Financial Reporting

Revision Notes

December 2024 Exam

Roy Goh
MFin, FCCA, CA, ACTA
[email protected]
Content
1. THE CONCEPTUAL FRAMEWORK FOR FINANCIAL
REPRTING ------------------------------------------------------------- 5
2. IAS 1 PRESENTATION OF FINANCIAL STATEMENTS -------------- 15
3. IFRS 13 FAIR VALUE MEASUREMENT ------------------------------- 18
4. IAS 16 PROPERTY, PLANT AND EQUIPMENT ----------------------- 23
5. IAS 23 BORROWING COST ------------------------------------------- 27
6. IAS 38 INTANGIBLE ASSETS ---------------------------------------- 28
7. IAS 36 IMPAIRMENT OF ASSETS ------------------------------------ 30
8. IAS 40 INVESTMENT PROPERTIES ---------------------------------- 32
9. IAS 2 INVENTORIES -------------------------------------------------- 33
10. IAS 41 AGRICULTURE ----------------------------------------------- 34
11. IAS 20 ACCOUNTING FOR GOVERNMENT GRANTS AND
DISCLOSURE OF GOVERNMENT ASSISTANCE ------------------- 35
12. IFRS 15 REVENUE FROM CONTRACTS WITH CUSTOMERS ------ 36
13. IAS 37 PROVISIONS, CONTINGENT LIABILITIES AND
CONTINGENT ASSETS ---------------------------------------------- 39
14. IAS 21 THE EFFECTS OF CHANGES IN FOREIGN
EXCHANGE RATES -------------------------------------------------- 41
15. IAS 32 FINANCIAL INSTRUMENTS: PRESENTATION ------------ 43
16. IFRS 9 FINANCIAL INSTRUMENTS -------------------------------- 45
17. IFRS 7 FINANCIAL INSTRUMENTS: DISCLOSURES -------------- 47
18. IAS 12 INCOME TAXES ---------------------------------------------- 48
19. SUBSTANCE OVER FORM ------------------------------------------- 49
20. IFRS 16 LEASES ----------------------------------------------------- 50
21. IAS 8 ACCOUNTING POLICIES, CHANGES IN
ACCOUNTING ESTIMATES AND ERRORS ------------------------- 53
22. IAS 10 EVENTS AFTER THE REPORTING PERIOD ---------------- 54
23. IFRS 5 NON-CURRENT ASSETS HELD FOR SALE AND
DISCONTINUED OPERATIONS ------------------------------------ 55
24. IAS 33 EARNINGS PER SHARE ------------------------------------- 56
25. RATIOS --------------------------------------------------------------- 58
26. IAS 7 STATEMENT OF CASH FLOWS ------------------------------- 62
27. IAS 27 SEPARATE FINANCIAL STATEMENTS --------------------- 64
28. IFRS 10 CONSOLIDATED FINANCIAL STATEMENTS ------------- 65
29. IAS 28 INVESTMENT IN ASSOCIATES AND JOINT
VENTURES ---------------------------------------------------------- 66
30. IFRS 3 BUSINESS COMBINATIONS -------------------------------- 67
31. IFRS S1 GENERAL REQUIREMENTS FOR DISCLOSURE OF
SUSTAINABILITY – RELATED FINANCIAL INFORMATION ----- 75
32. ARTICLES ------------------------------------------------------------ 81

2
FORMAT OF THE EXAM PAPER

FR BA JD 2024 final exam 3 hours

Section A Total

15 MCQ of 2 marks each 30 marks

Section B
2 case scenarios with 5 questions each at 2 marks 20 marks

Section C
1 case scenario 20 marks

Total 70 marks

Exam Date: December 2024 actual exam date to be confirmed

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Examinable Documents in FR

IAS 29 Examinable IFRS/IAS

Conceptual Framework for Financial Reporting (March 2018)
IAS 1 Presentation of Financial Statements
IAS 2 Inventories
IAS 7 Statement of Cash Flows
IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors
IAS 10 Events after the Reporting Period
IAS 12 Income Taxes
IAS 16 Property, Plant and Equipment
IAS 20 Accounting for Government Grants and Disclosure of Government
Assistance
IAS 21 The Effects of Changes in Foreign Exchange Rates
IAS 23 Borrowing Costs
IAS 27 Separate Financial Statements
IAS 28 Investments in Associates and Joint Ventures
IAS 32 Financial Instruments: Presentation
IAS 33 Earnings per Share
IAS 36 Impairment of Assets
IAS 37 Provisions, Contingent Liabilities and Contingent Assets
IAS 38 Intangible Assets
IAS 40 Investment Property
IAS 41 Agriculture
IFRS 3 Business Combinations
IFRS 5 Non-current Assets Held for Sale and Discontinued Operations
IFRS 7 Financial Instruments: Disclosures
IFRS 9 Financial Instruments
IFRS 10 Consolidated Financial Statements
IFRS 13 Fair Value Measurement
IFRS 15 Revenue from Contracts with Customers
IFRS 16 Leases
IFRS Sustainability Disclosure Standards
IFRS S1 General Requirements for Disclosure of Sustainability-related
Financial Information

IFRS are issued by IASB, IAS were issued by predecessor IASC and amended by
IASB.

4
1.1 Conceptual Framework for Financial Reporting (March 2018)

Status and Purpose of the Conceptual Framework

The Conceptual Framework for Financial Reporting (Conceptual Framework)

describes the objective of, and the concepts for, general purpose financial
reporting. The purpose of the Conceptual Framework is to:

(a) assist the International Accounting Standards Board (Board) to develop IFRS
Standards (Standards) that are based on consistent concepts;

(b) assist preparers to develop consistent accounting policies when no Standard

applies to a particular transaction or other event, or when a Standard allows a
choice of accounting policy; and

(c) assist all parties to understand and interpret the Standards.

Chapter 1 The objective of general purpose financial reporting

The objective of general purpose financial reporting is to provide financial

information about the reporting entity that is useful to existing and potential
investors, lenders and other creditors in making decisions relating to
providing resources to the entity. Those decisions involve decisions about:

(a) buying, selling or holding equity and debt instruments;

(b) providing or settling loans and other forms of credit; or

(c) exercising rights to vote on, or otherwise influence, management’s actions

that affect the use of the entity’s economic resources.

The decisions above would depend on the returns that existing and potential
investors, lenders and other creditors expect, for example, dividends, principal and
interest payments or market price increases. Investors’, lenders’ and other
creditors’ expectations about returns depend on their assessment of the amount,
timing and uncertainty of (the prospects for) future net cash inflows to the entity
and on their assessment of management’s stewardship of the entity’s economic
resources. Existing and potential investors, lenders and other creditors need
information to help them make those assessments.

However, general purpose financial reports do not and cannot provide all of the
information that existing and potential investors, lenders and other creditors need.
Those users need to consider pertinent information from other sources, for
example, general economic conditions and expectations, political events and
political climate, and industry and company outlooks.

General purpose financial reports are not designed to show the value of a reporting
entity; but they provide information to help existing and potential investors, lenders
and other creditors to estimate the value of the reporting entity.
Economic resources and claims

Information about the entity’s economic resources and claims can help users to
identify the reporting entity’s financial strengths and weaknesses. That information
can help users to assess the reporting entity’s liquidity and solvency, its needs for
additional financing and how successful it is likely to be in obtaining that financing.
It can also help users to assess management’s stewardship of the entity’s
economic resources. Information about priorities and payment requirements of
existing claims helps users to predict how future cash flows will be distributed
among those with a claim against the reporting entity.

Changes in economic resources and claims

Changes in a reporting entity’s economic resources and claims result from:

1. that entity’s financial performance reflected by accruals accounting and past

cash flows

2. from other events or transactions such as issuing debt or equity instruments

Chapter 2 Qualitative Characteristics of Useful Financial Information

The qualitative characteristics of financial information are likely to be most useful to
the existing and potential investors, lenders and other creditors for making
decisions.

Fundamental Qualitative Characteristics

1. Relevance (FS must be suitable for decision making)

Relevant financial information is capable of making a difference in the decisions
made by users. Information may be capable of making a difference in a decision
even if some users choose not to take advantage of it or are already aware of it
from other sources.

2. Materiality (when amount is significant, it will influence decisions)

Information is material if omitting, misstating or obscuring it could reasonably be
expected to influence decisions that the primary users of general purpose financial
reports make on the basis of those reports, which provide financial information
about a specific reporting entity. In other words, materiality is an entity-specific
aspect of relevance based on the nature or magnitude, or both, of the items to
which the information relates in the context of an individual entity’s financial report.
Consequently, the Board cannot specify a uniform quantitative threshold for
materiality or predetermine what could be material in a particular situation.

3. Faithful Representation (economic substance over legal form)

Financial reports represent economic phenomena in words and numbers. To be
useful, financial information must not only represent relevant phenomena, but it
must also faithfully represent the substance of the phenomena that it purports to
represent. In many circumstances, the substance of an economic phenomenon and
its legal form are the same. If they are not the same, providing information only
about the legal form would not faithfully represent the economic phenomenon

6
Applying the fundamental qualitative characteristics

Information must both be relevant and provide a faithful representation of what it

purports to represent if it is to be useful. Neither a faithful representation of an
irrelevant phenomenon nor an unfaithful representation of a relevant phenomenon
helps users make good decisions.

The most efficient and effective process for applying the fundamental qualitative
characteristics would usually be as follows (subject to the effects of enhancing
characteristics and the cost constraint, which are not considered in this example).

First, identify an economic phenomenon, information about which is capable of

being useful to users of the reporting entity’s financial information.

Second, identify the type of information about that phenomenon that would be
most relevant.

Third, determine whether that information is available and whether it can provide a
faithful representation of the economic phenomenon. If so, the process of satisfying
the fundamental qualitative characteristics ends at that point. If not, the process is
repeated with the next most relevant type of information.

Enhancing qualitative characteristics

1. Comparability (good to have current year and previous year as comparison)

Users’ decisions involve choosing between alternatives, for example, selling or
holding an investment, or investing in one reporting entity or another.
Consequently, information about a reporting entity is more useful if it can be
compared with similar information about other entities and with similar information
about the same entity for another period or another date.

2. Verifiability (good to have invoices and statements as evidence)

Verifiability helps assure users that information faithfully represents the economic
phenomena it purports to represent. Verifiability means that different
knowledgeable and independent observers could reach consensus, although not
necessarily complete agreement, that a particular depiction is a faithful
representation. Quantified information need not be a single point estimate to be
verifiable. A range of possible amounts and the related probabilities can also be
verified.

3. Timeliness (good file to FS on-time)

Timeliness means having information available to decision-makers in time to be
capable of influencing their decisions. Generally, the older the information is the
less useful it is. However, some information may continue to be timely long after
the end of a reporting period because, for example, some users may need to
identify and assess trends.

4. Understandability (good to show breakdown of figures and disclosure notes)

Classifying, characterising and presenting information clearly and concisely makes it
understandable.

7
Applying the enhancing qualitative characteristics

Enhancing qualitative characteristics should be maximised to the extent possible.

However, the enhancing qualitative characteristics, either individually or as a group,
cannot make information useful if that information is irrelevant or not faithfully
represented.

Applying the enhancing qualitative characteristics is an iterative process that does

not follow a prescribed order. Sometimes, one enhancing qualitative characteristic
may have to be diminished to maximise another qualitative characteristic. For
example, a temporary reduction in comparability as a result of prospectively
applying a new financial reporting standard may be worthwhile to improve
relevance or faithful representation in the longer term. Appropriate disclosures may
partially compensate for non-comparability.

Cost is a pervasive constraint on the information that can be provided by financial

reporting. Reporting financial information imposes costs, and it is important that
those costs are justified by the benefits of reporting that information. There are
several types of costs and benefits to consider. Because of the inherent subjectivity,
different individuals’ assessments of the costs and benefits of reporting particular
items of financial information will vary. Therefore, the Board seeks to consider costs
and benefits in relation to financial reporting generally, and not just in relation to
individual reporting entities. That does not mean that assessments of costs and
benefits always justify the same reporting requirements for all entities. Differences
may be appropriate because of different sizes of entities, different ways of raising
capital (publicly or privately), different users’ needs or other factors.

Chapter 3 Financial Statements and the Reporting Entity

Chapters 1 and 2 discuss information provided in general purpose financial reports

and Chapters 3–8 discuss information provided in general purpose financial
statements, which are a particular form of general purpose financial reports.

Objective and scope of financial statements

The objective of financial statements is to provide financial information about the

reporting entity’s assets, liabilities, equity, income and expenses that is useful to
users of financial statements in assessing the prospects for future net cash inflows
to the reporting entity and in assessing management’s stewardship of the entity’s
economic resources. Financial statements provide information from the perspective
of the reporting entity as a whole, not from the perspective of any particular group
of the entity’s existing or potential investors, lenders or other creditors.

That information is provided:

(a) in the statement of financial position, by recognising assets, liabilities and

equity;
(b) in the statement(s) of financial performance by recognising income and
expenses; and
(c) in other statements and notes, by presenting and disclosures

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Going concern assumption

Financial statements are normally prepared on the assumption that the reporting
entity is a going concern and will continue in operation for the foreseeable future.
Hence, it is assumed that the entity has neither the intention nor the need to enter
liquidation or to cease trading. If such an intention or need exists, the financial
statements may have to be prepared on a different basis. If so, the financial
statements describe the basis used.

Chapter 4 The elements of Financial Statements

The elements of financial statements defined in the Conceptual Framework are:

(a) assets, liabilities and equity, which relate to a reporting entity’s financial
position; and

(b) income and expenses, which relate to a reporting entity’s financial

performance.

Those elements are linked to the economic resources, claims and changes in
economic resources and claims are defined as follows:

Items Element Definition or description

Economic resource Asset A present economic resource controlled by

the entity as a result of past events.

An economic resource is a right that has the

potential to produce economic benefits.

Claim Liability A present obligation of the entity to transfer

an economic resource as a result of past
events.

Equity The residual interest in the assets of the

entity after deducting all its liabilities.

Changes in economic Income Increases in assets, or decreases in liabilities,

resources and claims, that result in increases in equity, other than
reflecting financial those relating to contributions from holders of
performance equity claims.

Expenses Decreases in assets, or increases in liabilities,

that result in decreases in equity, other than
those relating to distributions to holders of
equity claims.

Other changes in - Contributions from holders of equity claims,

economic resources and distributions to them.
and claims
- Exchanges of assets or liabilities that do not
result in increases or decreases in equity.

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Asset: 1. Rights to receive cash, goods and services, exchange economic
resources, over physical objects (PPE, IP, Inv) and to use intellectual property. 2.
Economic Benefits does not need to be certain or likely, that the right will
produce economic benefits. It is only necessary that the right already exists and will
produce economic benefits beyond. 3. Control is the ability to direct the use of an
economic resource or to prevent another entity to use and obtain benefits.

Liabilities: 1. Legal or constructive Obligation exist. 2. Transfer of economic

resource include obligations to pay cash, deliver goods or services or exchange
economic resources on unfavourable terms. 3. Present obligation exist as a result
of past events.

Chapter 5 Recognition and derecognition

Only items that meet the definition of an asset, a liability or equity are
recognised in the statement of financial position (SOFP). Similarly, only items that
meet the definition of income or expenses are recognised in the statement(s) of
financial performance (i.e. SOPL and OCI) with relevance and faithful
representation.

SOFP at beginning of reporting period

Assets minus liabilities equal equity
+
Statement(s) of financial performance
Income minus expenses
+ Changes in
Equity
Contributions from equity holders minus
distributions to equity holders
=
SOFP at end of reporting period
Assets minus liabilities equal equity

Derecognition

Derecognition is the removal of all or part of a recognised asset or liability from an

entity’s statement of financial position. Derecognition normally occurs when that
item no longer meets the definition of an asset or of a liability:

(a) for an asset, derecognition normally occurs when the entity loses control of all
or part of the recognised asset; and

(b) for a liability, derecognition normally occurs when the entity no longer has a
present obligation for all or part of the recognised liability.

Accounting requirements for derecognition aim to faithfully represent both:

(a) any assets and liabilities retained after the transaction or other event that led
to the derecognition (including any asset or liability acquired, incurred or
created as part of the transaction or other event); and

(b) the change in the entity’s assets and liabilities as a result of that transaction
or other event.

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Chapter 6 Measurement
Elements recognised in financial statements are quantified in monetary terms. This
requires the selection of a measurement basis. A measurement basis is an
identified feature—for example, historical cost, fair value or fulfilment value —of an
item being measured. Applying a measurement basis to an asset or liability creates
a measure for that asset or liability and for related income and expenses.

1. Historical Cost
Historical cost measures assets, liabilities and related income and expenses at the
price of the transaction or event that gave rise to them. Unlike current value,
historical cost does not reflect changes in values, except to the extent that those
changes relate to impairment of an asset or a liability becoming onerous.

The historical cost of an asset comprising the consideration paid to acquire or

create the asset plus transaction costs.

The historical cost of a liability when it is incurred or taken on is the value of the
consideration received to incur or take on the liability minus transaction costs.

2. Current Value

Current value of assets, liabilities and related income and expenses uses updated
information to reflect conditions at the measurement date. Because of the updating,
current values of assets and liabilities reflect changes, since the previous
measurement date, in estimates of cash flows and other factors. Unlike historical
cost, the current value of an asset or liability is not derived from the price of the
transaction that gave rise to the asset or liability.

Current value measurement bases include:

(a) fair value;

(b) value in use (VIU) for assets and fulfilment value for liabilities; and

(c) current cost.

2a. Fair Value

Fair value (FV) is the price that would be received to sell an asset, or paid to
transfer a liability, in an orderly transaction between market participants at the
measurement date. In some cases, fair value can be determined directly by
observing prices in an active market. In other cases, it is determined indirectly
using measurement techniques, for example, cash-flow-based measurement
techniques on future cash flows, time value of money, uncertainty in cash flows and
liquidity.

2b. Value In Use (VIU) and Fulfilment Value

Value in use is the present value of future cash flows (PVFCF), or other economic
benefits that an entity expects to derive from the use of an asset and from its
ultimate disposal.

Fulfilment value is the present value of the cash, or other economic resources,
that an entity expects to be obliged to transfer as it fulfils a liability.

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Present Value = Future Value x 1__
(1 + r)n
compounded present values, often known as, “Unwinding of Finance Cost” and
“Amortised Cost”

Future Value = Present Value x (1 + r) n

where:

r = discount rate or effective interest rate (EIR)

n = number of compounding periods

2c. Current Cost

The current cost of an asset is the cost of an equivalent asset at the measurement
date, comprising the consideration that would be paid at the measurement date
plus the transaction costs that would be incurred at that date.

