Professional Documents
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ACCA Financial Reporting Workbook June 2022
ACCA Financial Reporting Workbook June 2022
Applied Skills
Financial
Reporting (FR)
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Second edition 2021
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Essential Reading
Tangible non-current assets 533
Intangible assets 549
Impairment of assets 555
Revenue and government grants 561
Introduction to groups 567
The consolidated statement of financial position 573
The consolidated statement of profit or loss and other comprehensive income 587
Accounting for associates 595
Financial instruments 607
Leasing 615
Provisions and events after the reporting period 623
Inventories and biological assets 637
Taxation 643
Presentation of published financial statements 651
Reporting financial performance 663
Earnings per share 673
Interpretation of financial statements 681
Limitations of financial statements and interpretation techniques 691
Statement of cash flows 697
Specialised, not-for-profit and public sector entities 709
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Formula to learn
This boxed feature will highlight important formula which you need to learn for
your exam.
PER alert
This feature identifies when something you are reading will also be useful for your
PER requirement (see ‘The PER alert’ section above for more details).
Illustration
Illustrations walk through how to apply key knowledge and techniques step by step.
Activity
Activities give you essential practice of techniques covered in the chapter.
Essential reading
Links to the Essential reading are given throughout the chapter. The Essential
reading is included in the free eBook, accessed via the Exam Success Site (see inside
cover for details on how to access this).
At the end of each chapter you will find a Knowledge diagnostic, which is a summary of the main
learning points from the chapter to allow you to check you have understood the key concepts. You
will also find a Further study guidance contains suggestions for ways in which you can continue
your learning and enhance your understanding. This can include: recommendations for question
practice from the Further question practice and solutions, to test your understanding of the topics
in the Chapter; suggestions for further reading which can be done, such as technical articles and
ideas for your own research. The Chapter summary provides more detailed revision of the topics
covered and is intended to assist you as you prepare for your revision phase.
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Introduction vi
6 Revenue and government grants Further reading and a worked example covering
performance obligations satisfied over time
Additional activities on government grants
(income and capital)
13 Provisions and events after the Revision of IAS 37 covered in earlier studies,
reporting period including practice activities
Additional detailed worked example of the
discounting of a provision
Revision of contingent assets and liabilities, and
IAS 10 Events after the Reporting Period
22 Specialised, not-for-profit and Detail behind the primary aims and regulatory
public sector entities framework for these specialised entities.
Additional detail and activities behind their
performance measurement KPIs
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Introduction viii
The syllabus
The broad syllabus headings are:
C Analysing and interpreting the financial statements of single entities and groups
Main capabilities
On successful completion of this exam, candidates should be able to:
A Discuss and apply a conceptual and regulatory framework for financial reporting.
D Prepare and present financial statements for single entities and business combinations
in accordance with International accounting standards.
Financial
Accounting (FA)
A4 The concepts and principles of groups and consolidated financial Chapter 7–10
statements
B6 Leasing Chapter 12
B8 Taxation Chapter 15
C Analysing and interpreting the financial statements of single entities and groups
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Introduction x
E2 Work on relevant response options, using available functions and Skills checkpoints
technology, as would be required in the workplace
E3 Navigate windows and computer screens to create and amend Skills checkpoints
responses to exam requirements, using the appropriate tools
The complete syllabus and study guide can be found by visiting the exam resource finder on the
ACCA website: www.accaglobal.com
Total 100
Section A and B questions will be selected from the entire syllabus. These sections will contain a
variety of objective test questions. The responses to each question or subpart in the case of OT
cases are marked automatically as either correct or incorrect by computer.
Section C questions will mainly focus on the following syllabus areas but a minority of marks can
be drawn from any other area of the syllabus.
• Analysing and interpreting the financial statements of single entities and groups (syllabus area
C)
• Preparation of financial statements (syllabus area D)
The responses to these questions are expert marked.
It is essential that you use the ACCA Exam Practice Platform (www.accaglobal.com) when
preparing for your FR exam. The Exam Practice Platform contains a number of full CBE questions
that are aligned to the current syllabus and are consistent with the format and structure of
questions you will face in your exam. The Exam Practice Platform allows you to attempt questions
under exam conditions and to mark your own answers using the suggested solution and marking
guide.
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Introduction xii
cess skills
Exam suc
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Answe
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Approach to Application
reta
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Spreadsheet Interpretation
Go od
skills skills
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Specific FR skills
These are the skills specific to FR that we think you need to develop in order to pass the exam.
