asset in a manner that differs
from the best use of the asset that is assumed by the market.
• Market values, as a means to estimate fair value, presume that an entity is a willing seller.
In some cases, an entity may be unwilling to sell an asset because it believes that it can
derive greater service potential from the continuing use of the asset in the entity rather
than from selling it.
• It does not reflect the principle that, when the recoverable amount of an asset is assessed,
it is more relevant to consider what an entity can expect to recover from an asset
(IAS 36, para. BCZ17).
The IASC primarily objected to the IAS 36 definition of ‘recoverable amount’ based on the value
in use of the asset for the following reasons:
• If the net selling price (i.e. fair value less costs of disposal) is greater than the value in use,
rational management will dispose of the asset. The definition of ‘recoverable amount’
should reflect this commercial reality.
• To the extent that the net selling price exceeds the value in use, and when management
decides to retain the asset, the additional loss falling on the entity (the difference between
the net selling price and value in use) should be allocated to future periods consistent with
management’s decision to retain the asset in each of those periods (IAS 36, para. BCZ22).
Question 7.3
East Ltd (East) owns a machine used in the manufacture of steering wheels, which are sold directly
to major car manufacturers.
• The machine was purchased on 1 January 20X3 at a cost of $500 000 through a vendor
financing arrangement on which interest is being charged at the rate of 10 per cent per annum.
• During the year ended 31 December 20X4, East sold 10 000 steering wheels at a selling
price of $190 per wheel.
• The most recent financial budget approved by East’s management, covering the period
1 January 20X5–31 December 20X9, indicates that the company expects to sell each steering
wheel for $200 during 20X5, the price rising in later years in line with a forecast inflation of
3 per cent per annum.
• During the year ended 31 December 20X5, East expects to sell 10 000 steering wheels.
This number is forecast to increase by 5 per cent each year until 31 December 20X9.
• East estimates that each steering wheel costs $160 to manufacture, which includes $110
variable costs, $30 share of fixed overheads and $20 transport costs.
• Costs are expected to rise by 1 per cent during 20X6, and then by 2 per cent per annum
until 31 December 20X9.
• During 20X7, the machine will be subject to regular maintenance costing $50 000.
• In 20X5, East expects to invest in new technology costing $100 000. This technology will
reduce the variable costs of manufacturing each steering wheel from $110 to $100 and the
share of fixed overheads from $30 to $15 (subject to the availability of technology, which is
still under development).
• East is depreciating the machine using the straight-line method over the machine’s 10-year
estimated useful life. The current estimate (based on similar assets that have reached the
end of their useful lives) of the disposal proceeds from selling the machine is $80 000 net
of disposal costs. East expects to dispose of the machine at the end of December 20X9.
• East has determined a pre-tax discount rate of 8 per cent, which reflects the market’s
assessment of the time value of money and the risks associated with this asset.
Assume a tax rate of 30 per cent. What is the value in use of the machine in accordance with IAS 36?
Calculation of the value in use of the machine owned by East Ltd (East) includes the projected
cash inflows (i.e. sales income) from the continued use of the machine and projected cash
outflows that are necessarily incurred to generate those cash inflows (i.e. cost of goods sold).
Additionally, projected cash inflows include $80 000 from the disposal of the asset in 20X9.
Cash outflows include routine capital expenditures of $50 000 in 20X7. Note cash flows do not
include financing interest (i.e. 10%), tax (i.e. 30%) and capital expenditures to which East has not
yet committed (i.e. $100 000); they also do not include any savings in cash outflows from these
capital expenditures, as required by IAS 36.
The cash flows (inflows and outflows) are presented below in nominal terms. They include an
increase of 3 per cent per annum to the forecast price per unit (B), in line with forecast inflation.
The cash flows are discounted by applying a discount rate (8%) that is also adjusted for inflation.
Value in
Year ended 31.12.X5 31.12.X6 31.12.X7 31.12.X8 31.12.X9 use
Quantity (A) 10 000 10 500 11 025 11 576 12 155
Price per unit (B) $200 $206 $212 $219 $225
Estimated cash $2 000 000 $2 163 000 $2 337 300 $2 535 144 $2 734 875
inflows (C = A × B)
Misc. cash inflow: $80 000

disposal proceeds
(D)
Total estimated $2 000 000 $2 163 000 $2 337 300 $2 535 144 $2 814 875
cash inflows
(E = C + D)
Cost per unit (F) $160 $162 $165 $168 $171
Estimated cash ($1 600 000) ($1 701 000) ($1 819 125) ($1 944 768) ($2 078 505)
outflows
(G = A × F)
Misc. cash outflow: ($50 000)

maintenance costs
(H)
Total estimated ($1 600 000) ($1 701 000) ($1 869 125) ($1 944 768) ($2 078 505)
cash outflows
(I = G + H)
Net cash flows $400 000 $462 000 $468 175 $590 376 $736 370
(J = E – I)
Discount factor (1/1.081) = (1/1.082) = (1/1.083) = (1/1.084) = (1/1.085) =

8% (K) 0.9259 0.8573 0.7938 0.7350 0.6806
Discounted future $370 360 $396 073 $371 637 $433 926 $501 173 $2 073 169
cash flows
(L = J × K)
Question 7.4
Example 1: Identification of CGUs, IAS 36, Illustrative examples, para. IE1.
(a) Retail store chain
Store X belongs to a retail store chain, M. X makes all its retail purchases through M’s
purchasing centre. Pricing, marketing, advertising and human resources policies (except for
hiring X’s cashiers and sales staff) are decided by M. M also owns five other stores in the
same city as X (although in different neighbourhoods) and 20 stores in other cities. All stores
are managed in the same way as X. X and four other stores were purchased five years ago,
and goodwill was recognised.
Is X a CGU?
(b) Plant for an intermediate step in a production process