The current cost of a liability is the consideration that would be received for an
equivalent liability at the measurement date minus the transaction costs that would
be incurred at that date.

Current cost, like historical cost, is an entry value: it reflects prices in the market
in which the entity would acquire the asset or would incur the liability. Hence, it is
different from fair value, value in use and fulfilment value, which are exit values.

However, unlike historical cost, current cost reflects conditions at the measurement
date. In some cases, current cost cannot be determined directly by observing prices
in an active market and must be determined indirectly by other means. For
example, if prices are available only for new assets, the current cost of a used asset
might need to be estimated by adjusting the current price of a new asset to reflect
the current age and condition of the asset held by the entity.

Chapter 7 Presentation and Disclosure

1. Presentation and disclosure as communication tools

A reporting entity communicates information about its assets, liabilities, equity,

income and expenses by presenting and disclosing information in its financial
statements.

Effective communication of information in financial statements makes that

information more relevant and contributes to a faithful representation of an entity’s
assets, liabilities, equity, income and expenses. It also enhances the
understandability and comparability of information in financial statements. Effective
communication of information in financial statements requires:

(a) focusing on presentation and disclosure objectives and principles rather than
focusing on rules;

(b) classifying information in a manner that groups similar items and separates
dissimilar items; and

12
(c) aggregating information in such a way that it is not obscured either by
unnecessary detail or by excessive aggregation.

2. Presentation and disclosure objectives and principles

To facilitate effective communication of information in financial statements, when

developing presentation and disclosure requirements in Standards a balance is
needed between:

(a) giving entities the flexibility to provide relevant information that faithfully
represents the entity’s assets, liabilities, equity, income and expenses; and

(b) requiring information that is comparable, both from period to period for a
reporting entity and in a single reporting period across entities.

3. Classification

Classification is the sorting of assets, liabilities, equity, income or expenses on the

basis of shared characteristics for presentation and disclosure purposes. Such
characteristics include—but are not limited to—the nature of the item, its role (or
function) within the business activities conducted by the entity, and how it is
measured.

Classifying dissimilar assets, liabilities, equity, income or expenses together can

obscure relevant information, reduce understandability and comparability and may
not provide a faithful representation of what it purports to represent.

4. Aggregation

Aggregation is the adding together of assets, liabilities, equity, income or expenses

that have shared characteristics and are included in the same classification.

The IFRS Interpretations Committee is the interpretative body of the IFRS

Foundation.

Its mandate is to review on a timely basis widespread accounting issues that have
arisen within the context of current International Financial Reporting Standards
(IFRSs). The work of the Interpretations Committee is aimed at reaching consensus
on the appropriate accounting treatment (IFRIC Interpretations) and providing
authoritative guidance on those issues.

In developing interpretations, the Interpretations Committee works closely with

similar national committees. The interpretations cover both:

• newly identified financial reporting issues not specifically dealt with in

IFRSs; and
• issues where unsatisfactory or conflicting interpretations have developed,
or seem likely to develop in the absence of authoritative guidance

The Interpretations Committee comprises 14 voting members drawn from a

variety of countries and professional backgrounds. They are appointed by
the Trustees of the IFRS Foundation and are selected for their ability to maintain
an awareness of current issues as they arise and the technical ability to resolve
them.

IFRIC interpretations are subject to IASB approval and have the same authority as
a standard issued by the IASB.

13
1.2 International Sustainability Standards Board (ISSB)

The International Sustainability Standards Board (ISSB) was formed on 3

November 2021 as a result of strong market demand for high-quality,
comprehensive global baseline of sustainability disclosures that focus on the needs
of investors and the financial markets.
Sustainability factors are becoming a mainstream part of investment decision-
making. There are increasing calls for companies to provide high-quality, globally
comparable information on sustainability-related risks and opportunities, as
indicated by feedback from many consultations with market participants.
There is also a strong desire to address a fragmented landscape of voluntary,
sustainability-related standards and requirements that add cost, complexity and
risk to both companies and investors.
The ISSB has international support with its work to develop sustainability disclosure
standards backed by the G7, the G20, the International Organization of Securities
Commissions (IOSCO), the Financial Stability Board, African Finance Ministers and
Finance Ministers and Central Bank Governors from more than 40 jurisdictions.
The ISSB has set out four key objectives:

1. to develop standards for a global baseline of sustainability disclosures;

2. to meet the information needs of investors;
3. to enable companies to provide comprehensive sustainability information to
global capital markets; and
4. to facilitate interoperability with disclosures that are jurisdiction-specific and/or
aimed at broader stakeholder groups.

The ISSB builds on the work of market-led investor-focused reporting initiatives,

including the Climate Disclosure Standards Board (CDSB), the Task Force for
Climate-related Financial Disclosures (TCFD), the Value Reporting Foundation’s
Integrated Reporting Framework and industry-based SASB Standards, as well as
the World Economic Forum’s Stakeholder Capitalism Metrics.
The ISSB is committed to delivering standards that are cost-effective, decision-
useful and market informed.

• The standards are developed with efficiency in mind, helping companies to

report what is needed globally to investors across markets globally.
• The standards are designed to provide the right information, in the right way, to
support investor decision-making and facilitate international comparability to
attract capital.

A company can avoid double-reporting by applying the ISSB’s standards. When

jurisdictional requirements build on the global baseline, companies are able to meet
jurisdictional requirements while benefiting from the efficiency and comparability of
the global baseline.

14
2. IAS 1 Presentation of Financial Statements
XYZ Group – Statement of Financial Position as at 31 December 2011

31 Dec 2011 31 Dec 2010

ASSETS $’000 $’000

Non-current assets
Property, plant and equipment 350,700 360,020
Goodwill 80,800 91,200
Other intangible assets 227,470 227,470
Investments in associates 100,150 110,770
FVTOCI financial assets 142,500 156,000
901,620 945,460
Current assets
Inventories 135,230 132,500
Trade receivables 91,600 110,800
Other current assets 25,650 12,540
Cash and cash equivalents 312,400 322,900
564,880 578,740
Total assets 1,466,500 1,524,200
EQUTY AND LIABILITIES
Equity attributable to owners of the parent
Share capital 650,000 600,000
Retained Earnings 243,500 161,700
Other Components of Equity (OCE)
(includes RR, FVTOCI Reserves, Share 10,200 21,200
Options, Foreign Currency reserves)
903,700 782,900
Non-controlling interest 70,050 48,600

Total equity 973,750 831,500

Non-current liabilities
Long-term borrowings 120,000 160,000
Deferred tax 28,800 26,040
Long-term provisions 28,850 52,240

Total non-current liabilities 177,650 238,280

Current liabilities
Trade and other payables 115,100 187,620
Short-term borrowings 150,000 200,000
Current portion of long-term borrowings 10,000 20,000
Current tax payable 35,000 42,000
Short-term provisions 5,000 4,800
Total current liabilities 315,100 454,420
Total liabilities 492,750 692,700
Total equity and liabilities 1,466,500 1,524,200

15
XYZ Group – Statement of Profit or Loss and Other Comprehensive Income
for the year ended 31 December 2011
(presentation in one statement and by function in $’000)

2011 2010
Revenue 390,000 355,000
Cost of sales (245,000) (230,000)
Gross profit 145,000 125,000
Other income 20,667 11,300
Distribution costs (9,000) (8,700)
Administrative expenses (20,000) (21,000)
Other expenses (2,100) (1,200)
Finance costs (8,000) (7,500)
Share of profit of associates 35,100 30,100
Profit before tax 161,667 128,000
Income tax expense (40,417) (32,000)
Profit for the year from continuing operations 121,250 96,000
Loss for the year from discontinued operations - (30,500)
PROFIT FOR THE YEAR 121,250 65,500
Other comprehensive income:
Items that will not be reclassified to profit or loss:
Gains and losses on property revaluation (IAS16) 933 3,367
Remeasurements of net defined benefit pension asset or
liability (IAS 19) (667) 1,333
Gains and losses on remeasuring FA@FVTOCI (IFRS 9) (166) (1,000)
106 3,700
Items that may be reclassified subsequently to profit
or loss:
Group exchange differences from translating functional
currencies into presentation currencies (IAS 21) 5,334 10,667
Effective portion of gains and losses on cash flow hedges
(IFRS 9)
4,833 (8,334)
10,167 2,333
Other comprehensive income for the year, net of tax 10,273 6,033
TOTAL COMPREHENSIVE INCOME FOR THE YEAR _131,523 71,533
Profit attributable to:
Owners of the parent 97,000 52,400
Non-controlling interests 24,250 13,100
121,250 65,500
Total comprehensive income attributable to:
Owners of the parent 85,800 52,833
Non-controlling interests 45,723 18,700
131,523 71,533
Earnings per share (in cents):
Basic and diluted 0.46 0.30

16
XYZ Group – Statement of Changes in Equity (SOCE) for the year ended 31
December 2011 ($’000)
Share Retained Translation FVTOCI Cash Revaluation Total Non - Total
capital earnings of foreign financial flow surplus / controlli equity
operations assets hedge reserve ng
s interest
Balance at
1 January
2010 600,000 118,100 (4,000) 1,600 2,000 - 717,700 29,800 747,500
Changes in
accounting
policy - 400 - - - - 400 100 500
Restated
balance 600,000 118,500 (4,000) 1,600 2,000 - 718,100 29,900 748,000
Changes in
equity for
2010
Dividends - (10,000) - - - - (10,000) - (10,000)
Total
comprehensi
ve income
for the (2,40
(k)
year - 53,200 6,400 16,000 0) 1,600 74,800 18,700 93,500
Balance at
31 Decemb
er 2010 600,000 161,700 2,400 17,600 (400) 1,600 782,900 48,600 831,500
Changes in
equity for
2010
Issue of
share capital 50,000 - - - - - 50,000 - 50,000
Dividends - (15,000) - - - - (15,000) - (15,000)
Total
comprehensi
ve income
for the year - 96,600 3,200 (14,400) (400) 800 85,800 21,450 107,250
Transfer to
retained
earnings - 200 - - - (200) - - -
Balance at
31 Decemb
er 2011 650,000 243,500 5,600 3,200 (800) 2,200 903,700 70,050 973,750

17
3. IFRS 13 Fair Value Measurement

Definition of Fair Value

This IFRS defines fair value as the price that would be received to sell an asset or
paid to transfer a liability in an orderly transaction between market participants at
the measurement date.

Entry Price The price paid to acquire an asset or received to assume a liability in
an exchange transaction.

Exit Price The price that would be received to sell an asset or paid to transfer a
liability.

Expected Cash Flow The probability-weighted average (ie mean of the distribution)
of possible future cash flows.

The Asset or Liability

A fair value measurement is for a particular asset or liability. Therefore, when

measuring fair value an entity shall take into account the characteristics of the
asset or liability if market participants would take those characteristics into account
when pricing the asset or liability at the measurement date. Such characteristics
include, for example, the following:

(a) the condition and location of the asset; and

(b) restrictions, if any, on the sale or use of the asset.

The Transaction

A fair value measurement assumes that the asset or liability is exchanged in an

orderly transaction between market participants to sell the asset or transfer the
liability at the measurement date under current market conditions.

A fair value measurement assumes that the transaction to sell the asset or transfer
the liability takes place either:

(a) in the principal market for the asset or liability; or

(b) in the absence of a principal market, in the most advantageous market for the
asset or liability.

Market Participants

An entity shall measure the fair value of an asset or a liability using the
assumptions that market participants would use when pricing the asset or liability,
assuming that market participants act in their economic best interest.

The Price

Fair value is the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction in the principal (or most advantageous) market at
the measurement date under current market conditions (ie an exit price) regardless
of whether that price is directly observable or estimated using another valuation
technique.

18
Application to non-financial assets

Highest and best use for non-financial assets

A fair value measurement of a non-financial asset takes into account a market

participant’s ability to generate economic benefits by using the asset in its highest
and best use or by selling it to another market participant that would use the asset
in its highest and best use.

Application to liabilities and an entity’s own equity instruments

General Principles

A fair value measurement assumes that a financial or non-financial liability or an

entity’s own equity instrument (eg equity interests issued as consideration in a
business combination) is transferred to a market participant at the measurement
date. The transfer of a liability or an entity’s own equity instrument assumes the
following:

(a) A liability would remain outstanding and the market participant transferee
would be required to fulfill the obligation. The liability would not be settled
with the counterparty or otherwise extinguished on the measurement date.

(b) An entity’s own equity instrument would remain outstanding and the market
participant transferee would take on the rights and responsibilities associated
with the instrument. The instrument would not be cancelled or otherwise
extinguished on the measurement date.

Valuation Techniques

An entity shall use valuation techniques that are appropriate in the circumstances
and for which sufficient data are available to measure fair value, maximising the
use of relevant observable inputs and minimising the use of unobservable inputs.

Market Approach
The market approach uses prices and other relevant information generated by
market transactions involving identical or comparable (ie similar) assets, liabilities
or a group of assets and liabilities, such as a business.

Cost Approach
The cost approach reflects the amount that would be required currently to replace
the service capacity of an asset (often referred to as current replacement cost).

Income Approach
The income approach converts future amounts (eg cash flows or income and
expenses) to a single current (ie discounted) amount. When the income approach is
used, the fair value measurement reflects current market expectations about those
future amounts.

Present Value Techniques

This is the use of present value techniques to measure fair value.

19
Inputs to valuation techniques

General Principles

Valuation techniques used to measure fair value shall maximise the use of relevant
observable inputs and minimise the use of unobservable inputs.

Fair Value Hierarchy

To increase consistency and comparability in fair value measurements and related

disclosures, this IFRS establishes a fair value hierarchy that categorises into three
levels, the inputs to valuation techniques used to measure fair value. The fair value
hierarchy gives the highest priority to quoted prices (unadjusted) in active markets
for identical assets or liabilities (Level 1 inputs) and the lowest priority to
unobservable inputs (Level 3 inputs).

Level 1 Inputs (highest priority)

Level 1 inputs are quoted prices (unadjusted price is the most reliable fair value) in
active markets for identical assets or liabilities that the entity can access at the
measurement date.

A Level 1 input will be available for many financial assets and financial liabilities,
some of which might be exchanged in multiple active markets (eg on different
exchanges). Therefore, the emphasis within Level 1 is on determining both of the
following:

(a) the principal market for the asset or liability or, in the absence of a principal
market, the most advantageous market for the asset or liability; and

(b) whether the entity can enter into a transaction for the asset or liability at the
price in that market at the measurement date.

Level 2 Inputs

Level 2 inputs are inputs other than quoted prices included within Level 1 that are
observable for the asset or liability, either directly or indirectly.

If the asset or liability has a specified (contractual) term, a Level 2 input must be
observable for substantially the full term of the asset or liability. Level 2 inputs
include the following:

(a) quoted prices for similar assets or liabilities in active markets.

(b) quoted prices for identical or similar assets or liabilities in markets that are
not active.

(c) inputs other than quoted prices that are observable for the asset or liability,
for example:

(i) interest rates and yield curves observable at commonly quoted intervals;

(ii) implied volatilities; and

(iii) credit spreads.

(d) market-corroborated inputs.

20
Level 3 Inputs (lowest priority)

Level 3 inputs are unobservable inputs for the asset or liability.

Unobservable inputs shall be used to measure fair value to the extent that relevant
observable inputs are not available, thereby allowing for situations in which there is
little, if any, market activity for the asset or liability at the measurement date.
However, the fair value measurement objective remains the same, ie an exit price
at the measurement date from the perspective of a market participant that holds
the asset or owes the liability. Therefore, unobservable inputs shall reflect the
assumptions that market participants would use when pricing the asset or liability,
including assumptions about risk.

21
Assets and their respective IASs as presented in Financial Statements:

Statement of Financial Position (SOFP) as at 31.3.2012

Assets
Non-Current Assets Relevant IASs
Tangible
Property, plant and equipment (PPE) IAS 16 + 23 + 36
PPE on finance leases IFRS 16
Investment properties IAS 40

Intangible
Goodwill (purchased goodwill) IFRS 3
Intangible assets (brand name, software) IAS 38
Development expenditure capitalised IAS 38

Current Assets
Inventories IAS 2 + Substance over form
Amount due from customers IAS 11
Trade receivables IFRS 9
Grant receivables IAS 20

22
4. IAS 16 Property, Plant and Equipment

4.1 Initial Measurement at COST

Initial cost of PPE includes the following:

1. Purchase + 2. Specific + 3. Attributable + 4. Borrowing + 5. Future

Cost Labour Cost Cost Cost

1. Purchase Cost
Purchase price after trade but before settlement discounts, and includes
transport and handling costs and non-refundable tax such as import duties, etc

2. Specific Labour
If self-constructed, labour costs of own employees (but abnormal costs such as
wastage and errors are excluded). Please note: Also written off to Statement of
Profit or Loss (SOPL) immediately are staff training costs – these must not be
capitalised; even IAS 38 on Intangibles says so.

3. Attributable Cost
These includes site-preparation and installation costs and professional fees
(such as legal and architect’s fees)

4. Borrowing Cost
Also included can be borrowing costs under IAS 23 during construction phase
only (for self-constructed assets); and

5. Future Cost
The future removing, dismantling and restoration costs which qualify as a
liability (where a present obligation exists) under IAS 37, after discounting to
present value, must be included in the initial cost of PPE. Incidentally if
discounted, it must be unwound i.e. compound present value to future value.
The journal entry is as follows:

Dr NCA – PPE (Asset)

Cr Provision for restoration (Liability)

The debit entry will add to the Initial Cost of the PPE and cause more
depreciation, while the credit entry to provisions will gradually be added to, as
the unwinding process unfolds. The journal entry of unwinding of finance
cost is as follows:

Dr Finance Cost (SOPL)

Cr Provision for restoration (Liability)

23
4.2 Subsequent Measurement

IAS 16 allows for 2 subsequent measurement models, namely the Cost Model and
the Revaluation Model. Entities shall apply that model to the entire class of PPE.

Cost Model
Historical Cost of PPE – Acc Dep = Carrying Value (CV)

Revaluation Model
Fair Value of PPE – Acc Dep = Carrying Value

4.3 Methods of Depreciation

1. Straight line method

Depreciation = given % x Cost or (Cost – Residual Value) / useful life

2. Reducing balance method

Depreciation = *CV x given % = falling depreciation charge

*Carrying Value (CV) = Cost – Acc Dep – Acc Impairment

 R
Depreciation % = 1 − n   100%
 C

where n : no. of useful life

R : residual value
C : cost of asset

As residual value have already been included, there is no need to minus it from the
cost price when calculating depreciation using the reducing balance method.