In this Workbook, there are five Skills Checkpoints which define each skill and show how it is
applied in answering a question. A brief summary of each skill is given below.
STEP 4: Apply your technical knowledge to the data presented in the question.
Work through calculations taking your time and read through each answer option
with care. OT questions are designed so that each answer option is plausible. Work
through each response option and eliminate those you know are incorrect
Skills Checkpoint 1 covers this technique in detail through application to a series of exam-
standard question.
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Introduction xiv
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Introduction xviii
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Introduction xx
Question practice
Question practice is a core part of learning new topic areas. When you practice questions, you
should focus on improving the Exam success skills – personal to your needs – by obtaining
feedback or through a process of self-assessment.
Sitting this exam as a computer-based exam and practicing as many exam-style questions as
possible in the ACCA CBE practice platform will be the key to passing this exam. You should
attempt questions under timed conditions and ensure you produce full answers to the discussion
parts as well as doing the calculations. Also ensure that you attempt all mock exams under exam
conditions.
ACCA have launched a free on-demand resource designed to mirror the live exam experience
helping you to become more familiar with the exam format. You can access the platform via the
Study Support Resources section of the ACCA website navigating to the CBE question practice
section and logging in with your my ACCA credentials. Question practice is a core part of learning
new topic areas. When you practice questions, you should focus on improving the Exam success
skills – personal to your needs – by obtaining feedback or through a process of self-assessment.
Learning objectives
On completion of this chapter, you should be able to:
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Exam context
The IASB’s Conceptual Framework for Financial Reporting underpins the methods used in financial
reporting. It is used as the basis to develop International Financial Reporting Standards (IFRS
Standards) and offers valuable guidance on how to account for an item where no IFRS Standard
exists, and how to understand and interpret IFRS Standards. Knowledge of the Conceptual
Framework will be examined by objective test questions in Section A or Section B of the FR exam,
although it may also be relevant when interpreting financial statements in Section C.
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1
Chapter overview
The Conceptual Framework
Contents
Liability Derecognition
Enhancing qualitative
characteristics
Equity
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1 What is a conceptual framework?
A conceptual framework for financial reporting is a statement of generally accepted theoretical
principles, which form the frame of reference for financial reporting.
Its theoretical principles provide the basis for:
• The development of accounting standards; and
• The understanding and interpretation of accounting standards.
Therefore, a conceptual framework will form the theoretical basis for determining which events
should be accounted for, how they should be measured and how they should be communicated
to users of financial statements.
2.2 Status
The Conceptual Framework is not an IFRS Standard. It does not override any IFRS Standard, but
instead forms the conceptual basis for the development and application of IFRS Standards.
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2.3 Contents
The Conceptual Framework is divided into eight chapters. You do not need to know all of the
content of the Conceptual Framework for the Financial Reporting exam. In the rest of this chapter,
we will cover the key parts of the Conceptual Framework that are included in the Financial
Reporting syllabus.
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Fundamental qualitative characteristics
3.2.1 Comparability
Comparability: The qualitative characteristic that enables users to identify and understand
KEY
TERM similarities in, and differences among, items (Conceptual Framework: para. 2.25).
For example:
• Consider the disclosure of accounting policies. Users must be able to distinguish between
different accounting policies in order to be able to compare similar items in the accounts of
different entities.
• When an entity changes an accounting policy, the change is applied retrospectively so that
the results from one period to the next can still be usefully compared.
• Comparability is not the same as uniformity. Accounting policies should be changed if the
change will result in information that is reliable and more relevant, or where the change is
required by an IFRS.
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3.2.2 Verifiability
Verifiability: This helps assure users that information faithfully represents the economic
KEY
TERM 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 (Conceptual Framework: para. 2.30).
3.2.3 Timeliness
3.2.4 Understandability
Financial reports are prepared for users who have a reasonable knowledge of business and
economic activities and who review and analyse the information diligently (Conceptual
Framework: para. 2.36).
Asset: A present economic resource controlled by the entity as a result of past events
KEY
TERM (Conceptual Framework: para. 4.2).
An economic resource is a right that has the potential to produce economic benefits (Conceptual
Framework: para. 4.14).
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An entity controls an economic resource if it has the present ability to direct the use of the
economic resource and obtain the economic benefits that may flow from it (Conceptual
Framework: para. 4.20).