A significant raw material used for plant Y’s final production is an intermediate product
bought from plant X of the same entity. X’s products are sold to Y at a transfer price that
passes all margins to X. Sixty per cent of X’s final production is sold to Y, and the remaining
40 per cent is sold to customers outside the entity. Eighty per cent of Y’s final production is
sold to customers outside the entity.
For each of the following cases, what are the CGUs for X and Y?
Case 1: X could sell the products it sells to Y in an active market. Internal transfer prices are
higher than market prices.
Case 2: There is no active market for the products X sells to Y.
Suggested responses are based on Example 1 in the Illustrative Examples section of IAS 36.
(a) In identifying whether Store X is a CGU, the following are considered:

(i) Internal management reporting is organised to measure performance on a store-by-
store basis.
(ii) The business is run on a store-by-store profit basis or on a regional or city basis.
All M’s stores are in different neighbourhoods and probably have different customer bases.
So, although X is managed at a corporate level, X generates cash inflows that are largely
independent of those of M’s other stores. Therefore, it is likely that X is a CGU.
(b) Case 1
X could sell its products in an active market, thereby generating cash inflows that would be
largely independent of the cash inflows from Y. Therefore, it is likely that X is a separate CGU,
although part of its production is used by Y.
It is likely that Y is also a separate CGU. Y sells 80 per cent of its products to customers
outside the entity. Therefore, its cash inflows can be regarded as largely independent.
Internal transfer prices do not reflect market prices for X’s output. Therefore, in determining
the values in use of both X and Y, the entity adjusts financial budgets and forecasts to
reflect management’s best estimate of future prices that could be achieved in arm’s length
transactions for X’s products that are used internally.
Case 2
It is likely that the recoverable amount of each plant cannot be assessed independently
of the recoverable amount of the other plant because:
(a) The majority of X’s production is used internally and cannot be sold in an active market.
As such, the cash inflows of X depend on the demand for Y’s products. Therefore,
X cannot be considered to generate cash inflows that are largely independent
of those of Y.
(b) The two plants are managed together.
As a consequence, it is likely that plants X and Y form the smallest group of assets that
generates cash inflows that are largely independent.
Question 7.5
Three members of the IASB dissented to the issuing of IAS 36. The members’ concerns are set out
in paras DO1–10 of IAS 36. What were the two key concerns raised in the members’ dissenting
opinions?
Three members of the IASB dissented from the decision to issue IAS 36 because of their concerns
about the impairment test in IAS 36 for goodwill. Their concerns arose particularly in relation to the
merger of an acquired business with an acquirer’s pre-existing operations.
A key concern cited relates to the failure of the impairment test to distinguish between the benefits
provided by the acquirer’s pre-existing internally generated goodwill at the time of the acquisition
and the benefits provided by the purchased goodwill. As a result, the acquirer’s pre‑existing
internally generated goodwill provides a ‘shield’ against impairment of the purchased goodwill.
A further shield against impairment is also provided by internally generated goodwill that is
generated subsequent to the acquisition. Interestingly, the dissenting members did not offer
views as to how such internally generated goodwill could be measured.
Another key concern cited relates to the failure of the impairment test to incorporate a subsequent
cash flow test. Under this test, actual cash flows are required to be substituted for estimated cash
flows, which were estimated when a past impairment test occurred. An impairment loss has to be
recognised if the actual cash flows would have created an impairment loss for goodwill.

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To be used in conjunction with Financial Reporting, 4th Edition.

The decision-usefulness objective of financial reporting provides some guidance to standard

Cash basis Accrual basis

Year ended 30 June 20X4

Year ended 30 June 20X5

Depreciation expense 15 453

Year ended 30 June 20X6

Depreciation expense 15 453

Year ended 30 June 20X7

Depreciation expense 15 453

Year ended 30 June 20X8

Depreciation expense 15 454

Accumulated depreciation 61 813

Year ended 30 June 20X4

Lease receivable 68 000

Lease receivable 2 647

(Receipt of 1st lease payment)

Year ended 30 June 20X5

Year ended 30 June 20X6

Year ended 30 June 20X7

Year ended 30 June 20X8

Motor vehicle 10 000

Therefore, the amount of the provision for sick leave:

Note: IAS 1 paragraph numbers are provided for your reference.

Interest revenue accounted for using

Operating profit 1 393 713

Sales 19 194 434

(a) As outlined in para. 96 of IAS 1, reclassification adjustments do not arise on changes in

Other comprehensive income $

Notes to the financial report

Note 1: Revenues and other income

Note 2: Advertising campaign—new product 97/IAS 1

Note 3: Write-down of inventory 97/IAS 1

Note 4: Damages—lawsuit 97/IAS 1

Note 5: Depreciation and amortisation 104/IAS 1

(see Section 3.2 of ‘Case study data’).

Note 6: Bad and doubtful debts

Note 7: Employee benefits 104/IAS 1

(b) Product expenses $

(c) Administrative expenses

(d) Other expenses (from ordinary activities)

Share Revaluation Retained

Shareholders’ equity As at 30 June 20X6

Comprehensive income items for the year ended 30 June 20X7

Dividends paid or declared for the year ended 30 June 2017

Statement of financial position for Webprod Ltd as at 30 June 20X7

Extracts from notes to accounts

2. Trade and other receivables $

4. Other current assets $

6. Property, plant and equipment

Factory plant and equipment (at cost) 1 790 246

Fixtures and fittings—retail outlets (at cost) 76 300

Total property, plant and equipment 4 099 730

8. Trade and other payables $

11. Issued capital

Cash flows from operating activities 1. Cash received from customers

Cash flows from investing activities 8. Interest received