3. Machine hour (Flying hour) rate method which is an allocation of depreciation to

the usage of the machine. More machine hours used would generate more
depreciation charges, vice versa.

4. Each part of an item of property, plant and equipment with a cost that is
significant in relation to the total cost of the item shall be depreciated separately.

5. The depreciable amount of an asset shall be allocated on a systematic basis over

its useful life.

6. The residual value and the useful life of an asset shall be reviewed at least at
each financial year-end and, if expectations differ from previous estimates, the
change(s) shall be accounted for prospectively as a change in an accounting
estimate in accordance with IAS 8 Accounting Policies, Changes in Accounting
Estimates and Errors.

7. The depreciation method used shall reflect the pattern in which the asset’s future
economic benefits are expected to be consumed by the entity.

24
8. The depreciation method applied to an asset shall be reviewed at least at each
financial year-end and, if there has been a significant change in the expected
pattern of consumption of the future economic benefits embodied in the asset, the
method shall be changed to reflect the changed pattern. Such a change shall be
accounted for as a change in an accounting estimate in accordance with IAS 8.

4.4 Revision of Assets Lives

A change in asset lives is not a change in accounting policy (IAS 8).

The asset will then be depreciated over its revised useful life (maybe longer or
shorter).

Revised Depreciation = (Remaining CV – Residual Value) / Remaining useful life

4.5 Change in depreciation method

A change in method is not a change in accounting policy (IAS 8).

Revised Depreciation = (Remaining CV – Residual Value) / Remaining useful life

4.6 Revaluation Model: Revaluation upwards

When an asset increases in value for the first time, the increase is credited (Cr) to
the revaluation reserve (revaluation surplus).

DR Non-Current Assets cost/valuation (Cost/CV is increased, Cr if decreased)

DR Accumulated depreciation (The acc dep on the asset is eliminated)
CR Revaluation Reserve (RR)

IAS 1 requires increase or decrease in revaluation be disclosed in OCI as “items

that will not be reclassified to profit or loss”

Unless there was a previous impairment (revaluation downwards) on the same

asset, then, any subsequent increases will be credited to the SOPL and excess to
Revaluation Reserve.

DR NCA
CR SOPL (to offset previous impairment charge)
CR RR (any excess)

The figure posted to the revaluation reserve can be calculated quickly as follows:

Revaluation Reserve = Fair Value (FV) – CV at date of revaluation

25
4.7 Transfer from RR to RE

Rule #1 RR created and #2 New Dep > Old Dep

Each year the extra depreciation charged as a result of the revaluation should be
transferred from the revaluation reserve to retained earnings. This is a movement
within equity that appears only in SOCE.

DR Revaluation Reserve (RR)

CR Retained Earnings (RE)

4.8 Revaluation Model: Revaluation downwards

When an asset decreases in value for the first time, the revaluation loss is debited
(DR) to the SOPL.

DR Acc Dep
DR SOPL
CR NCA

However, if previous revaluation upwards exist in the revaluation reserve, then any
subsequent revaluation downwards will first eliminate the existing remaining
revaluation reserve with any excess charged to the SOPL.

DR RR (first eliminate)
DR SOPL (any excess)
DR Acc Dep
CR NCA

4.9 Disposal of a previously revalued asset

When a revalued asset is sold the basic accounting is the same for an asset held at
depreciated historic cost.

DR Bank
DR Acc Dep
CR PPE, Cost
CR Gain on Disposal (Balance), if Loss on disposal, then DR

However, there is potentially an additional journal to complete. Should any balance

remain in the revaluation reserve for this asset it should be transferred to Retained
Earnings. This is a posting in the SOCE and not in the OCI.

DR Revaluation Reserve (RR)

CR Retained Earnings (RE)

26
5. IAS 23 Borrowing Cost

Interest expenses (finance cost) incurred on borrowing to self-construct, acquire

and production of a qualifying asset must be capitalised i.e. as an addition to the
cost of the non-current asset itself.

• Capitalisation of borrowing cost shall begin when the construction /

development starts or when the borrowing starts, whichever is later.

• Capitalisation of borrowing costs shall be suspended, but is written off to

Statement of Profit or Loss, during extended periods in which active
development is interrupted

• Capitalisation shall cease when construction / development is complete or when

the borrowing cost no incurred, whichever is sooner.

• Borrowing costs must be capitalised as part of the cost of that asset. Borrowing
costs are based on the effective interest rates on specifically borrowed funds or
on the weighted average cost of a pool of funds such as overdraft facilities in
the form of general borrowings.

Specifically borrowed funds: Borrowing Cost = EIR% x Specific Loan

Pool of funds: Borrowing Cost = Weighted Average Cost x Asset Value

• Capitalisation should commence when expenditure is being incurred on the

asset, but this is not necessarily from the date funds are borrowed

• Interest earned from the temporary investment of specific loans should be

deducted from the Borrowing being capitalised, except during periods of
suspension (or before construction/development begins)

• If not eligible for capitalisation, borrowing cost must be expensed. B/C cannot
be capitalised for assets measured at fair value

Borrowing Construction Borrowing Construction

Starts Starts Stops Stopped / Completed

Years

Capitalisation Capitalisation
starts from later Capitalisation be suspended stops at earlier
of 2 dates if construction is interrupted of 2 dates

27
6. IAS 38 Intangible Assets

6.1 4 Characteristics of Intangible Assets

When all 4 characteristics of an Intangible Asset are met, it will be capitalised on

the face of the SOFP.

1. separately identifiable

2. control exist

3. future economic benefits

4. reliable estimate

All above four characteristics must be met to recognise an intangible asset on the
statement of financial position. If they are not met, the amount must be expensed
off to the statement of profit or loss unless it forms part of a Business Combination
such as a parent company acquires a subsidiary company, then the amount shall be
capitalised as part of purchased goodwill.

6.2 Measurement

An intangible asset shall be measured initially at cost.

Cost Model

After initial recognition, an intangible asset shall be carried at its cost less any
accumulated amortisation and any accumulated impairment losses. Brands acquired
shall be recognised as cost model.

Revaluation Model

After initial recognition, an intangible asset shall be carried at a revalued amount

only when active market exist, being its fair value at the date of the revaluation
less any subsequent accumulated amortisation and any subsequent accumulated
impairment losses. For the purpose of revaluations under this Standard, fair value
shall be determined by reference to an active market. Revaluations shall be made
with such regularity that at the balance sheet date the carrying amount of the asset
does not differ materially from its fair value.

6.3 Intangible Assets with Finite Useful Lives

The depreciable amount of an intangible asset with a finite useful life shall be
amortised on a systematic basis over its useful life.

Intangible Assets with Indefinite Useful Lives

An intangible asset with an indefinite useful life shall not be amortised but tested
for impairment under IAS 36 Impairment of Assets.

28
6.4 Internally generated intangible assets
Internally generated brands, mast heads, publishing titles, customer lists and items
similar in substance shall not be recognised as intangible assets (they cannot be
distinguished from the cost of developing the business as a whole).

6.5 Research is original and planned investigation undertaken with the

prospect of gaining new scientific or technical knowledge and understanding.
Research expenses are charged to the statement of profit or loss when incurred.

6.6 Development is the application of research findings or other knowledge to

a plan or design for the production of new or substantially improved materials,
devices, products, processes, systems or services before the start of commercial
production or use. Development costs are charged to as expenses in the
Statement of Profit or Loss (SOPL) unless it meets all the following 6 criteria,
then, it will be recognised as Intangible Assets in SOFP as Development Costs
Capitalised and will be amortised when benefits start to flow into the company.

(1) the technical feasibility of completing the intangible asset so that it will be
available for use or sale.

(2) its intention to complete the intangible asset and use or sell it.

(3) its ability to use or sell the intangible asset.

(4) how the intangible asset will generate probable future economic benefits.
Among other things, the entity can demonstrate the existence of a market for
the output of the intangible asset or the intangible asset itself or, if it is to be
used internally, the usefulness of the intangible asset.

(5) the availability of adequate technical, financial and other resources to

complete the development and to use or sell the intangible asset.

(6) its ability to measure reliably the expenditure attributable to the intangible
asset during its development.

29
7. IAS 36 Impairment of Assets
An asset is impaired when its carrying amount is greater than its recoverable
amount, in turn, the recoverable amount (RA) of an asset is defined as the
higher of its fair value less cost to sell (FVLCS) of disposal and its value in use
(VIU).
i.e. NCA, CV > RA = impairment of assets

Carrying Value > Recoverable Amount

Greater of

Fair Value less cost to sell Value in Use (PV of future cash flow
i.e. PVFCF)
Frequency of Impairment Testing

IAS 36 required the recoverable amount of an asset to be measured whenever

there is an indication that the asset may be impaired and at least at year end. The
Standard also requires:

(a) the recoverable amount of an intangible asset with an indefinite useful life to
be measured annually, irrespective of whether there is any indication that it
may be impaired.

(b) the recoverable amount of an intangible asset not yet available for use to be
measured annually, irrespective of whether there is any indication that it
may be impaired.

(c) goodwill acquired in a business combination to be tested for impairment

annually.

7.1 External sources of Impairment

(a) significant decline in asset’s market value

(b) significant adverse changes in PESTEL factors

(c) increase in interest rates resulting in decreases in the asset’s value in use
and recoverable amount

(d) the carrying amount of the net assets of the entity is more than its market
capitalisation

7.2 Internal sources of Impairment

(e) evidence of obsolescence or physical damage of an asset

(f) significant adverse changes such as the asset becoming idle, plans to
discontinue or restructure the operation, plans of early dispose of an asset
and reassessing the useful life of an asset as finite rather than indefinite

(g) evidence is available from internal reporting that indicates that the economic
performance of an asset is, or will be, worse than expected

30
7.3 Impairment Losses of a Single Asset

Impairment losses are written off to the Statement of Profit or Loss (SOPL) unless a
previous revaluation surplus exists on the same asset.

DR RR (to eliminate any remaining balance)

DR P&L (excess)
CR NCA

7.4 Impairment Losses of a Group of Assets

Impairment losses are written off to the SOPL and credited in the following priority:

DR P&L
CR Specific NCA
CR Goodwill
CR Other NCA on pro-rata basis on capital value
(these NCA shall not be reduced below their RA and zero)
Impairment losses should be charged to the profit or loss after eliminating any
previous Revaluation Reserve for the specific asset.

Subsequent revaluation would eliminate any impairment losses charged to profit or

loss before crediting to Revaluation Reserve.

7.5 Reversal of Impairment Loss

Reversals of previously impaired asset shall be credited back to the SOPL an

amount equal to offset a previous impairment charge.

Reversal of NCA represents an increase in asset value:

DR NCA
CR P&L (to offset the previous impairment charge on the same asset)
CR RR (excess to RR)

31
8. IAS 40 Investment Properties

An investment property is property held (owned or under a finance lease) for

rentals or capital appreciation or both, rather than for:

Use in the production or supply of goods or services or for administrative purposes,

or Sale in the ordinary course of business

8.1 Treatment

Fair value model - changes in fair value being recognised in profit or loss

(Caution: FV model must not be confused with revaluation model where increases
go to a revaluation reserve).

Cost model (as per IAS 16)

8.2 Transfer from IAS 40 Investment Property to own use IAS 16 PPE

The fair value at date of change will become the cost price of PPE

Dr PPE $Cost
Cr Investment Property $FV

8.3 Transfer from own use IAS 16 PPE to IAS 40 Investment Property
First, revalue under IAS 16 from cost to FV.

Next, transfer to Investment Property Account.

Dr Investment Property at $FV

Dr Acc Dep
Cr PPE, cost
Cr SOPL (first reverse previous charge)
Cr Revaluation Reserve (then to RR)

If impairment of PPE exist,

Dr Investment Property at $FV

Dr Revaluation Reserve (first reverse RR)
Dr SOPL (then excess charge to SOPL)
Dr Acc Dep
Cr PPE, cost

At year end, if FV increase: Dr Investment Property

Cr Revaluation Reserve

At year end, if FV decrease: Dr Revaluation Reserve (first eliminate)

Dr SOPL (then excess charge to SOPL)
Cr Investment Property

32
9. IAS 2 Inventories

Inventories should be carried at the lower of cost and net realisable value (NRV)

9.1 Cost of Inventories

The cost of inventories shall comprise all costs of purchase, costs of conversion and
other cost incurred in bringing the inventories to their present location and
condition.

Cost of purchase
Purchase price, irrecoverable taxes, transport, handling and other costs directly
attributable to the acquisition of finished goods, materials and services.

Trade discounts are deducted but cash or settlement discounts are not.

Costs of conversion
Costs directly related to the units of production, such as direct labour. exclusions:
abnormal costs, storage costs, administration costs and selling expenses.

9.2 Net Realisable Value

The amount at which the inventories are expected to realise should be based on the
most reliable evidence available at the time of the estimate less any costs directly
related to selling the inventories.

For consistency purposes, an entity shall apply the FIFO or Weighted Average to all
inventories of the same nature. The standard does not allow LIFO.

33
10. IAS 41 Agriculture

This standard should be applied to account for the following when they relate to
agricultural activity:

(a) biological assets;

(b) agricultural produce at the point of harvest; and
(c) government grants.

IAS 41 is applied to the agriculture produce at the point of harvest. Thereafter, IAS
2 Inventories or another applicable IAS.

FRS 41 does not deal with processing of agricultural produce after harvest.

Recognition and measurement

A biological asset or agricultural produce is recognised when all the following are
met:

1. control exist,
2. future probable benefits, and
3. fair value or cost can be measure reliably

If the fair value is unavailable, the biological asset shall be measured at the Cost
Model (cost less accumulated depreciation less any accumulated impairment losses)

When fair value becomes available, the biological asset shall be measured at fair
value less cost to sell.

Finance costs, taxation and relocation costs are not capitalised as part of biological
asset or agricultural produce.

Gains and losses

1. Changes in fair value to profit or loss in the period it arises

2. A loss may arise from initial recognition of biological asset due to cost to sell
exceeds the fair value.
3. A gain may arise from initial recognition due to a biological asset is born.
4. A gain or loss may arise at the point of harvesting the agricultural produce.

Government Grant

For biological assets measured at fair value less cost to sell:

1. An unconditional government grant should be recognised in the SOPL when it

becomes receivable.
2. A conditional government grant is recognised when the attaching conditions are
met.

34
11. IAS 20 Accounting for Government Grants and Disclosure
of Government Assistance

Government assistance takes many forms, including grants, equity finance,

subsidised loans and advisory assistance.

Government grants are made to persuade or assist enterprises to pursue courses of

action which are deemed to be socially or economically desirable.

11.1 Grant to buy asset

Such as HDB Grants, government grants for schools and hospitals to buy equipments
(NCA).

a. grant to be set up as Deferred Income (SOFP as liability) which is then

recognised as income on a systematic and rational basis over the useful life of
the asset. It is necessary to split the deferred income into CL and NCL.

Dr Bank
Cr NCL – Deferred Income
Cr CL – Deferred Income

And amortise when depreciation is charged

Dr CL – Deferred Income
Cr P&L – Grant Income

b. deduct the grant from the cost of the asset and depreciate the net cost.

11.2 Grant to pay expenses

Such as Jobs Credit in 2009 during the Financial Crisis to help companies pay salary
expenses.

a. grant should be recognised immediately in the P&L so a s to match them

with the expenditure during the same accounting period.

b. If related to future periods, grant should be recognised as deferred income

In SOFP split between Current and Non-current liabilities (important exam
point) and amortised when future expenses are incurred. (matching
principle)

35
12. IFRS 15 Revenue with Contracts with Customers

Revenue is income arising in the course of an entity’s ordinary activities.

12.1 Recognition

An entity shall recognise revenue that depict the transfer of promised goods or
services by applying the following 5 steps:

Step 1: Identify the contract with a customer

Step 2: Separately identify each performance obligations in the contract

Step 3: Determine the transaction price (consideration)

Step 4: Allocate the transaction price to separate performance obligations in

the contract

Step 5: Recognise revenue as the entity satisfies a performance obligation

12.2 Presentation

When either party to a contract has performed, an entity shall present the contract
in the statement of financial position as a contract asset or a contract liability,
depending on the relationship between the entity’s performance and the customer’s
payment. An entity shall present any unconditional rights to consideration
separately as a receivable.

12.3 Contract Revenue and Costs

A construction contract is a contract specifically negotiated for the construction of

an asset or a combination of assets that take a long time to complete such as the
construction of a bridge, building, dam, pipeline, road, ship or tunnel.

The service provider will charge a contract fee, incur contract costs and earn a
contract profit. Due to the long-term nature of construction contracts, the customer
will make progress payments to the construction company.

It is necessary for the construction company to recognise contract revenue,

contract cost and contract profit in the SOPL on an accruals basis. The resulting
contract asset (or contract liability) will appear in the SOFP.

36
Contract with performance obligation satisfied over time

A construction contract is a contract specifically negotiated for the construction of

an asset or a combination of assets that take a long time to complete such as the
construction of a bridge, building, dam, pipeline, road, ship or tunnel.

The service provider will charge a contract fee, incur contract costs and earn a
contract profit. Due to the long-term nature of construction contracts, the customer
will make progress payments to the construction company.

It is necessary for the construction company to recognise contract revenue,

contract cost and contract profit in the SOPL on an accruals basis. The resulting
contract asset (or contract liability) will appear in the SOFP.

This can be done using an Input Method to calculate the estimated contract profit
based on percentage of completion as follows:

1. Cost to date as a percentage of Total Contract Cost:

Cost to date = Percentage completion (%)

Total Contract Cost

OR

2. Agreed Value of Work Completed as a percentage of the Agreed

Contract Price:

Agreed Value of Work Completed = Percentage completion (%)

Contract Price

Contract Revenue to date (% x Contract Revenue) $x

Less: Amount invoiced to date ($x)
Contract asset or (contract liability) $x / ($x)

In the early stages of a contract, an entity may not be able to reasonably measure
the outcome of a performance obligation, but the entity expects to recover the
costs incurred in satisfying the performance obligation.

The entity shall recognise revenue only to the extent of the costs incurred until
such time that it can reasonably measure the outcome of the performance
obligation.

For contracts where performance obligations are satisfied over a period of time, the
stage of completion is required to calculate how much revenue should be
recognised to date. There is no requirement to calculate the estimated profit/loss
on the contract (except to the extent of determining whether the contract is
onerous).

For the purposes of the FR exam, any costs incurred to fulfil a contract with a
customer should be expensed to the statement of profit or loss as they are
incurred.