Economic benefits include:
• Cash flows, such as returns on investment sources
• Exchange of goods, such as by trading, selling goods, provision of services
• Reduction or avoidance of liabilities, such as paying loans
(Conceptual Framework: para. 4.16)
Liability: A present obligation of the entity to transfer an economic resource as a result of past
KEY
TERM events (Conceptual Framework: para. 4.2).
An essential characteristic of a liability is that the entity has an obligation. An obligation is ‘a duty
or responsibility that the entity has no practical ability to avoid’ (Conceptual Framework: para.
4.29).
Equity: The residual interest in the assets of an entity after deducting all its liabilities
KEY
TERM (Conceptual Framework: para. 4.2).
Income: Increases in assets, or decreases in liabilities, that result in increases in equity, other
KEY
TERM than those relating to contributions from equity participants (Conceptual Framework: para.
4.2).
Expenses: Decreases in assets, or increases in liabilities, that result in decreases in equity,
other than those relating to distributions to equity participants (Conceptual Framework: para.
4.2).
The Conceptual Framework describes financial reporting as providing information about financial
position and changes in financial position: assets and liabilities are defined first, and income and
expenses are defined as changes in assets and liabilities, rather than the other way around.
Consider the following situations and in each case determine whether an asset, liability or neither
exists as defined by the Conceptual Framework.
1 PAT Co purchased a licence for $20,000. The licence gives PAT Co sole use of a particular
manufacturing process which, in turn, will save them $3,000 a year for the next five years.
2 BAW Co gifted an individual, Don Brennan, $10,000 to set up a car repair shop. In return,
BAW Co has requested that priority treatment is given to the fleet of cars used by BAW Co’s
salesmen.
3 DOW Co operates a car dealership and provides a warranty with every car it sells. The
warranty guarantees that the cars will operate as expected for a period of 12 months from the
date of purchase.
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Solution
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5.3 Derecognition
Derecognition normally occurs when the item no longer meets the definition of an element:
• For an asset – when control is lost (derecognise part of a recognised asset if control of that
part is lost)
• For a liability – when there is no longer a present obligation
(Conceptual Framework: para. 5.26)
Activity 3: Recognition
Solution
6 Measurement
The Conceptual Framework specifically refers to two measurement bases:
• Historical cost
• Current value
It outlines the information provided by both but stresses that the choice between them depends
on what information the primary users of the financial statements require.
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6.1 Historical cost
Historical cost: Historical cost for an asset is the cost that was incurred when the asset was
KEY
TERM acquired or created and, for a liability, is the value of the consideration received when the
liability was incurred.
Historical cost accounting (HCA) is the traditional form of accounting, modified in some instances
by revaluations of certain assets.
Fair value: The price that would be received to sell an asset, or paid to transfer a liability, in an
KEY
TERM orderly transaction between market participants at the measurement date (Conceptual
Framework: para. 6.12 and IFRS 13: Appendix A).
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6.2.2 Value in use
Value in use: The present value of the cash flows, or other economic benefits, that an entity
KEY
TERM expects to derive from the use of an asset and from its ultimate disposal (Conceptual
Framework: para. 6.17).
Value in use looks at the likely future value to the entity of using the asset.
Value in use considers entity-specific factors, whereas fair value is market specific.
Current cost of an asset: The current cost of an asset is the cost of an equivalent asset at the
KEY
TERM measurement date, comprising the consideration that would be paid at the measurement
date, plus the transaction costs that would be incurred at that date (Conceptual Framework:
para. 6.21).
Current cost of a liability: 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 (Conceptual Framework: para. 6.21).
Current cost differs from historical cost as current cost assesses the price to purchase at the
reporting date, rather than the date the asset was acquired or liability assumed.
Where the current cost cannot be obtained from information in the market, then the entity can
adjust for condition and age to buy a similar model.
Activity 4: Measurement
Ergo Co acquired an item of plant on 1 July 20X5 at a cost of $250,000. Ergo Co depreciates its
plant at a rate of 20% on a reducing balance basis. As at 30 June 20X6, the manufacturer still
makes the same item of plant and its current price is $300,000.
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Required
What is the correct carrying amount to be shown in the statement of financial position of Ergo Co
as at 30 June 20X6 under historical cost and current cost?
Historical cost: $200,000; Current cost: $300,000
Historical cost: $200,000; Current cost: $240,000
Historical cost: $250,000; Current cost: $300,000
Historical cost: $250,000; Current cost $240,000
You have been asked to show the effect of different measurement bases for the following asset:
An item of equipment was purchased on 1 January 20X3 for $140,000. The equipment is
depreciated at 25% per annum using the reducing balance method.