37
Statement of Profit or Loss and Other Comprehensive Income (SOPL &
OCI) for year ended 31.3.2012

Statement of Profit or Loss Relevant standards

Finance cost IFRS 9 at EIR

Profit before tax

Tax (both income tax and deferred tax) IAS 12
Profit after tax

Other comprehensive income

Gain (loss) on FVTOCI financial asset IFRS 9

Statement of Financial Position as at 31.3.2012

Non-Current Assets Relevant standards

PPE under finance leases IFRS 16
Equity and Reserve
Equity share capital
Other components of equity
Other Reserves - Option to convert to Equity IAS 32 + IFRS 9 + IFRS 7
Non-Current Liabilities
Lease obligations > 12 months IFRS 16
10% Convertible Debt add unwinding
of finance cost (amortised cost) IAS 32 + IFRS 9 + IFRS 7
Redeemable Preference Share Capital IAS 32 + IFRS 9 + IFRS 7
Deferred Tax Liabilities (DTL) IAS 12

Current Liabilities
Account payables IAS 37
Provisions IAS 37 + IAS 10
Lease obligations < 12 months IFRS 16
Accrued lease interest IFRS 16
Provision for taxation IAS 12

38
13. IAS 37 Provisions, Contingent Liabilities and Contingent
Assets

13.1 Liability
A liability is a present obligation of the entity arising from past events, the
settlement of which is expected to result in an outflow from the entity of resources
embodying economic benefits.

13.2 Provision
A provision is a liability of uncertain timing or amount.

Obligating Event
An obligating event is an event that creates a legal or constructive obligation that
results in an entity having no realistic alternative to settling that obligation.

Legal Obligation
A legal obligation is an obligation that derives from:

(a) a contract (through its explicit or implicit terms);

(b) legislation; or

(c) other operation of law.

Constructive Obligation

A constructive obligation is an obligation that derives from an entity’s actions

where:

(a) by an established pattern of past practice, published policies or a sufficiently

specific current statement, the entity has indicated to other parties that it
will accept certain responsibilities; and

(b) as a result, the entity has created a valid expectation on the part of those
other parties that it will discharge those responsibilities.

13.3 A Contingent Liability is:

(a) a possible obligation that arises from past events and whose existence will
be confirmed only by the occurrence or non-occurrence of one or more
uncertain future events not wholly within the control of the entity; or

(b) a present obligation that arises from past events but is not recognised
because:

(i) it is not probable that an outflow of resources embodying economic

benefits will be required to settle the obligation; or

(ii) the amount of the obligation cannot be measured with sufficient

reliability.

13.4 Contingent Asset

A contingent asset is a possible asset that arises from past events and whose
existence will be confirmed only by the occurrence or non-occurrence of one or
more uncertain future events not wholly within the control of the entity.

39
13.5 Warranties and Guarantees

A provision should be recognised for the best estimate of the costs of making good
under the warranty products sold before the SOFP date.

13.6 Onerous Contract

An onerous contract is a contract in which unavoidable costs of meeting the

obligations under the contract exceed the economic benefits expected to be
received under it. Prudence would require that if a future liability is foreseen we
should recognise it.

Dr SOPL as Expenses
Cr Liability

The present obligation under the contract should be recognised as a provision.

13.7 Restructuring

Examples of restructuring include sale or termination of a business, closure or

relocation of a business, changes in management structure, fundamental
reorganisations.

A provision should only be recognised if both conditions are met

1. detailed formal plan for the restructuring has been identified

2. valid expectation has been raised in those affected that it will be carried out
by either implementing the plan or announcing it to those affected

13.8 Future restoration and removal cost

The present value of the future restoration cost must be provided for in NCL and
the unwinding of finance cost must be carried out to increase the NCL. See also IAS
16.

13.9 Future operating losses

No provision for future operating losses is allowed as no past event had taken
place, such as future interest costs in Finance Leases (IFRS 16) cannot be provided.
However, an expected future operating loss may require impairment testing under
IAS 36.

13.10 Reimbursements

Any insurance reimbursements will be recognised as a separate asset.

40
14. IAS 21 The Effects of Changes in Foreign Exchange Rates

A foreign currency transaction is a transaction that is denominated or requires

settlement in a foreign currency, including transactions arising when an entity:

(a) buys or sells goods or services whose price is denominated in a foreign

currency;

(b) borrows or lends funds when the amounts payable or receivable are
denominated in a foreign currency; or

(c) otherwise acquires or disposes of assets, or incurs or settles liabilities,

denominated in a foreign currency.

Definitions

Closing rate is the spot exchange rate at the year end.

Spot exchange rate is the exchange rate for immediate delivery.

Functional currency is the currency of the primary economic environment in

which the entity operates.

Presentation currency is the currency in which the financial statements are

presented.

Monetary items are units of currency held and assets and liabilities to be received
or paid in a fixed or determinable number of units of currency.

Foreign operation is an entity that is a subsidiary, associate, joint venture or

branch of a reporting entity, the activities of which are based or conducted in a
country or currency other than those of the reporting entity.

Net investment in a foreign operation is the amount of the reporting entity’s

interest in the net assets of that operation.

41
Recognition

A foreign currency transaction shall be recorded, on initial recognition in the

functional currency, by applying to the foreign currency amount the spot exchange
rate between the functional currency and the foreign currency at the date of the
transaction.

Exchange differences arising on the settlement of monetary items or on translating

monetary items shall be recognised in profit or loss in the period in which they
arise.

The results and financial position of an entity shall be translated into a different
presentation currency using the following procedures:

(a) assets and liabilities for each statement of financial position presented (i.e.
including comparatives) shall be translated at the closing rate at that year
end;

(b) income and expenses for each Statement of Profit or Loss and Other
Comprehensive Income (i.e. including comparatives) shall be translated at
exchange rates at the dates of the transactions; and

(c) all resulting exchange differences shall be recognised as a separate

component of equity.

For practical reasons, a rate that approximates the exchange rates at the dates of
the transactions, for example an average rate for the period, is often used to
translate income and expense items. However, if exchange rates fluctuate
significantly, the use of the average rate for a period is inappropriate.

Matching Principle

When a gain or loss on a non-monetary item is recognised directly in equity, any

exchange component of that gain or loss shall be recognised directly in equity.

Conversely, when a gain or loss on a non-monetary item is recognised in profit or

loss, any exchange component of that gain or loss shall be recognised in profit or
loss.

42
15. IAS 32 Financial Instruments: Presentation

The issuer of a financial instrument shall classify in accordance with the substance
of the contractual arrangement and the definitions of a financial liability, a financial
asset and an equity instrument.

15.1 Financial Asset

A financial asset is any asset that is:

(a) cash;

(b) an equity instrument of another entity;

(c) a contractual right:

(i) to receive cash or another financial asset from another entity; or

(ii) to exchange financial assets or financial liabilities with another entity

under conditions that are potentially favourable to the entity; or

(d) a contract that will or may be settled in the entity’s own equity instruments

15.2 Financial Liabilities

A financial liability is any liability that is:

(a) a contractual obligation:

(i) to deliver cash or another financial asset to another entity; or

(ii) to exchange financial assets or financial liabilities with another entity

under conditions that are potentially unfavourable to the entity; or

(b) a contract that will or may be settled in the entity’s own equity instruments

15.3 Equity Instrument

An equity instrument is any contract that evidences a residual interest in the assets
of an entity after deducting all of its liabilities.

That is, Assets – Liabilities = Equity

43
15.4 Compound Instruments

The issuer of a non-derivative financial instrument shall evaluate the terms of the
financial instrument to determine whether it contains both a liability and an
equity component. Such components shall be classified separately as financial
liabilities, financial assets or equity instruments.

a. Convertible Debt

At the issue date, split:

Debt at issue date

= PVFCF discounted at equivalent interest rate without conversion rights

Equity – Share Option in Other Components of Equity (OCE)

= Total Amount Received - PVFCF

b. Redeemable Preference Shares

This have the legal form of equity but the substance of a liability.

IAS 32 requires:

Redeemable Preference Shares to be disclosed as NCL in the SOFP and

Preference Dividends as Finance Cost in the SOPL.

44
16. IFRS 9 Financial Instruments

16.1 Initial Measurement

At initial recognition an entity shall measure financial assets at Fair Value (FV) add
transaction cost, except:

1. Financial Assets at Fair Value through Profit or Loss, and

2. Trade Receivables that do not have a significant financing component at their

transaction price (in accordance to IFRS 15)

16.2 Subsequent Measurement – Financial Assets

1. Fair Value Through Profit or Loss (FVTPL)

This is the normal default classification for financial assets and will apply to all
financial assets unless they are designated to be measured and accounted for in
any other way and includes any financial assets held for trading purposes and also
derivatives.

Initial recognition at fair value is normally cost incurred and this will exclude
transactions costs, which are charged to profit or loss as incurred.

Remeasurement to fair value takes place at each reporting date, with any
movement in fair value taken to profit or loss for the year, which effectively
incorporates an annual impairment review.

2. Fair Value Through Other Comprehensive Income (FVTOCI)

This classification applies to equity instruments only and must be designated

upon initial recognition. It will typically be applicable for equity interests that an
entity intends to retain ownership of on a continuing basis.

Initial recognition at fair value would include transaction costs of purchase. The
accounting treatment automatically incorporates an impairment review, with any
change in fair value taken to other comprehensive income in the year.

Upon derecognition, Dr OCE Cr RE to remove the movements in FV in OCE. There is

no recycling of FVTOCI to P&L. Thus, it will not be disclosed as “items that may be
reclassified subsequently to profit or loss” in IAS 1.

45
3. Amortised Cost

This classification can apply to debt instruments and must be designated upon
initial recognition. For the designation to be effective, the financial asset must pass
two tests as follows:

(a) Business Model Test

the financial asset is held within a business model whose objective is to hold
financial assets in order to collect contractual cash flows and

(b) Cash Flow Characteristics Test

the contractual terms of the financial asset give rise on specified dates to
cash flows that are solely payments of principal and interest on the principal
amount outstanding.

Financial Assets:
1. FVTPL = remeasure at FV with changes to SOPL
Intend to trade, default classification, FVTPL = FV only. Exp off Transaction cost

2. FVTOCI = remeasure at FV with changes to OCI

Intend to hold, equity shares only, FVTOCI = FV + Transaction cost

3. Amortised cost = remeasure at amortised cost using EIR method

Loan receivables only. Capitalise Transaction cost.
Amortised cost = PVFCF @ original EIR

16.3 Impairment of Financial Asset

Impairment will be recognised based on loss expectations, which will allow entities
to start providing for impairment earlier than under the incurred-loss model.

Under the expected-loss model, the amortised cost of a loan or other financial asset
is calculated using the effective interest rate method (EIR), as being the present
value of the expected cashflows (PVFCF) over the life of the loan, discounted at the
EIR.

Unlike the incurred-loss model, it does not wait for a loss event before recognising
that a certain level of impairment will reduce the recoverable amount of the loans.
In certain circumstances, particularly where there is deterioration in underlying
economic conditions, the basis for estimating the expected cashflows may be
changed during the life of the loan and the consequent increase in loss provision
would be recognised immediately.

16.4 Financial Liabilities

A Financial Liability is first measured at its fair value less issue cost except
financial liability at FVTPL only measure at fair value.

After initial recognition, an entity shall measure all financial liabilities at amortised
cost using the effective interest method, except for financial liabilities at fair value
through profit or loss (FVTPL).

46
17 IFRS 7 Financial Instruments: Disclosures

The IFRS requires disclosure of:

(a) the significance of financial instruments for an entity’s financial position and
performance.

(b) qualitative and quantitative information about exposure to risks arising from
financial instruments, including specified minimum disclosures about credit
risk, liquidity risk and market risk. The qualitative disclosures describe
management’s objectives, policies and processes for managing those risks.
The quantitative disclosures provide information about the extent to which the
entity is exposed to risk, based on information provided internally to the
entity’s key management personnel. Together, these disclosures provide an
overview of the entity’s use of financial instruments and the exposures to
risks they create.

47
18. IAS 12 Income Taxes
SOPL (by nature) Tax Computation

Sales (cash + credit) x Profit before tax A

Less: COS (cash pur + credit pur) (x) Add back non-deductible expenses:
Gross Profit x Depreciation x
Less: Depreciation (x) Provisions x
Provisions (x) Interest expenses accrued x
Salaries (x) Government fines x
Finance cost (x)
Government Fines (x) Less deductible expenses:
Profit before tax A Capital allowances (x)
Less: Tax expenses (x) Expenses paid (x)
Profit after tax x Chargeable Income B

The ‘tax expenses’ comprise of:

Current year provision x

Add: under provision for tax expenses in the previous year x
Less: over provision for tax expenses in the previous year (x)
Add: deferred tax for the year x
Taxation charge for the year x

18.1 Deferred Tax Liabilities (DTL)

CV of Asset > TB of Asset = TTD x TR = DTL c/d

CV of Asset < TB of Asset = DTD x TR = DTA c/d

18.2 Deferred Tax Assets (DTA)

CV of Liability > TB of Liability = DTD x TR = DTA c/d

CV of Liability < TB of Liability = TTD x TR = DTL c/d

__________

Net DTL c/d in SOFP

18.3 Increase DTL entries: Dr Tax

Cr DTL

18.4 Increase DTL due to Revaluation Upwards: Dr RR (TR% x RR)

Dr Tax (balance)
Cr DTL
18.5 Decrease DTL entries: Dr DTL
Cr Tax

48
19. Substance over Form

Form refers to the legal position which often relates to the ownership of legal title
of an asset.

Substance refers to the economic reality of the situation i.e. is the asset actually
treated as if it’s owned.

19.1 Sale and Repurchase

Legal form is such that the asset is sold with an option to repurchase

Substance is to treat as a secured loan with interest expenses if repurchase is

probable and the seller retains the use of the asset

19.2 Consignment Stock (goods on sale or return basis)

The inventory is physically held by the seller but legally owned by the
manufacturer.

The seller should recognise inventory and payables if it bear risks and rewards.

The manufacturer should recognise inventory if it bear risks and rewards.

Such as the seller should not recognise as sales of consignment stock when the
customer still have the right to return the goods.

19.3 Factoring Trade Receivables

Legal Form is such that trade receivables are factored to a financial institute, who
then recovers cash when the trade receivable is collected

Treat as sale with loss if financial institute is without recourse:

Dr Bank
Dr Finance Cost
Cr Trade Receivables

Treat as loan with interest expense if financial institute is with recourse:

Dr Bank
Cr Loan

The receivables continue to appear in SOFP and is subjected to impairments

and provisions.

49
20. IFRS 16 Leases

20.1 What is a lease?

A contract is, or contains, a lease if the contract conveys the right to control the
use of an identified asset for a period of time (including production units) in
exchange for consideration.

20.2 Lessee (User) Books: Expense

A lessee may expense right-of-use assets if the lease is:

(a) 12 months or less; and

(b) the lease asset is of low value.

Examples of low-value underlying assets can include tablet and personal

computers, small items of office furniture and telephones.

Lessee expenses lease payments on ST leases and low value assets

The lessee shall expense the lease payments on a straight-line basis over the
lease term or another systematic basis if that basis is more representative of the
benefit.

20.3 Lessee (User) Books: Capitalise

Initial Measurement

At the commencement date, a lessee shall capitalise a right-of-use asset at cost

and recognise a lease liability.

The cost of right-of-use asset includes:

(a) the present value of lease obligations

(b) deposits paid;
(c) any direct costs incurred by the lessee; and
(d) the present value of future dismantle and restoration (Dr IFRS 16 Lease
Assets Cr IAS 37 Provisions)

Subsequent Measurement

Lease Assets

After the commencement date, the lessee shall apply the following to measure
right-of-use assets:

1. Cost Model:

Lease Asset, Carrying Amount = Cost – Acc Dep – Acc Impairment in IAS
36 and remeasurements of lease liability

If lessee becomes the owner at end of lease, deprecite over the useful life.
Otherwise, depreciate over shorter of lease term or useful life.

or

50
2. Fair Value Model in IAS 40 if it meets the definition of an investment
property

or

3. Revaluation Model in IAS 16 to the same class of PPE

20.4 Lease Liability

Lease Payment in Arrears

LEASE PERIOD OBLI B/D + INTEREST - PAID = OBLI C/D

1 X X (X) A
2 X B (C) X
3 X X (X) -

CL: Lease Obli < 12 mth = Next Year’s Repayment “C” – Next Year’s Interest “B”

NCL = Total Liability “A” – CL

SOFP (extract)
NCL
Lease obligation more than 1 year $x

CL
Lease obligation less than 1 year $x

20.5 Lease Liability

Lease Payment in Advance

LEASE OBLI B/D PAID CAPITAL INTEREST OBLI C/D

PERIOD - = + =
1 X (X) X D A
2 X (C) X B X
3 X (X) X X -

CL = Next Year’s Repayment “C” = Accrued Interest “D” + Lease Obli < 12 mth

NCL: Lease Obli > 12 mth = Total Liability “A” – CL

SOFP (extract)
NCL
Lease obligation more than 1 year $x

CL
Accrued interest $x
Lease obligation less than 1 year $x

When payments are made in advance, interest outstanding at the end of the year
and needs to be accrued.

51
20.6 Sale and Leaseback Agreements (SLA)

What is sale and leaseback agreements?

The seller transfers (sells) an asset to the buyer and leases that asset back.

SLA is a sale

If the transfer meets IFRS 15, it is accounted for as a sale of the asset:

The seller shall split the asset carrying amount into right to use and gain or loss on
disposal.

If the selling price is not equal to the fair value of asset, or if the payments for the
lease are not at market rates, the seller must adjust the selling price at fair value.

Adjustments as follows:

(a) any below-market terms shall be accounted for as a prepayment of lease

payments; and

(b) any above-market terms shall be accounted for as additional financing

provided by the buyer-lessor to the seller-lessee.

Potential adjustments include the following:

(a) the difference between the fair value of the consideration for the sale and
the fair value of the asset; and

(b) the difference between the present value of the contractual payments for
the lease and the present value of payments for the lease at market rates.

SLA is not a sale

If the transfer of an asset by the seller-lessee does not satisfy the requirements
of IFRS 15 to be accounted for as a sale of the asset:

(a) the seller shall continue to recognise the asset and shall recognise a financial
liability equal to the transfer proceeds under IFRS 9.

(b) the buyer shall not recognise any asset and shall recognise a financial asset
equal to the transfer proceeds under IFRS 9.

52
21. IAS 8 Accounting Policies, Changes in Accounting
Estimates and Errors

21.1 Changes in Accounting Policies

Once chosen accounting policies should be applied consistently unless changing the
policy would result in fairer presentation. Policies may also need amending where
changes in standards take place. A change in accounting policy can only take place
if it is required by statute, by a new accounting standard and for accounts to show
true and fair view

This change should be applied retrospectively unless otherwise stated. This will
result in the restatement of opening balances and comparatives. The retrospective
adjustment is referred to as a prior period adjustment and shown in the statement
of changes in equity.