The equipment is still available and its list price at 31 December 20X4 is $180,000, although the
current model is 20% more efficient than the model the entity purchased in 20X3.
It is estimated that the equipment could be sold for $44,000, although the company would have
to spend about $500 in advertising costs to do so. The asset is expected to generate net cash
inflows of $20,000 for the next five years after which time it will be scrapped. The company’s cost
of borrowing is 6%. The cumulative present value of $1 in five years’ time is $4.212.
Required
1 What is carrying amount of the equipment in the statement of financial position as at 31
December 20X4 using historical cost?
$70,000
$78,750
$105,000
$140,000
2 What is the carrying amount of the equipment in the statement of financial position as at 31
December 20X4 using fair value?
$32,868
$43,500
$44,000
$44,500
3 What is the carrying amount of the equipment in the statement of financial position as at 31
December 20X4 using current cost?
$70,313
$75,000
$84,375
$101,250
4 What is the carrying amount of the equipment in the statement of financial position as at 31
December 20X4 using the value in use method?
$32,868
$43,500
$83,740
$84,240
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7 Concepts of capital and capital maintenance
7.1 Capital
There are two concepts relating to capital:
• Financial concept of capital in which capital refers to the net assets or equity of an entity
• Physical concept of capital in which capital is regarded as the productive capacity of the
entity, for example, units of output per day
A financial concept of capital is adopted by most entities (Conceptual Framework: para. 8.1).
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Chapter summary
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Qualitative The elements Recognition
characteristics of useful of financial and
financial information statements derecognition
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Measurement Concepts of capital and
capital maintenance
Historical cost
• Most common Capital
• Measured at the transaction • Financial concept of capital =
date and not subsequently net assets/equity
updated • Physical concept of capital =
• Asset: Cost of acquisition/ productive capacity
creation of asset plus
transaction costs
• Liability: Value to incur/take on Capital maintenance
the liability less transaction
• A 'profit' is made where
costs
'capital' has increased over the
period (excluding transactions
with holders of equity claims)
Current value
• Financial capital
• Information is updated to maintenance – profit is made if
reflect changes in value at the net assets/equity increase
measurement date • Physical capital maintenance –
• Fair value: Price that would be profit is made if the physical
received to sell an asset/paid productive capacity/operating
to transfer a liability in an capacity increases
orderly transaction between
market participants at the
measurement date
• Value in use (assets)/fulfilment
value (liabilities)
– Value in use – present value
of the cash flows expected to
be derived from the asset
– Fulfilment value – present
value of the cash flows
expected to be obliged to
transfer to fulfil the liability
• Current cost: Cost of an
equivalent asset/consideration
that would be received for an
equivalent liability at the
measurement date
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Knowledge diagnostic
6. Measurement
Using the historical cost basis is an objective and readily understood method, but overstates
profits and return on capital employed in times of inflation.
Using the current value basis attempts to solve this problem. Current value includes:
• Fair value
• Value in use
• Fulfilment value
• Current cost
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8. IAS 1 Presentation of Financial Statements
In order to achieve fair presentation, an entity must comply with International Financial Reporting
Standards (IFRS Standards, IASs and IFRIC Interpretations).
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Further study guidance
Question practice
Now try the following from the Further question practice bank (available in the digital edition of
the Workbook):
1 Conceptual framework
Further reading
You should make time to read this article, which is available in the study support resources section
of the ACCA website:
Extreme makeover – IASB edition
www.accaglobal.com
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Activity answers
Activity 3: Recognition
Recognition in the financial statements:
(1) First, it is necessary to consider whether the amounts spent on training should be recognised
as an asset or an expense. To be an asset, there must be:
- Present economic resource
- Control
- A past event
Whilst it is clear that there is a past event (the provision of training) and the training is a resource
that has the potential to produce economic benefits (the staff that will be able to do a better job),
the staff are not personally controlled by the company and thus the increased capability to do
their jobs is not under the control of the company.
(2) The issue here is whether the dividend should be recognised as a liability or not at the year
end. A liability exists only where three criteria are met at the year end:
- A present obligation
- (As a result of) a past event
- Expected to result in a transfer of economic resources.
A present obligation is one that exists at the year end. As the dividend payment has not been
communicated outside the company at the year end, there is no obligation for it to be paid: the
directors could change their mind as to how much or whether a dividend should be paid without
any consequences.
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A present obligation does not therefore exist at the year end and no liability can be recognised for
proposed dividends. It is declaration of a dividend externally that creates an obligation for it to be
paid, and this has not happened at the year end. A liability would be recognised from 10
February, even if the dividend has not been legally approved by shareholders, as a constructive
obligation is sufficient to generate a liability under IFRS Standards; ie the creation of a valid
expectation in those affected that a payment will be made.
When the dividend is recognised, it will be recognised as a reduction in equity, rather than as an
expense as it is a distribution to equity participants in the business.
Activity 4: Measurement
The correct answer is: Historical cost: $200,000; Current cost: $240,000
Historical cost: $250,000 × 80% = $200,000 carrying amount
Current cost: $300,000 × 80% = $240,000 carrying amount
Working
Historical cost carrying amount
Historical cost
$
1.1.X3 b/d 140,000
1.1.X3–31.12.X3 Dep’n @ 25% (35,000)
31.12.X3 Carrying amount 105,000
1.1.X4–31.12.X4 Dep’n @ 25% (26,250)
31.12.X4 Carrying amount 78,750
Working
Current cost carrying amount
Current cost
(restated)
$
150,000
1.1.X3 b/d (180,000 × 100%/120%)
1.1.X3-31.12.X3 Dep’n @ 25% (37,500)
31.12.X3 Carrying amount 112,500
1.1.X4-31.12.X4 Dep’n @ 25% (28,125)
31.12.X4 Carrying amount 84,375
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4
Working
Value in use
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The regulatory
2 framework
Learning objectives
On completion of this chapter, you should be able to:
Explain why IFRS Standards on their own are not a complete A3(b)
regulatory framework.
Exam context
Building on your basic knowledge of the IFRS Standards introduced in your earlier studies, the FR
exam expands your knowledge of the standards and their application. It is important to
understand why we have IFRS Standards and to recognise the key aims of the IASB. This chapter
also looks at the impact of IFRS Standards worldwide and their interaction with local accounting
standards.
This is an area that is most likely to be tested as part of a Section A objective test question (OTQ).
However, it is important to understand the basis of setting IFRS Standards for answering any
narrative explanation of why standards were required, for example, with the changes to the
leasing standard and the introduction of IFRS 16 Leases.
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Chapter overview
The Regulatory Framework
Advantages
Disadvantages
Definition
Advantages
Disadvantages
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1 The need for a regulatory framework
A regulatory framework for accounting is needed for two principal reasons:
(a) To act as a central source of reference of generally accepted accounting practice (GAAP) in
a given market; and
(b) To designate a system of enforcement of that GAAP to ensure consistency between
companies in practice.
The aim of a regulatory framework is to narrow the areas of difference and choice in financial
reporting and to improve comparability. This is even more important when we consider how
different financial reporting can be around the world.
Compliance with IFRS Standards cannot be required without their adoption in national or regional
law.
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Disadvantages
(a) IFRS Standards may not meet local needs
(b) Loss of control and independence
(c) Interference and conflicts with national and regional law
(d) Language, translation and interpretation issues
Tutorial Note
You must keep up to date with the IASB’s progress and the problems it encounters in the financial
press. You should also be able to discuss:
• Use and application
of IFRS Standards
• Due process
of the IASB
• The IASB’s relationship with other standard setters which looks at current and future work
of the IASB
• Criticisms
of the IASB
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Activity 1: Barriers to international harmonisation
Solution
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Général (PCG), a specific set of reporting codes, which is more prescriptive in nature than IFRS
Standards.
The Russian Federation requires listed companies to use IFRS Standards.
Norway is currently considering whether to revise their national standards to converge with IFRS
Standards for small and medium entities.
4.5 Africa
In 2019, 17 African countries adopted IFRS Standards for listed companies and other public
companies. These included the Republic of Congo, Senegal and Cameroon to increase the
number of African jurisdictions/countries requiring some adoption of IFRS Standards to 49.
Essential reading
The IASB has significant information on their website about the ongoing consideration and
adoption of IFRS Standards on a global basis on its website:
https://www.ifrs.org/use-around-the-world/
The Essential reading is available as an Appendix of the digital edition of the Workbook.
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5.1 Standard setting process
The following summarises the key steps in the standard-setting process:
The period of exposure for public comment is normally 120 days. However, in exceptional
circumstances, proposals may be issued with a comment period of no less than 30 days. Draft
IFRS Interpretations are exposed for a 60-day comment period (IFRS Foundation Due Process
Handbook: para. 6.7).