21.2 Changes in Accounting Estimates

Changes in estimates are adjusted prospectively in the current year’s financial

statements. Such as changes in asset life and changes in depreciation method.

21.3 Prior Period Errors

Material prior period errors should be corrected retrospectively by adjustment against

the opening balance of retained earnings in the statement of changes in equity
(referred to as Prior Year Adjustments) as well as restating comparatives

53
22. IAS 10 Events after the Reporting Period

Events after the year end are those events, favourable and unfavourable, that
occur between the year end and the date when the financial statements are
authorised for issue. Two types of events can be identified:

(a) those that provide evidence of conditions that existed at the year end
(adjusting events after the reporting period); and
(b) those that are indicative of conditions that arose after the year end (non-
adjusting events after the reporting period).

22.1 Adjusting Events

Events that provide evidence of conditions existing at year end, such as:

- Settlement of court case or insurance claims

- Discovery of fraud or error that FS are incorrect
- Bad debt and bankruptcy of customers
- Inventory sold for less than cost

Adjusting Events are adjusted in the Financial Statements for the year end

22.2 Non-Adjusting Events

Events that DO NOT reflect evidence or conditions which existed at year end

Accounting Treatment:
Non-Adjusting Events are not adjusted and are disclosed if material, otherwise,
ignore.

The following events must be disclosed where material

- Destruction by flood or fire

- Legal suit
- Impairments arising after year end
- Plans to discontinue operations
- Issue of shares after year end (but bonus issues are adjusted under IAS 33)
- Disposal / acquisition of subsidiary
- Dividends declared after year end shall not be recognised on SOFP, only disclose
in notes to the accounts

54
23. IFRS 5 Non-Current Assets Held For Sale and Discontinued
Operations

IFRS 5 requires:

(a) assets that meet the criteria to be classified as held for sale (HFS) to be
measured at the lower of carrying amount and fair value less costs to
sell, and depreciation on such assets to cease; and

(b) assets that meet the criteria to be classified as held for sale to be presented
separately on the face of the SOFP and the results of discontinued
operations to be presented separately in the SOPL.

23.1 Non-Current Assets Held for sale (HFS)

NCA HFS (or disposal group) must be:

1. available for immediate sale in its present condition subject, and

2. the sale must be highly probable.

For the sale to be highly probable, the management must be:

- the sale is expected to be completed within 12 months
- committed to a plan to sell the asset (or disposal group), and
- an active programme to locate a buyer and complete the plan
- the price must be reasonable in relation to its current fair value.

When the sale is expected to occur beyond one year and the delay was caused by
events which were unforeseen and beyond the control of management, the entity
shall measure the costs to sell at their present value. Discontinued operation will
include the disposal of a parent’s investment in a subsidiary in the parent’s
individual financial statements and/or those of the group.

23.2 Discontinued Operations

A discontinued operation is described as a component of an entity that either has

been disposed of, or is classified as held for sale, and:

(a) represents a separated major line of business or geographical area of

operations
(b) is part of a single co-ordinated plan to dispose of a separate major line of
business or geographical area of operations or
(c) is a subsidiary acquired exclusively with a view to resale.’

Statement of Profit or Loss (extract)

Continuing operations $
Revenue X
Profit before tax X
Tax expense (X)
Profit from continuing operations X
Discontinued operation
Loss from discontinued operations (X)
Total profit for the period X

55
24. IAS 33 Earnings per Share

EPS = Profit (loss) attributable to ordinary equity holders = in cents

Weighted average number of ordinary shares

Note: Earnings attributable to ordinary shareholders is after tax, after NCI and after
preference dividends.

Basic EPS (past events) Diluted EPS (future events)

1. Full Market Price Issue 1. Convertible Debt
2. Bonus Issue 2. Share Options and Warrants
3. Rights Issue

24.1 Full Market Price Issue

An issue at full market value involves cash being received by the issuer. This has
an impact on earnings and consequently a weighted average calculation needs to
be done for the number of shares.

24.2 Bonus Issue

A bonus issue is when free shares are given normally to existing shareholders as a
reward for their loyalty. There is no cash impact and as such bonus issues are
assumed to be issued at the first day of the financial year i.e treat as if always in
issue and restate comparative EPS. Current year EPS is calculated including
bonus shares issued as normal.

24.3 Rights Issue

From an earnings per share point of view a rights issue is a combination of an issue
at full market price and a bonus issue.

1. Calculate new price

2. Calculate bonus fraction

old price
Bonus Fraction =
new price

3. Calculate current year share capital (Weighted Average shares in issue)

Before RightsIssue: shares before rights  months  bonus fraction shares

After Rights Issue: shares after rights  months shares
Total weighted average number of shares shares

Earnings
Current Year EPS =
Weighted Average Shares

4. Restate Comparative EPS

new price
Restate Comparative EPS = Prior Year EPS x
old price

 56
24.4 Convertible Debt
It is assumed that all derivatives are converted into shares with maximum dilution

1. Calculate extra earnings = interest saved after tax

2. Calculate extra shares = maximum number of shares from conversion

3. Calculate Diluted EPS = Earnings + Extra Earnings

Shares + Extra Shares

24.5 Options
Share options are similar to a future rights issue, which comprised part bonus issue
and part full price issue represented by the fair value of shares. The EPS is affected
by the bonus element.

1. Calculate shares at Fair Value = Options x Option Price

Market Value of shares

2. Calculate Free Shares = Number of Options – Number of Shares at Fair Value

3. Calculate Diluted EPS = Earnings

Shares + Free Shares

57
25. Ratios

25.1 Profitability

1) Gross Profit Margin (GPM) = Gross Profit x 100%

Revenue

High GPM indicates the company is selling expensive premium products / services

Low GPM indicates the company is selling affordable basic products / services

2) Operating Profit Margin = Profit before interest and tax (PBIT) x 100%
Revenue

3) Net Profit Margin (NPM) = Net Profit x 100%

Revenue

4) Operating Expenses = GPM – Operating Profit Margin

5) Return on Capital Employed= Profit before interest and tax (PBIT) x 100%
(ROCE) Capital Employed (CE)

Capital Employed (CE) = NCA + CA – CL i.e. Asset Base

or = Equity + NCL i.e. Capital Structure

6) Asset Turnover = Revenue_____

Asset Base (CE)

High Asset Turnover indicates full use of assets to generate income such as selling
a basic product with minimum asset requirements.

Low Asset Turnover indicates less than optimal use of assets to generate income
such as selling a premium luxury product with minimum use of assets

ROCE = Operating Profit Margin x Asset Turnover

PBIT x 100% = _PBIT__ x 100% x Revenue

CE Revenue CE

58
25.2 Liquidity

1) Current Ratio = Current Assets___

Current Liabilities

2) Quick Ratio = Current Assets – Inventories

(Acid Test Ratio) Current Liabilities

Inventories are considered to be slow-moving and is not quickly turned into

receivables or cash, thus, it is removed to measure how quickly the remaining
current assets can be used to pay up current liabilities.

25.3 Efficiency

1) Inventory holding period = Inventories_ x 365 days

Cost of Sales

= Cost of Sales
Inventories

2) Average collection period = Trade Receivables x 365 days

(AR days) *Credit Sales

= Credit Sales____
Trade Receivables

3) Average payment period = Trade Payables___ x 365 days

(AP days) **Credit Purchases

= Credit Purchases
Trade Payables

* total sales may be used instead.

** total purchases or cost of sales may be used instead.

4) Cash Cycle measures the time it takes a company to convert its Inventories,
Receivables and Payables into cash as follows:

Inventory Days + AR Days – AP Days = Cash Cycle Days

59
25.4 Gearing

1) Gearing Ratio = Debt x 100%

CE

= Debt_ x 100%
Equity

If questions do not specify, either one of these may be used.

2) Interest Cover = PBIT

Interest Payable

25.5 Investors

1) Dividend Cover = Profit after Tax (PAT)

Dividends

2) Earnings per Share = Earnings

(EPS) Shares

3) Price / Earnings Ratio = Market Price per Share

(PE Ratio) Earnings per Share

4) Dividend Yield = Dividends

Market Capitalisation

Market Capitalisation = Market Price per Share x Number of shares

5) Return on Equity = _PAT_

(ROE) Equity

60
25.5 Not-for-Profit and Public Sector Entities

Specialised, not-for-profit and public sector entities

a) Discuss the different approaches that may be required when assessing the
performance of specialised, not-for-profit and public sector organisations.

When we are analysing the performance of specialised, not-for-profit and public

sector entities, the approach is different from that of profit-seeking entities.

1. Profitability ratios may not be useful in not-for-profit entities.

2. Statement of profit or loss are prepared on an accruals basis but in the case
of not-for-profit entities, statements of cash flows are often preferred.

3. Specialised, not-for-profit and public sector organisations may focus on areas

other than maximising profits and market shares. Such as customer service,
waiting time, service quality, etc. Thus, other performance measures are
used, including Efficiency, Effectiveness and Economy, namely, the 3Es. And
the next E, Environment has gained importance over the years.

There are many papers on performance measurement and appraisal in ACCA,

such as F5, F7 and F9. Thus, any knowledge from other papers can also be
applied.

4. It is important to take note of the industry of the specialised, not-for-profit

and public sector entity in question to give a quality analysis.

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26. IAS 7 Statement of Cash Flows

Statement of Cash Flow for the year ended 31 March 2012

$’000 $’000
Cash flows from operating activities (CFO)
Profit before tax x
Adjustments for:
Depreciation of tangible assets x
Amortisation of intangible assets x
Loss/(Profit) on disposal of non-current assets x/(x)
Amortisation of government grants (x)
Investment income (x)
Interest expense x
x
Changes in working capital
Increase in inventories (x)
Increase in trade receivables (x)
Increase in trade payables x
Cash generated from operations x
Interest paid (x)
Tax paid (x)
Net cash from operating activities x

Cash flows from investing activities (CFI)

Purchase of PPE (x)
Acquisition of Intangible asset (x)
Receipt of government grant x
Proceeds from sale of PPE x
Interest received x
Dividend received x
Net cash used in investing activities x

Cash flows from financing activities (CFF)

Proceeds from issue of share capital x
Proceeds from long-term borrowings x
Payment of finance lease liabilities (x)
Dividend paid (x)
Net cash from financing activities x
Net increase in cash and cash equivalents (C&CE) x
Cash and Cash equivalents at start of year x
Cash and cash equivalents at end of year x

62
Consolidation

IAS 27 Separate Financial Statements

If Control If Unanimous If Significant If Simple

Exist Agreement Influence Investment Exist
(>50% votes) (20%-50% votes) (20%-49% votes) (1%-19% votes)

Not in FR Syllabus

IFRS 10 IFRS 11 Joint IFRS 9 Financial

Consolidated Arrangements Instruments:
Financial Recognition and
Statements Measurements

If Joint Ventures

IFRS 3 Business IAS 28

Combinations Investments in
Associates and
Joint Ventures

IFRS 12 Disclosure of Interests in Other Entities

Not in FR Syllabus

63
27. IAS 27 Separate Financial Statements

27.1 Consolidated financial statements

Consolidated financial statements are the financial statements of a group in which

the assets, liabilities, equity, income, expenses and cash flows of the parent and its
subsidiaries are presented as those of a single economic entity.

27.2 Separate financial statements

Separate financial statements are those presented by a parent (ie an investor with
control of a subsidiary) or an investor with joint control of, or significant influence
over, an investee, in which the investments are accounted for at cost or in
accordance with IFRS 9 Financial Instruments: Recognition and Measurement.

64
28. IFRS 10 Consolidated Financial Statements

An investor controls an investee if and only if the investor has all the following:

(a) power over the investee;

(b) exposure, or rights, to variable returns from its involvement with the investee
; and

(c) the ability to use its power over the investee to affect the amount of the
investor’s returns .

Typically, control exists when the parent holds >50% of voting rights. Thus, the
parent shall apply IFRS 3 to consolidate the subsidiary.

28.1 Consolidation Procedures

A parent shall prepare consolidated financial statements from the date the investor
controls the investee as follows:

(a) combine like items of assets, liabilities, equity, income, expenses and cash
flows of the parent with those of its subsidiaries.

(b) offset (eliminate) the carrying amount of the parent’s investment in each
subsidiary and the parent’s portion of equity of each subsidiary (IFRS 3
explains how to account for any related goodwill).

(c) eliminate in full intra-group assets and liabilities, equity, income, expenses
and cash flows relating to transactions between entities of the group (profits
or losses resulting from intra-group transactions that are recognised in assets,
such as inventory and fixed assets, are eliminated in full). Intra-group losses
may indicate an impairment that requires recognition in the consolidated
financial statements.

28.2 Non-Controlling Interest

A parent shall present non-controlling interests (NCI) in the consolidated statement

of financial position (CSOFP) within equity, separately from the equity of the
owners of the parent.

65
29. IAS 28 Investment in Associates and Joint Ventures

An associate is an entity over which the investor has significant influence.

Typically, an associate exist when the investor controls between 20% - 49% voting
rights.

The existence of significant influence by an entity is usually evidenced in one or

more of the following ways:

(a) representation on the board of directors or equivalent governing body of the

investee;

(b) participation in policy-making processes, including participation in decisions

about dividends or other distributions;

(c) material transactions between the entity and its investee;

(d) interchange of managerial personnel; or

(e) provision of essential technical information.

Consolidated financial statements are the financial statements of a group in

which assets, liabilities, equity, income, expenses and cash flows of the parent and
its subsidiaries are presented as those of a single economic entity.

29.1 Equity Method

The equity method is a method of accounting whereby the investment is initially

recognised at cost and adjusted thereafter for the post- acquisition change in the
investor’s share of the investee’s net assets. The investor’s profit or loss includes its
share of the investee’s profit or loss and the investor’s other comprehensive income
includes its share of the investee’s other comprehensive income.

Upon consolidation, cost of investment is adjusted to show Investment in

Associate in the CSOFP. However, other inter-company balances are not
eliminated.

In the CSOPL, dividends income from investee is eliminated since it is already

included in the share of investee’s profit or loss.

66
30. IFRS 3 Business Combinations

Subsequent to IFRS 10 where control has been established, the parent shall
account for each business combination by applying the Acquisition Method (Full
Line by Line Method or Purchase Method) to prepare Consolidated Financial
Statements.

Single Entity Concept

When the Parent has control over the Subsidiary either through a majority holding
of its voting shares or controlling its board of directors, it is considered a single
entity along with its subsidiary. Thus inter-company transactions (often held in
‘current accounts’) must be cancelled, and only transactions with the outside world
must be reported in the Consolidated Accounts.

Financial Reporting (FR) will examine a simple group including two subsidiaries and
one associate in a “horizontal” group or “fellow” subsidiaries. There will be both full
and partial goodwill.

P (Parent Co.)

S1 S2 A
(Subsidiary 1) (Subsidiary 2) (Associate Co)

67
30.1 Fair Value of Cost of Investment (COI)

1. IFRS 3 requires Acquisition Cost of a subsidiary to be expensed of to the profit

and loss and not to be added as Cost Of Investment (COI).

2. IFRS 3 requires Contingent Considerations (i.e. future settlements) to be

recognised as part of the parent’s COI (or purchase considerations) and IFRS
3 do not require it to be probable.

3. COI less Fair Value of Net Assets (FVNA) acquired = Goodwill

COI may comprise of:

a. Cash (Dr COI Cr Bank) $x

b. Land (Dr COI Cr PPE) $x
c. Share exchange (Dr COI Cr Share Capital) $x
d. Loan (Dr COI Cr Loan) $x
e. Future cash (Dr COI Cr Deferred Consideration) $x
(present value at acquisition and unwind at year end)
f. Contingent Consideration*
- Equity (Dr COI Cr Other Components) $x
- Cash (Dr COI Cr Liability) $x
Total COI $x

* Contingent consideration resulting in Equity shall not be remeasured and

subsequent issue of shares will be accounted for in Equity i.e. Dr Other
Components of Equity Cr Share Capital)

* Contingent consideration resulting in Liability shall be remeasured in

accordance to IFRS 9 or IAS 37.

68
30.2 Goodwill

1. Full Goodwill: given FV of NCI in exam:

Full Goodwill at Acquisition (Acq)

= (P’s COI at Acq + FV of NCI at Acq) - 100% S’s FVNA at Acq

NCI at YE
= FV of NCI at Acq + S’s Post Acq RE movement – NCI% of Goodwill impairment

2. Partial Goodwill with no goodwill allocated to NCI

Proportionate Goodwill at Acq

= P’s COI – P’s share of S’s FVNA = P’s Goodwill only

NCI at YE = NCI’s % of S’s FVNA at YE

In partial goodwill, there is no goodwill allocated to the NCI so there will not be any
share of goodwill impairment to the NCI.

3. IFRS 3 prohibits the amortisation of goodwill. Instead, goodwill is tested for

impairment under IAS 36 and any reversal of impairment loss on goodwill is
prohibited.

4. Any gain from a bargain purchase (negative goodwill) is recognised as

revenue immediately in the CSOPL. If no CSOPL is required, the bargain
purchase will be credited to the group retained earnings.

69
30.3 Pre / Post Retained Earnings in Mid-Year Acquisitions and Disposals

In the case of mid-year acquisitions and disposals, it is important to determine the

pre and post retained earnings by Time Apportionment unless otherwise given
pre and post profits.

a. During mid-year acquisitions of subsidiary, it is important to split the

Subsidiary’s Retained Earnings (RE) into Pre-Acq RE and Post-Acq RE in order to
calculate Goodwill and NCI at YE. This is because before the acquisition, the Parent
is not entitled to any Pre-Acq RE but is entitled it’s share (% acquired) in the
Subsidiary’s Post-Acq RE.

b. The same is true for mid-year disposal of subsidiary where the Parent would
be entitled a share of the Subsidiary’s profits before disposal and calculate a gain or
loss on disposal.

1. Parent lost control in Subsi to become an Associate relationship

2. There is no more group at YE, no more CSOFP
3. Remove Subsi’s FVNA, Goodwill and NCI
4. Remove any amount previously accumulated in OCE
5. Calculate gain or loss on Disposal

IFRS 3 Parent Group Disposal Account

Sales Proceeds $x
Add: FV of Associate $x
Add: NCI $x
Add: Items in OCE $x
$x
Less: FVNA disposed ($x)
Less: Goodwill disposed ($x)
Group Gain/(Loss) on disposal in P&L $x

IAS 27 Individual Parent Co Disposal Account

Sales Proceeds $x
Less: Cost of investment disposed
$COI / % owned x % sold ($x)
Individual Gain/(Loss) on disposal in P&L $x

There will be no partial disposal of subsidiary in Financial Reporting. It will be

restricted to disposals of the parent’s entire investment in the subsidiary.