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This is made up of 14 members with significant technical expertise who can offer guidance on the
application of IFRS Standards. This is often as a result of a question to the Committee who then
consider whether this requires further investigation based on the extent of the work required (is it
specific enough to be answered efficiently?).
An agenda decision will then decide whether further explanatory material is to be added to the
standard (such as in an appendix) or whether an actual amendment (‘Narrow Scope’ standard
setting).
Which of the following bodies is responsible for reviewing new financial reporting issues and
issuing guidance on the application of IFRS Standards?
The International Accounting Standards Board
The IFRS Foundation
The IFRS Interpretations Committee
The IFRS Advisory Council
6.2 Advantages
In favour of accounting standards (both national and international), the following points can be
made.
• They reduce, even eliminate, confusing variations in the methods used to prepare accounts.
• They provide a focal point for debate and discussions about accounting practice.
• They oblige companies to disclose the accounting policies used in the preparation of accounts.
• They are a less rigid alternative to enforcing conformity by means of legislation.
• They have obliged companies to disclose more accounting information than they would
otherwise have done if accounting standards did not exist. For example, IAS 33 Earnings per
Share.
6.3 Disadvantages
Many companies are reluctant to disclose information that is not required by national legislation,
with some arguing against standardisation and in favour of choice.
• One method of preparing accounts might be inappropriate in some circumstances.
• Standards may be subject to lobbying or government pressure (in the case of national
standards).
• Many national standards are not based on a conceptual framework of accounting, although
this is the basis for IFRS Standards.
• There may be a trend towards rigidity.
• There are also political problems, as any international body, whatever its purpose or activity,
faces difficulties in attempting to gain international consensus and the IASB is no exception to
this. It is complex for the IASB to reconcile the financial reporting situation between economies
as diverse as developing countries and sophisticated first-world industrial powers.
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Activity 3: Interpretation of IFRS Standards
Which of the following bodies provides strategic support and advice to the IFRS Foundation?
IFRS Advisory Council
IFRS Interpretations Committee
Global Preparers Forum
Accounting Standards Advisory Forum
PER alert
One of the competences you require to fulfil Performance Objective 7 of the PER is the ability
to prepare drafts or review primary financial statements in accordance with relevant
accounting standards and policies and legislation. The information in this chapter will give you
knowledge to help you demonstrate this competence.
Essential reading
There are additional activities which are recommended in Chapter 2, Section 5 of the Essential
reading.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
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Chapter summary
Disadvantages
• Practices may change leading to outdated principles
• Principles may be overly flexible
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Due process of IASB Criticisms of the IASB
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Knowledge diagnostic
3. IASB
The IASB issues IFRS Standards and revised IASs, and is an independent standard setter made up
of representatives from different global economies.
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Further study guidance
Question practice
Now try the following from the Further question practice bank (available in the digital edition of
the Workbook):
2 Regulators
3a Standard setters
Further reading
IASB publishes its workplan and future projects, including details of current and proposed
changes. The website also looks at the IFRS Standards adoption process on a global basis.
www.ifrs.org
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Activity answers
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Tangible non-current
3 assets
Learning objectives
On completion of this chapter, you should be able to:
Account for revaluation and disposal gains and losses for non- B1(d)
current assets.
Exam context
Property, plant and equipment is an important area of the ACCA Financial Reporting syllabus.
You can almost guarantee that in every exam you will be required to account for property, plant
and equipment at least once and it can feature as an OTQ in Section A or B, or as an adjustment
when preparing primary financial statements in Section C. This chapter builds on the knowledge
of IAS 16 Property, Plant and Equipment that you have already seen in your earlier studies and
also introduces IAS 23 Borrowing Costs and IAS 40 Investment Property.
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Chapter overview
Tangible non-current assets
Transfers
Disposals
Disclosure
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1 Property, Plant and Equipment (IAS 16)
1.1 Accounting for property, plant and equipment (PPE)
Essential reading
You should recall IAS 16 Property, Plant and Equipment from your previous studies. This chapter
builds on the knowledge you already have and therefore it is important that you recap on the key
topics. Chapter 3, Section 1 of the Essential reading provides revision on the important definitions,
recognition and measurement principles, basic revaluation, disposals and disclosure. Chapter 3,
Section 2 of the Essential reading provides revision of depreciation. It is essential that you are
comfortable with this material before continuing with this chapter.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
Binkie Co has a year end of 30 June 20X6. On 1 July 20X3, a decline in land value led the
company to reduce the carrying amount of land from $150,000 to $130,000. The decline was
recorded as an expense in profit or loss. There have been no further changes in the land until a
surge in land prices in the current year mean the land is worth $200,000 at 30 June 20X6.