70
30.4 Inter-Company Balances

a. Inter-Company Balances within a Group (i.e. Parent and Subsidiary)

The application of the Single Entity Concept requires inter-company balances

arising from trade and loan resulting in amounts due to and due by the Parent and
Subsidiary must be eliminated. It makes no sense for a company to owe money to
itself.

Often, the amount due to and due by the Parent and Subsidiary will not agree, this
is due to in-transit items at the year end. Therefore, such items must be treated
as received and then inter-company balances be eliminated.

1. Treat as if received in-transit items:

Dr Bank or Dr Inventory or Expenses

Cr Receivables Cr Payables

2. Eliminate inter-company balances:

Dr Payables
Cr Receivables

b. Inter-Company Balances with an Associate

Remember that Associates are not part of the group of companies, thus, the
amounts due to and due by the Parent and Associate are left unadjusted on the
CSOFP and is not eliminated.

71
30.5 Unrealised Profit (URP) in Inventory

1. Unrealised Profit within a Group

Individual companies within the group, namely Parent and Subsidiary) may buy and
sell inventories to each other at a profit. However, if such inventories, inflated with
profits, are still kept in stock at the year end, unrealised profit (URP) must be
eliminated. There is no problem of URP if the inventories have been sold to external
parties outside the group.

To eliminate inter-company sales: Dr Sales $ sales value

Cr Cost of sales $ sales value

a. Downstream Sales of inventories

This is when Parent sells inventories to Subsidiary. The Parent had made the
URP and the Subsidiary have the inflated inventories in stock at year end.

To eliminate PURP: Dr Parent’s RE $URP

Cr Inventories on CSOFP $URP

b. Upstream Sales of inventories

This is when Subsidiary sells inventories to Parent. Here, the Subsidiary made
the URP while the Parent have the inflated inventories in stock at year end.

To eliminate SURP: Dr Subsidiary’s RE $URP

Cr Inventories on CSOFP $URP

2. Unrealised Profit with an Associate

a. Downstream Sales of inventories

Dr Cost of sales
Cr Investment in associate

b. Upstream Sales of inventories

Dr Share of profits of associate

Cr Inventories

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30.6 Unrealised Profit in Non-Current Assets

a. Downstream sales of NCA

Parent sells NCA to Subsidiary.

- eliminate URP in Parent: Dr Parent’s RE $URP

Cr NCA in CSOFP $URP

- eliminate extra Dep in Subsidiary: Dr NCA in CSOFP $extra Dep

Cr Subsidiary’s RE $extra Dep

b. Upstream sales of NCA

Subsidiary sells NCA to Parent.

- eliminate URP in Subsidiary: Dr Subsidiary’s RE $URP

Cr NCA in CSOFP $URP

- eliminate extra Dep in Parent: Dr NCA in CSOFP $extra Dep

Cr Parent’s RE $extra Dep

30.7 Fair Value Adjustments

The cost of the investment is established at fair value (FV) and must therefore be
compared to the Parent’s share of the Subsidiary’s net assets taken over, also at
fair value. This ensures the difference between the two figures, goodwill, is realistic.

At the acquisition date, there are fair value adjustments on the Subsidiary’s non-
current assets, thus, resulting in depreciation adjustments in the post-acquisition
period.

Increase FV: Dr NCA Charge Additional Dep: Dr S’s RE

Cr S’s RE (time apportion if needed) Cr NCA

30.8 Parent’s Accounting Policy

Upon consolidation, the Subsidiary must follow the Parent’s accounting policy.

30.9 Inter-Company Dividends

Upon consolidation, any inter-company dividends from Subsidiary due to Parent

must be eliminated in the CSOFP.

In the CSOPL, inter-company dividends from Subsidiary is also eliminated because

such dividends are already included in Sales Revenue under the Acquisition Method.

73
30.10 CSOPL

1. IFRS 3 requires Acquisition Method. Thus, 100% Parent (P) is added line by
line to 100% Subsidiary (S) regardless of percentage of control.

2. For mid-year acquisitions, we need to time apportion both S’s and A’s SOPL.

3. The NCI is calculated as:

Profit attributable to = NCI% x S’s adjusted PAT

(PAT Adj: FV Dep & Amort, SURP, Time Apportionment, GW Impairment)

Total CI attributable to = NCI’s PAT (above) + NCI% x S’s adjusted OCI

(OCI adj: Revaluation gain/loss on PPE and FVTOCI Financial Assets)

Note: Revaluation at YE, Impairment at YE and Dividends are 1 day so there

is no need to time apportion.

Impairment of goodwill is shown separately on the face of the CSOPL

4. Only one line is disclosed for Associate. Do not add Associate line by line.

Share of Associate’s Profit = A% x A’s adjusted PAT (before A’s Dividends)

Any impairment of investment Associate is netted off in this line item.

5. All dividend income from S and A are eliminated. Thus, any dividends shown
on the CSOPL belongs to P only.

6. All inter-company transaction between Parent and Subsidiary must be

eliminated such as inter-company sales and URP (2 minus 1 plus).

7. IAS 28 requires adjustment of URP between Parent and Associate.

a. Downstream Sales of inventories

Dr Cost of sales
Cr Investment in associate

b. Upstream Sales of inventories

Dr Share of profits of associate
Cr Inventories

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31. IFRS S1 General Requirements for Disclosure of
Sustainability – Related Financial Information

IFRS S1 is issued by the International Sustainability Standards Board in June 2023

with the objective to require an entity to disclose information about its
sustainability-related risks and opportunities that is useful to primary users of
general purpose financial reports in making decisions relating to providing
resources to the entity.

It focus on information concerning an entity’s ability to generate cash flows over

the short, medium and long term is inextricably linked to the interactions between
the entity and its stakeholders, society, the economy and the natural environment
throughout the entity’s value chain.

IFRS S1 requires an entity to disclose information about all sustainability-related

risks and opportunities that could reasonably be expected to affect the entity’s cash
flows, its access to finance or cost of capital over the short, medium or long term.
For the purposes of this Standard, these risks and opportunities are collectively
referred to as ‘sustainability-related risks and opportunities that could reasonably
be expected to affect the entity’s prospects’.

This Standard shall apply to annual reporting periods beginning on or after 1

January 2024. Earlier application is permitted. An entity is not required to disclose
comparative information in the first annual reporting period in which it applies this
Standard.

Scope

An entity shall apply this Standard in preparing and reporting sustainability-related

financial disclosures irrespective of IFRS or other generally accepted accounting
principles (GAAP). Sustainability-related risks and opportunities that could not
reasonably be expected to affect an entity’s prospects are outside the scope of this
Standard.

Conceptual foundations

Relevance and faithful representation are the fundamental qualitative

characteristics of useful sustainability-related financial information. Enhancing
qualitative characteristics includes comparability, verifiability, timeliness and
understandability.

Fundamental qualitative characteristics

Fair representation or faithful representation shall present fairly all sustainability-

related risks and opportunities that could reasonably be expected to affect an
entity’s prospects such as short, medium or long term cost of capital, direct or
indirect interaction with stakeholders in the entity’s value chain such as use of
natural resources (depletion of water) could create disruption of operations and
strategies adversely affecting financial performance and position. The opposite is
true for regeneration and preservation of that resource.

75
An entity shall use all reasonable and supportable information without undue cost
or effort (a) to identify the sustainability-related risks and opportunities that could
reasonably be expected to affect the entity’s prospects; and (b) to determine the
scope of its value chain, including its breadth and composition, in relation to each of
those sustainability-related risks and opportunities.
Materiality

An entity shall disclose material information about the sustainability-related risks

and opportunities that could reasonably be expected to affect the entity’s
prospects. The reported sustainability-related financial disclosures shall be the
same as the related financial statements. For example, the financial statements of
the parent, its subsidiaries and the group shall be the same as the sustainability-
related financial disclosures.

IFRS S1 defines materiality as omitting, misstating or obscuring that information

could reasonably be expected to influence decisions of primary users.

Connected information

An entity shall use consistent data and assumption in its presentation currency to
provide information on connections between items such as sustainability-related
risks and opportunities that could reasonably be expected to affect the entity’s
prospects and on the following core content:

(a) governance—the governance processes, controls and procedures the entity uses
to monitor and manage sustainability-related risks and opportunities;

(b) strategy—the approach the entity uses to manage sustainability related risks
and opportunities;

(c) risk management—the processes the entity uses to identify, assess, prioritise
and monitor sustainability-related risks and opportunities; and

(d) metrics and targets—the entity’s performance in relation to sustainability-

related risks and opportunities, including progress towards any targets the entity
has set or is required to meet by law or regulation

Example 1: A company finds that its supplier has employment practices that fall
short of international norms and decides to terminate its contract with that supplier.
This decision has an impact on the cost of the company’s supplies. The company
discloses the connection between its decision to terminate the contract with its
supplier and related information presented in its financial statements.

Example 2: A company decides to discontinue a product associated with significant

greenhouse gas emissions and therefore closes the related production facility. In its
disclosures, the company makes clear the link between its decision to manage the
climate-related risk, and any effects this has on its financial statements (as
prepared in accordance with applicable GAAP). The company discloses the linkage
between this decision and other sustainability-related risks and opportunities, such
as effects on the company's reputation and its relationships with local communities.

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Disclosures on Business model and value chain includes:

(a) a description of the current and anticipated effects of sustainability related risks
and opportunities on the entity’s business model and value chain; and

(b) a description of where in the entity’s business model and value chain
sustainability-related risks and opportunities are concentrated (for example,
geographical areas, facilities and types of assets).

Disclosure on Strategy and Decision-making includes:

(a) how the entity has responded to, and plans to respond to, sustainability-related
risks and opportunities in its strategy and decision-making;

(b) the progress against plans the entity has disclosed in previous reporting
periods, including quantitative and qualitative information; and

(c) trade-offs between sustainability-related risks and opportunities that the entity
considered (for example, in making a decision on the location of new operations, an
entity might have considered the environmental impacts of those operations and
the employment opportunities they would create in a community).

Disclosures on financial position, financial performance and cash flows

include:

(a) the effects of sustainability-related risks and opportunities on the entity’s

financial position, financial performance and cash flows for the reporting period
(current financial effects); and

(b) the anticipated effects of sustainability-related risks and opportunities on the

entity’s financial position, financial performance and cash flows over the short,
medium and long term, taking into consideration how sustainability-related risks
and opportunities are included in the entity’s financial planning (anticipated
financial effects).

Specifically an entity shall disclose quantitative and qualitative information on

sustainability-related risks and opportunities on the following:

(a) financial position, financial performance and cash flows for the reporting period;

(b) significant risk of a material adjustment within the next annual reporting period
to the carrying amounts of reported assets and liabilities

(c) how the entity expects its financial position to change over the short, medium
and long term, given its strategy to manage sustainability-related risks and
opportunities

Resilience - capacity to adjust to the uncertainties

An entity shall disclose a qualitative and, if applicable, quantitative assessment in a

single amount or range of the resilience of its strategy and business model about
how the assessment was carried out and its time horizon.

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Risk management

The objective of sustainability-related financial disclosures on risk management is

to enable users of general purpose financial reports:

(a) to understand an entity’s processes to identify, assess, prioritise and monitor

sustainability-related risks and opportunities, including whether and how those
processes are integrated into and inform the entity’s overall risk management
process; and

(b) to assess the entity’s overall risk profile and its overall risk management
process

Metrics and targets

The objective of sustainability-related financial disclosures on metrics and targets is

to enable users of general purpose financial reports to understand an entity’s
performance in relation to its sustainability-related risks and opportunities,
including progress towards any targets the entity has set, and any targets it is
required to meet by law or regulation.

An entity shall disclose, for each sustainability-related risk and opportunity that
could reasonably be expected to affect the entity’s prospects:

(a) metrics required by an applicable IFRS Sustainability Disclosure Standard; and

(b) metrics the entity uses to measure and monitor:

(i) that sustainability-related risk or opportunity; and

(ii) its performance in relation to that sustainability-related risk or opportunity,

including progress towards any targets the entity has set, and any targets it is
required to meet by law or regulation.

Sources of guidance

In addition to IFRS Sustainability Disclosure Standards, an entity shall refer to

applicable Sustainability Accounting Standards Board (SASB) Standards and
Climate Disclosure Standards Board (CDSB) Framework Application Guidance for
Water-related Disclosures and the CDSB Framework Application Guidance for
Biodiversity-related Disclosures (collectively referred to as ‘CDSB Framework
Application Guidance’)

Timing of reporting

An entity shall report its sustainability-related financial disclosures at the same time
as its related financial statements. The entity’s sustainability-related financial
disclosures shall cover the same reporting period as the related financial
statements.

78
Comparative information

Unless another IFRS Sustainability Disclosure Standard permits or requires

otherwise, an entity shall disclose comparative information in respect of the
preceding period for all amounts disclosed in the reporting period. If such
information would be useful for an understanding of the sustainability-related
financial disclosures for the reporting period, the entity shall also disclose
comparative information for narrative and descriptive sustainability-related financial
information

Statement of compliance

An entity whose sustainability-related financial disclosures comply with all the

requirements of IFRS Sustainability Disclosure Standards shall make an explicit and
unreserved statement of compliance. An entity shall not describe sustainability-
related financial disclosures as complying with IFRS Sustainability Disclosure
Standards unless they comply with all the requirements of IFRS Sustainability
Disclosure Standards

Judgements

An entity shall disclose information to enable users of general purpose financial

reports to understand the significant effect of judgements made in its sustainability-
related financial disclosures.

Measurement uncertainty

An entity shall disclose information to enable users of general purpose financial

reports to understand the most significant uncertainties affecting the amounts
reported in its sustainability-related financial disclosures.

An entity shall:

(a) identify the amounts that it has disclosed that are subject to a high level of
measurement uncertainty; and

(b) in relation to high level of measurement uncertainty disclose information about:

(i) the sources of measurement uncertainty—for example, the dependence of the

amount on the outcome of a future event, on a measurement technique or on the
availability and quality of data from the entity’s value chain; and

(ii) the assumptions, approximations and judgements the entity has made in
measuring the amount.

Errors

An entity shall correct material prior period errors by restating the comparative
amounts for the prior period(s) disclosed unless it is impracticable to do so.

79
How to apply IFRS S1?

IFRS S1 requires an entity to disclose information about all sustainability-related

risks and opportunities that could reasonably be expected to affect the entity’s cash
flows, its access to finance or cost of capital over the short, medium or long term
prospects.

These sustainability-related risks and opportunities arise out of interdependent

direct and indirect interactions between the entity and its external environment
such as stakeholders, society, the economy and the natural environment
throughout the entity’s value chain.

For example, if an entity’s business model depends on a natural resource— such as

water—the entity could both affect and be affected by the quality, availability and
affordability of that resource. Specifically, degradation or depletion of that
resource—including resulting from the entity’s own activities and from other
factors—could create a risk of disruption to the entity’s operations and affect the
entity’s business model or strategy and could ultimately negatively affect the
entity’s financial performance and financial position. In contrast, regeneration and
preservation of that resource— including resulting from the entity’s own activities
and from other factors— could positively affect the entity. Similarly, if an entity
operates in a highly competitive market and requires a highly specialised workforce
to achieve its strategic purposes, the entity’s future success will likely depend on
the entity’s ability to attract and retain that resource. At the same time, that ability
will depend, in part, on the entity’s employment practices—such as whether the
entity invests in employee training and wellbeing—and the levels of employee
satisfaction, engagement and retention. These examples illustrate the close
relationship between the value the entity creates, preserves or erodes for others
and the entity’s own ability to succeed and achieve its goals.

Resources and relationships that an entity depends on and affects by its activities
and outputs can take various forms, such as natural, manufactured, intellectual,
human, social or financial. They can be internal—such as the entity’s workforce, its
know-how or its organisational processes—or they can be external—such as
materials and services the entity needs to access or the relationships it has with
suppliers, distributors and customers. Furthermore, resources and relationships
include, but are not limited to, the resources and relationships recognised as assets
in the entity’s financial statements.

An entity’s dependencies and impacts are not limited to resources the entity
engages with directly, and to the entity’s direct relationships. Those dependencies
and impacts also relate to resources and relationships throughout the entity’s value
chain. For example, they can relate to the entity’s supply and distribution channels;
the effects of the consumption and disposal of the entity’s products; and the
entity’s sources of finance and its investments, including investments in associates
and joint ventures. If the entity’s business partners throughout its value chain face
sustainability related risks and opportunities, the entity could be exposed to related
consequences of its own.

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32. Articles

Extreme Makeover – IASB Edition

A building renovation can be tricky and it can be overwhelming: at the beginning,

you definitely know that some parts of the building need to be upgraded, but you
can often find more and more that needs to be fixed after the renovation begins.
Often, the project can take longer than you ever anticipated, and you change much
more of the building than you originally planned.

In March 2018, the International Accounting Standards Board (the Board) finished
its renovation of The Conceptual Framework for Financial Reporting (the Conceptual
Framework). Much like a renovation and its implications for the existing building,
the Board needed to consider that too many changes to the Conceptual Framework
may have knock-on effects to existing International Financial Reporting Standards
(IFRS®). Despite that, the Board has now published a new version of the
Conceptual Framework, and this article considers some of the more significant
changes to the Conceptual Framework that the Board has made.

Chapter 1 – The objective of general purpose financial reporting

A gentle introduction
As with any major renovation, all issues, both significant and minor, need to be
considered. When considering the objective of general purpose financial reporting,
the Board reintroduced the concept of ‘stewardship’. This is a relatively minor
change and, as many of the respondents to the Discussion Paper highlighted,
stewardship is not a new concept. The importance of stewardship by management
is inherent within the existing Conceptual Framework and within financial reporting,
so this statement largely reinforces what already exists.

Chapter 2 – Qualitative characteristics of useful financial information

Originally, the Board had not planned to make any changes to this chapter,
however following many comments made in responses to the Discussion Paper,
there have been some.

Leaving the foundations in place

Primarily, the qualitative characteristics remain unchanged. Relevance and faithful
representation remain as the two fundamental qualitative characteristics. The four
enhancing qualitative characteristics continue to be timeliness, understandability,
verifiability and comparability.

Restoring the original features

Whilst the qualitative characteristics remain unchanged, the Board decided to
reinstate explicit references to prudence and substance over form.

Although these two concepts were removed from the 2010 Conceptual Framework,
the Board concluded that substance over form was not a separate component of
faithful representation. The Board also decided that, if financial statements
represented a legal form that differed from the economic substance, then they
could not result in a faithful representation.

Whilst that statement is true, the Board felt that the importance of the concept
needed to be reinforced and so a statement has now been included in Chapter 2
that states that faithful representation provides information about the substance of
an economic phenomenon rather than its legal form.

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In the 2010 Conceptual Framework, faithful representation was defined as
information that was complete, neutral and free from error. Prudence was not
included in the 2010 version of the Conceptual Framework because it was
considered to be inconsistent with neutrality. However, the removal of the term led
to confusion and many respondents to the Board’s Discussion Paper urged for
prudence to be reinstated.

Therefore, an explicit reference to prudence has now been included in Chapter 2,

stating that ‘prudence is the exercise of caution when making judgements under
conditions of uncertainty’.

Is that level?
As is often the case with a building project, making one minor change may lead to
others, and everyone wants a building that is level. The problem with adjusting the
building blocks here, even slightly, was that by adding in the reference to prudence,
the Board encountered the further issue of asymmetry.

Many standards, such as International Accounting Standard (IAS®)

37, Provisions, Contingent Liabilities and Contingent Assets, apply a system
of asymmetric prudence. In IAS 37, a probable outflow of economic benefits would
be recognised as a provision, whereas a probable inflow would only be shown as a
contingent asset and merely disclosed in the financial statements. Therefore, two
sides in the same court case could have differing accounting treatments despite the
likelihood of the pay-out being identical for either party. Many respondents
highlighted this asymmetric prudence as necessary under some accounting
standards and felt that a discussion of the term was required. Whilst this is true,
the Board believes that the Conceptual Framework should not identify asymmetric
prudence as a necessary characteristic of useful financial reporting.

The 2018 Conceptual Framework states that the concept of prudence does not
imply a need for asymmetry, such as the need for more persuasive evidence to
support the recognition of assets than liabilities. It has included a statement that, in
financial reporting standards, such asymmetry may sometimes arise as a
consequence of requiring the most useful information.

Chapter 3 – Financial statements and the reporting entity

Building the extension

Since the inception of the Conceptual Framework, the chapter on the reporting
entity has been classified as ‘to be added’. Finally, this part of the extension has
been built, even though it might be described as an extension built out of
practicality, rather than excitement.

This addition relates to the description and boundary of a reporting entity. The
Board has proposed the description of a reporting entity as: an entity that chooses
or is required to prepare general purpose financial statements.
This is a minor terminology change and not one that many examiners could have
much enthusiasm for. Therefore, it is unlikely to feature in many professional
accounting exams!

Chapter 4 – The elements of financial statements

Not to everyone’s taste

As part of this project, the Board has changed the definitions of assets and
liabilities. To casual observers, it may seem like some of these changes are the
decorative equivalent of ‘repainting cream walls as magnolia’, but to some
accountants it can feel like a seismic change.

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The changes to the definitions of assets and liabilities can be seen below.

2010 definition 2018 definition supporting

concept

Asset (of an A resource A present economic

entity) controlled by the resource controlled
entity as a result by the entity as a
of past events and result of past
from which future events.
economic benefits
are expected to
flow to the entity.

Economic A right that has

resource the potential to
produce economic
benefits

Liability (of an A present A present An entity’s

entity) obligation of the obligation of the obligation to
entity arising from entity to transfer transfer and
past events, the an economic economic resource
settlement of resource as a result must have
which is expected of past events. the potential to
to result in an require the entity
outflow from the to transfer an
entity of resources economic resource
embodying to another party.
economic benefits.

Obligation A duty of
responsibility that
an entity has no
practical ability to
avoid.

The Board has therefore changed the definitions of assets and liabilities. Whilst the
concept of ‘control’ remains for assets and ‘present obligation’ for liabilities, the key
change is that the term ‘expected’ has been replaced. For assets, ‘expected
economic benefits’ has been replaced with ‘the potential to produce economic
benefits’. For liabilities, the ‘expected outflow of economic benefits’ has been
replaced with the ‘potential to require the entity to transfer economic resources’.

The reason for this change is that some people interpret the term ‘expected’ to
mean that an item can only be an asset or liability if some minimum threshold were
exceeded. As no such interpretation has been applied by the Board in setting recent
IFRS Standards, this definition has been altered in an attempt to bring clarity.

83
The Board has acknowledged that some IFRS Standards do include a probability
criterion for recognising assets and liabilities. For example, IAS 37 Provisions,
Contingent Liabilities and Contingent Assets states that a provision can only
be recorded if there is a probable outflow of economic benefits, while IAS
38 Intangible Assets highlights that for development costs to be recognised there
must be a probability that economic benefits will arise from the development.

The proposed change to the definition of assets and liabilities will leave these
unaffected. The Board has explained that these standards don’t rely on an
argument that items fail to meet the definition of an asset or liability. Instead,
these standards include probable inflows or outflows as a criterion for recognition.
The Board believes that this uncertainty is best dealt with in the recognition
or measurement of items, rather than in the definition of assets or liabilities.

Chapter 5 – Recognition and derecognition

In terms of recognition, the 2010 Conceptual Framework specified three recognition

criteria which applied to all assets and liabilities:

• the item needed to meet the definition of an asset or liability

• it needed to be probable that any future economic benefit associated with the
asset or liability would flow to or from the entity

• the asset or liability needed to have a cost or value that could be measured
reliably.

The Board has confirmed a new approach to recognition, which requires

decisions to be made by reference to the qualitative characteristics of financial
information. The Board has confirmed that an entity should recognise an asset
or a liability (and any related income, expense or changes in equity) if such
recognition provides users of financial statements with:

• relevant information about the asset or the liability and about any income,
expense or changes in equity

• a faithful representation of the asset or liability and of any income, expenses or

changes in equity, and

• information that results in benefits exceeding the cost of providing that

information

A key change to this is the removal of a ‘probability criterion’. This has been
removed as different financial reporting standards apply different criterion; for
example, some apply probable, some virtually certain and some reasonably
possible. This also means that it will not specifically prohibit the recognition of
assets or liabilities with a low probability of an inflow or outflow of economic
resources.

This is potentially controversial, and the 2018 Conceptual Framework addresses this
specifically in chapter 5; paragraph 15 states that ‘an asset or liability can exist
even if the probability of an inflow or outflow of economic benefits is low’.

The key point here relates to relevance. If the probability of the event is low, this
may not be the most relevant information. The most relevant information may be
about the potential magnitude of the item, the possible timing and the factors
affecting the probability.

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Even stating all of this, the Conceptual Framework acknowledges that the most
likely location for items such as this is to be included within the notes to the
financial statements.

Finally, a major change in chapter 5 relates to derecognition. This is an area not

previously addressed by the Conceptual Framework but the 2018 Conceptual
Framework states that derecognition should aim to represent faithfully both:

(a) the assets and liabilities retained after the transaction or other event that led to
the derecognition (including any asset or liability acquired, incurred or created as
part of the transaction or other event); and

(b) the change in the entity’s assets and liabilities as a result of that transaction or
other event.

Chapter 6 – Measurement

A new en-suite?
The 2010 version of the Conceptual Framework did not contain a separate section
on measurement bases as it was previously felt that this was unnecessary.
However, when presented with the opportunity of re-drafting the Conceptual
Framework, some additions which are helpful and practical may be considered,
even if we have previously managed without them.

In the 2010 Framework, there were a brief few paragraphs that outlined possible
measurement bases, but this was limited in detail. In the 2018 version, there is an
entire section devoted to the measurement of elements in the financial statements.

The first of the measurement bases discussed is historical cost. The accounting
treatment of this is unchanged, but the Conceptual Framework now explains that
the carrying amount of non-financial items held at historical cost should be adjusted
over time to reflect the usage (in the form of depreciation or amortisation).
Alternatively, the carrying amount can be adjusted to reflect that the historical cost
is no longer recoverable (impairment). Financial items held at historical cost should
reflect subsequent changes such as interest and payments, following the principle
often referred to as amortised cost.

The 2018 Conceptual Framework also describes three measurements of current

value: fair value, value in use (or fulfilment value for liabilities) and current
cost.

Fair value continues to be defined as the price in an orderly transaction between

market participants. Value in use (or fulfilment value) is defined as an entity-
specific value, and remains as the present value of the cash flows that an entity
expects to derive from the continuing use of an asset and its ultimate disposal.

Current cost is different from fair value and value in use, as current cost is an entry
value. This looks at the value in which the entity would acquire the asset (or incur
the liability) at current market prices, whereas fair value and value in use are exit
values, focusing on the values which will be gained from the item.

In addition to outlining these measurement bases, the Conceptual Framework

discusses these in the light of the qualitative characteristics of financial information.
However, it stops short of recommending the bases under which items should be
carried, but gives some guidance in the form of examples to show where certain
bases may be more relevant.

85
Relevance is a key issue here. The 2018 Conceptual Framework discusses that
historical cost may not provide relevant information about assets held for a long
period of time, and are certainly unlikely to provide relevant information about
derivatives. In both cases, it is likely that some variation of current value will be
used to provide more predictive information to users.

Conversely, the Conceptual Framework suggests that fair value may not be relevant
if items are held solely for use or to collect contractual cash flows. Alongside this,
the Conceptual Framework specifically mentions items used in a combination to
generate cash flows by producing goods or services to customers. As these items
are unlikely to be able to be sold separately without penalising the activities, a
cost-based measure is likely to provide more relevant information, as the cost is
compared to the margin made on sales.

Chapter 7 – Presentation and disclosure

On-site discussions
This is a new section, containing the principles relating to how items should be
presented and disclosed.

The first of these principles is that income and expenses should be included in the
statement of profit or loss unless relevance or faithful representation would be
enhanced by including a change in the current value of an asset or a liability in OCI.
The second of these relates to the recycling of items in OCI into profit or loss. IAS
1 Presentation of Financial Statements suggests that these should be disclosed
as items to be reclassified into profit or loss, or not reclassified.

The wisdom of crowds?

The recycling of OCI is contentious and some commenters argue that all OCI items
should be recycled. Others argue that OCI items should never be recycled, whilst
some argue that only some items should be recycled. Sometimes the best way
forward on a project isn’t necessarily to seek the wisdom of crowds.

The foreman’s call

Luckily, the Board has managed to find a middle ground on recycling. The 2018
Conceptual Framework now contains a statement that income and expenses
included in OCI are recycled when doing so would enhance the relevance or faithful
representation of the information. OCI may not be recycled if there is no clear basis
for identifying the period in which recycling should occur.

Summary
To the majority of preparers, these changes to the Conceptual Framework will have
little or no impact on the financial statements and they are seen as minor
terminology changes which simply confirm what is already in existence. However,
for ACCA candidates, some of these changes such as recognition and measurement
are key and can be examined in both the Financial Reporting and Strategic
Business Reporting exams.

Written by a member of the Financial Reporting examining team

86
Financial Instruments

International Financial Reporting Standard (IFRS®) 9 Financial Instruments is a

complex standard, especially for users and preparers of financial statements. It is
therefore no surprise that ACCA candidates also find it complex. Indeed, there is a
well-known quote from a previous Chair of the International Accounting Standards
Board (the Board) who said: ‘If you understand this [standard], you haven’t read it
properly.’

IFRS 9 is relevant to the Financial Reporting (FR) syllabus, and so this

article takes a high-level review of its application to the following:

1. Financial assets
2. Financial liabilities
3. Convertibles

1. Financial assets
There are two types of financial asset (equity and debt instruments), which can be
further split into different categories.

(a) Equity investments

Equity instruments are likely to be shares that have been purchased in a company,
but not enough to give the investee significant influence (associate), control
(subsidiary) or joint control (joint venture).

There are two options here, depending on the intention of the entity. The default
category is fair value through profit or loss (FVPL).

Equity instruments: fair value through profit or loss (FVPL)

FVPL is the default treatment for equity investments where transaction costs such
as broker fees are expensed and not capitalised within the initial cost of the asset.
Subsequently, the investment is revalued to fair value at each year end, with the
gain or loss being taken to the statement of profit or loss.

Alternatively, equity instruments can be classified as fair value through other

comprehensive income (FVOCI). It is important to note that this designation must
be made on acquisition and the equity investments cannot retrospectively be
treated as FVPL. This is only an option if the equity investment is intended to be a
long-term investment.

Equity instruments: fair value through other comprehensive income

(FVOCI)
Using FVOCI, the alternative treatment, transaction costs can be capitalised as part
of the initial cost of the investment. Similar to FVPL, the instrument would then be
revalued to fair value at the year end. The big difference is where the gain or loss is
recorded. In FVOCI, the gain or loss is recognised within Other Comprehensive
Income and held in an investment reserve. In this way it is similar to the
accounting for property, plant and equipment using the revaluation model. However
unlike the treatment for a revaluation surplus, there can be a negative FVOCI
reserve.

When the FVOCI instrument is sold, the reserve can be left in equity, or transferred
into retained earnings.

(b) Debt instruments

These are usually bonds or loan notes, or other instruments which are likely to
carry interest and a capital element of repayment. The treatment of the debt

87
instrument depends on the intention of the entity, and there are three options for
categorising debt instruments.

Debt instruments: fair value through other profit or loss (FVPL)

The default category is FVPL, but this is rare within ACCA exams and it is much
more common to apply one of the two alternative treatments, being amortised cost
or FVOCI.

Debt instruments: amortised cost

To apply this treatment, the instrument must pass two tests; first the business
model test and secondly the contractual cash flow characteristics test.

• Business model test – the entity must intend to hold the instrument in order
to collect the interest payments and receive repayment on maturity.

• Contractual cash flow characteristics test – the contractual terms give rise
to cash flows which are solely repayments of the interest and principle amount.

In the FR exam, it will only be the first test which may (or may not) be met, so
management must decide on their intention for holding the debt instrument. This
treatment tends to be the most common in exam scenarios, as it allows the
examiner to test the principles of amortised cost accounting.

The principles of amortised cost accounting require that interest must be recorded
on the amount outstanding. This is relatively straight forward for many
instruments. For example, on a $10m 5% loan, with $10m repayable at the end of
a three-year term, interest would simply be recorded as $500,000 a year.

The issues arise when the balance may be repaid at a premium. For example, the
terms of the $10m loan, issued on 1 January 20X1, may be that the holder receives
interest of 5% a year, but then receives $11m back at the end of the three year
term, on 31 December 20X3. This means that the holder is now earning interest in
two different ways. Firstly, they are earning the 5% payment each year. Secondly,
they are earning another $1m interest over three years in the form of receiving
more money back than they invested.

IFRS 9, Financial Instruments, requires that a constant rate of interest is applied

to this balance to better reflect the reality of the situation. This rate takes into
account both the annual payment and the premium payable on redemption. In the
FR exam, this rate will be provided in the question. The question will provide
information about the effective rate of interest. Let’s say that in this example, the
effective rate of interest is 8.08%. This rate is applied to the outstanding balance
each year in order to calculate the interest earned on the investment, which is the
amount to be recorded in investment income in the statement of profit or loss.

88
The easiest way to do this is often to use a table showing the movement of the
asset.

Balance 1 Interest Balance 31

Jan 8.08% Payment Dec
$’000 $’000 $’000 $’000

20X1 10,000 808 -500 10,308

20X2 10,308 833 -500 10,641

20X3 10,641 859 -500 11,000

The figures in the interest column would be the amounts recorded as investment
income in the statement of profit or loss each year. This is increasing to reflect the
fact that the amount owed is increasing as it gets closer to redemption.

The balance in the final column reflects the amount owed to the entity at each year
end, and shows how the balance outstanding increases from $10m to $11m over
the three year period.

The double entries for the asset in year one would be as follows:

1 January 20X1 – The $10m loan is given to the third party. This reduces the
entity’s cash balance, but creates a long-term receivable of $10m, meaning the
entry is Dr Receivable $10m, Cr Cash $10m.

The interest then accrues over the year at the effective rate of 8.09%. This
increases the amount of the receivable and is recorded in investment income, so
the entry is Dr Receivable $808k, Cr Investment income $808k.

31 December 20X1 – The entity receives a payment of $500,000, being 5% of the

original $10m loaned. This figure will be the same each year. This reduces the
value owed to the entity, so the entry is Dr Cash $500k, Cr Receivable $500k.

The result of these entries is that the entity has a closing receivable of $10.308m.
This will all be held as a non-current asset, as the amount is not receivable until 31
December 20X3.

This would carry on for the next two years, until the full amount is repaid at 31
December 20X3 with the entry Dr Cash $11m, Cr Receivable $11m.

The total interest to be recorded in the statement of profit or loss over the three
years is $2.5m, being the $808k + $833k + $859k. This $2.5m represents all the
interest earned by the entity over the three years. This consists of the $1.5m
annual payments ($500k a year), and the additional $1m received (the difference
between loaning the $10m and receiving the $11m).

Debt instruments: fair value through other comprehensive income (FVOCI)

The final possible treatment for a debt instrument is to hold it at fair value through

89
other comprehensive income (FVOCI). Similar to holding the instrument at
amortised cost, two tests must be passed in order to hold a debt instrument in this
manner.

• Business model test – the entity intends to hold the instrument in order to
collect the interest payments and receive repayment on maturity, but may sell
the asset if the possibility of buying one with a greater return arises.

• Contractual cash flow characteristics test – the contractual terms give rise
to cash flows which are solely repayments of the interest and principle amount.

Again, it is only the first of these that candidates will need to consider in the FR
exam, highlighting that the choice of category will depend on the intention of
management.

If the entity chooses to hold the debt instrument under the FVOCI or FVPL
category, they will still produce the amortised cost table as above, taking the same
figure to investment income. At the year end, the asset would then be revalued to
fair value, with the gain or loss being recorded in either the statement of profit or
loss if classed as FVPL or in other comprehensive income if classified as FVOCI.

2. Financial liabilities
In the FR exam, financial liabilities will be held at amortised cost. These will be
similar to the treatment shown earlier for assets held under amortised cost. Instead
of having investment income and an asset, there will be a finance cost and a
liability. The major difference in the accounting treatment relates to the initial
treatment upon issue of the financial liability. Initially these are recognised at NET
PROCEEDS, being the cash received net of any issue costs.

Therefore if an entity looks to raise $10m of funding, but pays a broker $200,000
for raising the finance, the initial double entry is to Dr Cash $9.8m and Cr Liability
with the $9.8m. Taking the $200,000 immediately to the statement of profit or loss
is incorrect because this fee must be spread over the life of the instrument. This is
effectively done by applying the effective interest rate to the outstanding liability,
which as we stated earlier will be given to the candidates in the exam.