Required
Account for the revaluation in the current year.
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Solution
The revaluation at 1 July 20X3 resulted in a decrease in value of $20,000, which was recorded in
profit or loss. There is an increase in value of $70,000 at 30 June 20X6. As land is not depreciated,
$20,000 of the increase is credited to profit or loss in the year to 30 June 20X6 to reverse the
previous loss. The excess increase in value of $50,000 is recognised in other comprehensive
income.
The double entry is:
Using the information in Illustration 1, but swapping round the figures, let’s assume that the land
original cost was $150,000, it was revalued upwards to $200,000 on 1 July 20X3 and the
valuation at 30 June 20X6 has fallen to $130,000.
Required
Account for the decrease in value.
Solution
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Revaluation at Revaluation at Revaluation mid-way
the start of the year the end of the year through the year
Depreciation for the year is Depreciation for the year is Two separate depreciation
based on the revalued amount. based on the cost or valuation calculations are required:
brought forward at the start of • Pro rata on the brought
the year. Depreciation for the forward cost or valuation to
year must be deducted in arrive at carrying amount at
arriving at the carrying the date of valuation
amount of the asset at the • Pro rata on the revalued
date of valuation. amount
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The following entry can be made annually over the remaining life of the asset:
If this entry is not made the full $40,000 is transferred to retained earnings when the asset is
disposed of/retired.
Crinkle prepares its financial statements to 31 December each year. It bought an asset that had a
useful life of five years for $10,000 in January 20X6. On 1 January 20X8, the asset was revalued
to $12,000. The expected useful life has remained unchanged (ie three years remain). It is the
policy of Crinkle to make a reserve transfer for excess depreciation.
Required
Account for the revaluation and state the treatment for depreciation from 20X8 onwards.
Solution
$
List price of machine 8,550
Trade discount (855)
Delivery costs 105
Set-up costs incurred internally 356
8,156
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Notes.
1 The machine was expected to have a useful life of 12 years and a residual value of $2,000.
2 Xavier’s accounting policy is to charge a full year’s depreciation in the year of purchase and
no depreciation is the year of retirement or sale.
3 Xavier has a policy of keeping all equipment at revalued amounts. No revaluations had been
necessary until 30 September 20X8 when one of the major suppliers of such machines went
bankrupt, causing a rise in prices. A specific market value for Xavier’s machine was not
available, but an equivalent brand-new machine would now cost $15,200 (including relevant
disbursements). Xavier treats revaluation surpluses as being realised through use of the asset
and transfers them to retained earnings over the life of the asset. The remaining useful life and
residual value of the machine remained the same.
4 Xavier’s year end is 30 September.
Required
1 What is the carrying amount of plant and equipment at 30 September 20X5?
$7,200
$7,317
$7,643
$8,427
2 What is the carrying amount of the plant and equipment at 30 September 20X8?
$10,800
$11,900
$13,200
$15,200
3 Which TWO of the following statements are correct when revaluing property, plant and
equipment?
All property, plant and equipment should be revalued
The revaluation should take place every three to five years
The revalued asset continues to be depreciated
The asset should be revalued to fair value if available
4 What is the balance on the revaluation surplus at 30 September 20X8?
$2,052
$4,696
$5,439
$6,104
5 How much of the revaluation surplus is transferred to retained earnings in the year to 30
September 20X9?
$
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Assessment focus point
The July 2020 Examiner’s Report noted disappointing performance from candidates in respect
of the disposal of revalued assets. The report included the following comments:
Candidates appeared to struggle with the disposal of a revalued asset, and how that is shown
in the statement of changes in equity. Many were able to produce a reserve transfer for the
additional depreciation on a revalued asset, but relatively few knew to release a revaluation
surplus upon the disposal of a revalued asset.
Required
Calculate the depreciation for the year.
Solution
Depreciation at the end of the first year, in which 150 flights totalling 400 hours were made would
then be:
$’000
Fuselage (20,000 / 20 years) 1,000
Undercarriage (5,000 × 150/500 landings) 1,500
Engines (8,000 × 400/1,600 hours) 2,000
4,500
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item being replaced, such as the old furnace lining, should be derecognised when the
replacement takes place (IAS 16: para. 13).
Following Illustration Depreciation of complex assets above, an overhaul of the aircraft was
required at the end of year 3 and every third year thereafter at a cost of $1.2 million.
Required
Explain how the overhaul would be accounted for.