Here, the effective interest rate on the liability now incorporates up to three
elements. It would incorporate the annual interest payable, any premium repayable
on redemption, and any issue costs. This is shown in the example below.

EXAMPLE
Oviedo Co issued $10m 5% loan notes on 1 January 20X1, incurring $200,000
issue costs. These loan notes are repayable at a premium of $1m on 31 December
20X3, giving them an effective interest rate of 8.85%.

In the above example, the 5% relates to the coupon rate, which is the amount
required as an annual payment each year. This is always based on the face (par)
value of the instrument, so means that $500,000 will be payable annually (being
5% of $10m).

As seen in the earlier example relating to financial assets held at amortised cost,
the effective interest rate will be applied to the outstanding balance in each period.
Again, a table is the easiest way to calculate this, as shown below.

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 Balance 1 Interest Balance 31
January 8.85% Payment December
$’000 $’000 $’000 $’000

20X1 9,800 867 -500 10,167

20X2 10,167 900 -500 10,567

20X3 10,567 933 -500 11,000

The entries in 20X1 will be as follows:

1 January 20X1 – The loan is issued, meaning that Oviedo Co receives $9.8m,
being the $10m less the issue costs. Therefore the entries are Dr Cash $9.8m, Cr
Liability $9.8m.

Over the year, interest on the liability is accrued at the effective interest rate of
8.85%, giving the entry Dr Finance cost $867k, Cr Liability $867k.

31 December 20X1 – The payment of $500k is made, giving the entry Dr Liability
$500k, Cr Cash $500k.

This leaves a closing liability of $10.167m. This will all be sat as a non-current
liability, as none of it will be repayable until 31 December 20X3.

If we look at the interest column, we will see that the total interest paid is $2.7m
($867k + $900k + $933k). This is the total which will be expensed to the
statement of profit or loss over the three year period. This amount consists of three
elements:

• $1.5m in annual payments ($500k a year)

• $1m premium repaid (issued $10m loan, but repaid $11m)
• $200k issue costs

As we can see, the issue costs have been expensed over three years, rather than
being expensed immediately in 20X1.

3. Convertibles
Convertible instruments are instruments which give the holder the right to either
demand repayment of the principle amount or to write off the debt and instead
convert the balance into shares. In the FR exam, you will only have to deal with
convertible instruments from the perspective of the issuer, being the person who
has received the cash.

Convertible instruments present a special challenge, as these could ultimately result

in the issue of shares or the repayment of the loan, but the choice will be in the
hand of the holder. As we do not know whether the holder will choose to receive
the cash or convert the instrument into shares, we must reflect an element of both
within the financial statements. Therefore these are accounted for initially
using split accounting, splitting it into the equity and liability components.

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The liability component is the first thing to calculate. We work this out by
calculating the present value of the payments at the market rate of interest (using
the interest on an equivalent bond without the conversion option). The discount
rates required to do this will be given to you in the exam.

In reality the market rate of interest will be higher than the coupon rate, being the
annual amount payable to the holder of the loan. This is because the holder of the
loan is willing to accept a lower rate of annual interest compared to the market, in
exchange for the option to convert the loan into shares.

Once the liability component has been calculated, the equity component is then
worked out. This is simply a balancing figure, and represents the difference
between the cash received and the liability component.

EXAMPLE
Oviedo Co issued $10m 5% convertible loan notes on 1 January 20X1. These will
either be repaid at par on 31 December 20X3, or converted into shares on that
date. Equivalent loan notes without the conversion carry an interest rate of 8%.
Relevant discount rates are shown below.

Amount payable in: Discount factor at 5% Discount factor at 8%

1 year 0.952 0.926

2 years 0.907 0.857

3 years 0.864 0.794

It is important to note that the 5% discount rates are a red herring . It is the
discount rates for the market rate of interest that are important, i.e. 8%. The only
thing we need the 5% for is to work out the annual payment. As these are $10m
5% loan notes, this simply means that Oviedo Co will need to make an annual
payment of $500k in relation to these.

Therefore we can work out the value that the market would place on these loan
notes by looking at the present value of all the payments, discounted at the market
rate of interest. If this is a normal loan, ignoring the conversion, Oviedo Co would
pay $500k in years 20X1 to 20X3, and then make a final repayment of $10m on 31
December 20X3.

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As the market rate of interest is 8%, the present value of these payments can be
calculated. These are calculated in the table below.

Year Payment Discount factor Present value

$’000 8% $’000

20X1 500 0.926 463

20X2 500 0.857 428.5

20X3 10,500 0.794 8,337

Total 9,229

The present value of all of the payments can be seen as $9.229m. This means that
Oviedo Co received $10m, but the present value of the payments to be made have
an initial value of only $9.229m. As a result, the holders of the loan notes are
effectively losing $771k compared to if they had simply given Oviedo Co a normal
loan at the market rate of interest.

This $771k is the amount of interest the holders are willing to lose in order to have
the option to convert the loan into shares. This is taken as the initial value of the
equity element.

On 1 January 20X1, the double entry to record the transaction in the records of
Oviedo Co are as follows:

Dr Cash $10m – reflecting the full cash received from the issue of the convertibles.
Cr Liability $9.229m – reflecting the present value of the liability on 1 January 20X1
Cr Equity $0.771m – reflecting the value of the equity component.

The equity balance would be held as ‘convertible options’ within other components
of equity. Subsequently, this equity amount remains fixed until conversion, but the
liability must be held at amortised cost. This must be built back up to $10m over
the next 3 years, to reflect the amount which the holder would require if they
demand repayment rather than conversion of the loan notes.

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 Balance 1 Interest Balance 31
January 8.85% Payment December
$’000 $’000 $’000 $’000

20X1 9,229 738 -500 9,467

20X2 9,467 757 -500 9,724

20X3 9,724 776 -500 10,000

As with the financial liability noted earlier, the interest column is taken to the
statement of profit or loss each year as a finance cost.

At the end of the three years, Oviedo Co will either repay the $10m liability, or this
will be turned into shares, with the $10m balance and the option balance of $771k
transferred to share capital and share premium.

Summary
This article has considered the key issues relating to financial instruments. To
perform well at FR, it is essential that candidates are able to identify the potential
treatments for financial assets, produce amortised cost calculations and understand
the accounting entries required for a convertible instrument. This is one of the most
technical areas of the syllabus, but also one of the central areas which will be
further developed in Strategic Business Reporting.

Written by a member of the Financial Reporting examining team

94
The use of fair values in the goodwill calculation

For ACCA candidates studying Financial Reporting (FR), consolidated financial

statements are a key topic. A central part of this syllabus area is accounting for the
acquisition of a subsidiary which will test the concept of fair value; this is the value
that the consideration paid for the subsidiary must be recorded. In addition to this,
the assets, liabilities and contingent liabilities of the subsidiary must also be
consolidated at their fair value. This article considers these values in each element
of the calculation.

1. Fair value of consideration

It makes logical sense that the amount to be paid for the subsidiary must be
recorded at its fair value. Accounting for a payment of cash is simple. However,
complexities arise when a parent company pays for the subsidiary in a number of
different ways. For the FR exam, it is vital that candidates are able to account for
each of these.

(a) Payments in cash

These are the most straight forward types of consideration to deal with, as the
entry is relatively simple: Dr goodwill Cr Cash with the amount paid. In an FR
exam, this amount is likely to have already been recorded in the parent company’s
assets as investment in subsidiary. This means that candidates may need to deduct
the amount of cash paid from investments and include it within the goodwill
calculation.

(b) Deferred cash

In addition to cash paid immediately, there may be an element of deferred cash,
being cash payable at a later date. For this to be accounted for as deferred cash,
there must be no conditions attached to the payment, or this becomes contingent
consideration (discussed further below). For deferred cash, the amount payable
needs to be discounted to present value. This reflects the time value of money and
represents the amount of money that the parent would have to put aside at the
date of acquisition in order to be able to pay for the subsidiary on the due date.
This is then included within goodwill and liabilities at the date of acquisition, with
the entry being Dr goodwill, Cr liabilities. As this represents the present value of the
consideration, this needs to be increased to the full amount over time. This process
is called unwinding the discount. Each year the liability is increased by the interest
rate used in the discounting. This subsequent increase is taken to finance costs,
making the double entry Dr finance cost, Cr Liability.

EXAMPLE
Pratt Co acquired 80% of Swann Co on 1 January 20X1. As part of the deal, Pratt
Co agreed to pay the previous owners of Swann Co $10m on 1 January 20X2. Pratt
Co has a cost of capital of 10%.

Solution
As Pratt Co gained control of Swann Co on 1 January 20X1, the goodwill needs to
be calculated on this date. As part of this, the $10m is payable in 1 year. The
present value of $10m in one year is $9.091m ($10m x 1/1.10). This is recorded in
goodwill, with an equivalent liability set up within current liabilities, as the amount
is payable in 12 months.

By the 31 December 20X1, the amount is now payable in one day. The previous
owners of Swann Co will be contacting Pratt Co in one day requesting the payment
of $10m. Therefore Pratt Co is required to show a liability of $10m in its financial
statements at this date. Currently, Pratt Co is showing a liability of $9.091m.

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Therefore this needs to be increased by 10% (the interest). This increase of $909k
($9091 x 10%) is added to the liability and recorded as a finance cost.

It is important to note that this does not affect the goodwill calculation in any way.
Goodwill is calculated at the date of acquisition, and subsequent changes to the
consideration payable are not adjusted in the goodwill calculation.

(c) Contingent consideration

Contingent consideration also relates to amounts payable to the previous owners in
the future. However, the key difference is that the payment of these amounts is
conditional upon certain events, such as the subsidiary performance hitting certain
targets after acquisition.

Therefore these will be recorded as a provision, as the amount payable is likely to

have an element of uncertainty (remember that a provision is a liability of uncertain
timing or amount). This is where it is important to tread carefully. While this is
recorded as a provision in the financial statements, the criteria of IAS® 37
Provisions, contingent liabilities and contingent assets does not apply here. When
we are producing consolidated financial statements we must apply the principle of
using the fair value of consideration, as stated by IFRS® 3, Business
Combinations.
The fair value of the contingent consideration payable will be a mix of the likelihood
of the event, and a reflection of the time value of money. However, it is important
not to overthink things. They key here is that the fair value of the contingent
consideration will be given to you in the exam. This needs to be included in the
goodwill on the date of acquisition with the double entry Dr goodwill, Cr provision.
Again, the fair value of the consideration is likely to have changed by the year end.
This is treated as a subsequent movement in the provision, with the subsequent
increase or decrease being taken through the statement of profit or loss. Just like
with the deferred consideration, this does not affect the calculation of goodwill in
any way.

EXAMPLE
Pratt Co also commits to paying $10m to Swann Co in two years if the results of
Swann Co continue to grow by 5% over that period. An external valuer has
assessed that this is not likely so estimates the fair value of this to be $4m at 1
January 20X1. At 31 December 20X1, this has increased and now the valuer
assesses the fair value to be $6m.

Solution
Many candidates fall into the trap of stating that this is not likely so no liability
should be recorded. In the individual financial statements, this would be true, but
when there is a conflict between the treatment in consolidated financial statements
and the individual financial reporting treatment, the consolidated rules would take
priority. So while the outflow may not be probable, IFRS 3 states that the
consideration must be recorded at fair value.

Therefore on 1 January 20X1 the fair value of $4m is added to the consideration in
the goodwill calculation and to provisions as a non-current liability.

At 31 December 20X1, this has increased from $4m to $6m. This increase of $2m is
not added to goodwill, but is instead expensed to the statement of profit or loss to
reflect the increase in the provision with the double entry Dr P/L, Cr provision. As
the amount is now potentially payable in one year, this will be moved from non-
current liabilities to current liabilities.

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(d) Paying in shares
In addition to the potential cash payments outlined above, the parent company
may also decide to pay for the subsidiary by giving the subsidiary’s previous owners
new shares in the parent company. The double entry for this is similar to the double
entry for a normal share issue.

The issue of shares at market value usually results in the receipt of cash, the
nominal value being taken to share capital and the excess being recorded in share
premium/other components of equity. This is similar to what is happening here, but
no cash is changing hands. Instead of the parent company receiving cash for the
shares, they are receiving a subsidiary.

The double entry for this is therefore to debit the full market value to goodwill,
credit the share capital figure in the consolidated statement of financial position
with the nominal amount and to take the excess to share premium/other
components of equity, also in the consolidated statement of financial position.

EXAMPLE
Pratt Co acquired 80% of Swann Co’s $5m share capital, which consisted of $1
ordinary shares. As part of the consideration for Swann Co, Pratt Co gave the
previous owners of Swann Co 2 $1 shares in Pratt Co for every 5 shares it acquired
in Swann Co. At 1 January 20X1, Pratt Co’s shares had a market value of $3.50.

Solution
Pratt Co has acquired 80% of Swann Co’s shares, meaning it has acquired 4m
shares (80% of the 5m shares in Swann Co). Therefore it issued 1.6m Pratt Co
shares, being 4m x 2/5. These 1.6m shares had a fair value of $5.6m (1.6m x
$3.50).

To record this, Pratt Co must add the full fair value of the consideration of $5.6m as
part of the consideration in the calculation of goodwill. $1.6m must be added to
share capital in the consolidated statement of financial position, being 1.6m shares
x $1 nominal value. This means that the excess of $4m is added to share
premium/other components of equity in the statement of financial position.

2. Fair value of net assets

In addition to recording the consideration paid at fair value, the fair value of the net
assets of the subsidiary at acquisition must be assessed as part of the
consolidation, in order to give an accurate picture of the goodwill arising on the
acquisition.

If a parent company was to buy an individual asset from the subsidiary, say an
item of property, this would be done at whatever the market price of the asset is,
irrespective of its carrying amount in the selling entity’s statement of financial
position. This same principle is applied to the acquisition of the entire entity. Upon
selling the entity, the previous owners would base the selling price on the fair value
of the assets, rather than their carrying amounts. Therefore, the consolidated
financial statements must make adjustments to consolidate the subsidiary’s assets
and liabilities at fair value at the date of acquisition. In the Financial Reporting
exam, this could occur in three different ways.

(a) Fair value adjustments to recognised assets

Assets such as property, plant and equipment, or inventory will be recognised in
the subsidiary’s financial statements at their carrying amounts. Adjustments must
be made to reflect the fair value of these assets.

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For example, inventory must be held in the financial statements of the subsidiary at
the lower of cost and net realisable value, but must be recognised in the
consolidated financial statements at fair value on acquisition. Similarly, the
subsidiary may hold property under the cost model, but this must be accounted for
at fair value in the consolidated financial statements.

In terms of depreciable non-current assets, a fair value adjustment is applied at the

date of acquisition, similar to applying the revaluation model under IAS
16, Property, Plant and Equipment. However, during the consolidation process,
a revaluation surplus is not created. The effect of adding a fair value adjustment to
the asset is that the value of goodwill will decrease. This is because goodwill is the
difference between the consideration paid and the identifiable net assets of the
entity. Therefore as the fair value adjustment increases the net assets, it produces
a lower, more accurate picture of the actual goodwill in the subsidiary.

As the group must make these fair value adjustments at acquisition, there is also
an additional depreciation adjustment to be made to depreciable assets. The
increase to fair value is not recorded in the subsidiary’s individual financial
statements but is a consolidation adjustment and so the additional depreciation is a
consolidation adjustment too. This means that the subsidiary’s depreciation in its
financial statements is based on the carrying amount of the asset before the fair
value adjustment has been made. As the fair value adjustment increases the value
of the asset, the additional depreciation on this must also be accounted for.

In the statement of profit or loss, this year’s depreciation expense on the fair value
adjustment must be included. In the statement of financial position, it is the
cumulative depreciation in all the years since acquisition that must be adjusted. In
both cases, the subsidiary’s profits will reduce following the adjustment for this fair
value depreciation. This means that both the parent’s share and the non-controlling
interest’s share of the post-acquisition profits will also be affected and must be
reduced.

(b) Internally generated assets

The subsidiary may also have internally generated assets that are unrecognised in
its individual financial statements. This is correct, particularly in relation to
intangibles, as most are prohibited from being capitalised under IAS 38,Intangible
Assets. In the consolidated financial statements these will need to be recognised at
fair value if they are identifiable, meaning they could either be separated from the
subsidiary or arise from legal or contractual rights.

This means that items such as internally generated brands or research expenditure
could be capitalised in the consolidated statement of financial position, despite not
meeting the criteria for capitalisation per IAS 38, Intangible Assets. Here, we can
see again that IFRS 3, Business Combinations, overrules the ‘usual’ rule for
individual accounting treatment.

The process of recording the fair value adjustment will be almost identical to that
noted above. The only difference is that it may lead to the creation of a new
intangible asset which is currently unrecognised. It will still have the effect of
increasing non-current assets and reducing goodwill. As this asset has a limited
useful life, it must be amortised over that remaining life. If it is deemed to have an
indefinite life, it will be subject to an annual impairment review.

(c) Contingent liabilities

This is probably the area that most candidates find difficult in the exam. Many
candidates have correctly learned the rule per IAS 37 that contingent liabilities are
only disclosed in the notes to the financial statements, and are not recognised in

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the financial statements themselves as a liability. For individual financial
statements, this is completely true. For consolidated financial statements, this is
not the case. In this case, these need to be included in the consolidated statement
of financial position at fair value.

These contingent liabilities must be recognised in the consolidated financial

statements at their fair value as they will have affected the price that a parent
company is willing to pay for the subsidiary, This is because the parent company
will have offered a lower price for the subsidiary knowing that the subsidiary may
have a potential payout to make in the future, even if they do not deem that to
have a high probability of being paid.

These contingent liabilities need to be consolidated at fair value as a liability at the

date of acquisition. This will reduce the net assets at acquisition, and therefore
increase the goodwill. Any subsequent fair value movements in this contingent
liability are recognised in the statement of profit or loss, rather than affecting the
goodwill calculation.

Summary
As we have seen, both the consideration paid and the net assets of the subsidiary
need to be included at fair value at the date of acquisition. More often than not, the
fair value of items will be provided in the Financial Reporting exam, such as the fair
value adjustment required to net assets, or the fair value of contingent
consideration. For the calculation of items such as deferred cash or an issue of
shares, the information will be given which allows candidates to calculate the
entries.

The key is to not confuse the rules for accounting for items in a consolidation with
the rules for individual accounting standards. As we have seen above, the fair value
adjustments will overrule the usual accounting treatment, so this is a vital area to
be aware of in order to score well within a consolidation question. Fair value
adjustments are very common in the exam, and candidates should be able to deal
with these adjustments, as it is a core area of accounting for subsidiaries.

Written by a member of the Financial Reporting examining team

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