Solution
The cost of the overhaul would be capitalised as a separate component. $1.2 million would be
added to the cost and the depreciation (assuming 150 flights again) would therefore be:
$’000
Total as above 4,500
Overhaul ($1,200,000/3) 400
4,900
2.1 Recognition
Consistent with the recognition criteria under IAS 16, IAS 40 requires that an investment property
is recognised when, and only when:
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2.2 Initial measurement
Investment property is measured initially at cost.
Cost includes purchase price and any directly attributable expenditure such as professional fees
for legal services, property transfer taxes and other transaction costs.
For self-constructed investment properties, cost is the cost at the date when the construction or
development is complete.
Carry the asset at its historic cost less • Investment property is measured at fair value
• Depreciation and at the end of the reporting period
• Any accumulated impairment loss • Any resulting gain or loss is included in profit
or loss for the period
• The investment property is not depreciated
On 1 October 20X9 Propex has the following properties. It uses the fair value model to measure
investment property:
(1) Tennant House which cost $150,000 on 1 October 20X4. The property is freehold and is
rented to private individuals for six-monthly periods. The current market value of the property
is $175,000.
(2) Stowe Place which cost $75,000. This is used by Propex as its headquarters. The building was
acquired on 1 October 20W9. The current market value is $120,000.
Propex depreciates its buildings at 2% per annum on cost.
Required
How should the property be shown in the statement of financial position at 1 October 20X9?
Tennant House
Stowe Place
Essential reading
Chapter 3, Section 3 of the Essential reading provides further detail on the fair value and cost
models for investment property.
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The Essential reading is available as an Appendix of the digital edition of the Workbook.
2.4 Transfers
Transfers to or from investment property should only be made when there is a change in use. For
example, owner occupation commences so the investment property will be treated under IAS 16 as
an owner-occupied property.
Consider the situation in which an investment property becomes owner-occupied on 1 July 20X6:
1 Jan X6 1 Jul X6 31 Dec X6
Date of transfer
Determine FV
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Activity 5: Transfer of PPE to investment property
Kapital owns a building which it has been using as a head office. In order to reduce costs, on 30
June 20X9 it moved its head office functions to one of its production centres and is now letting out
its head office. Company policy is to use the fair value model for investment property.
The building had an original cost on 1 January 20X0 of $250,000 and was being depreciated over
50 years. At 31 December 20X9, its fair value was judged to be $350,000.
Required
Explain how the building will be accounted for in the financial statements of Kapital Co at 31
December 20X9
Solution
2.5 Disposals
Derecognise (eliminate from the statement of financial position) an investment property on
disposal or when it is permanently withdrawn from use and no future economic benefits are
expected from its disposal.
Any gain or loss on disposal is the difference between the net disposal proceeds and the carrying
amount of the asset. It should generally be recognised as income or expense in profit or loss.
Compensation from third parties for investment property that was impaired, lost or given up shall
be recognised in profit or loss when the compensation becomes receivable (IAS 40: paras. 66–69).
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2.6.1 Fair value model – additional disclosures
An entity that adopts this must also disclose a reconciliation of the carrying amount of the
investment property at the beginning and end of the period (IAS 40: paras. 77–78).
Funds borrowed generally Weighted average of borrowing costs outstanding during the
period (excluding borrowings specifically for a qualifying
asset) multiplied by expenditure on qualifying asset. The
amount capitalised should not exceed total borrowing costs
incurred in the period (IAS 23: para. 14).
3.3.2 Suspension
Capitalisation is suspended during extended periods when development is interrupted. (IAS 23:
para. 20)
3.3.3 Cessation
Capitalisation ceases when substantially all the activities necessary to prepare the qualifying
asset for its intended use or sale are complete (IAS 23: para. 22).
The capitalisation of borrowing costs should be calculated pro-rata if the commencement or
cessation occurs within the period, or there has been a suspension within the period.
Essential reading
Chapter 3, Section 4 of the Essential reading provides more detail on the commencement,
suspension and cessation of capitalisation.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
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Illustration 4: Borrowing costs
On 1 January 20X6, Stremans Co borrowed $1.5 million to finance the production of two assets,
both of which were expected to take a year to build. Work started during 20X6. The loan facility
was drawn down and incurred on 1 January 20X6, and was utilised as follows, with the remaining
funds invested temporarily.
The loan rate was 9% and Stremans Co can invest surplus funds at 7%.
Required
Ignoring compound interest, calculate the borrowing costs that may be capitalised for each of the
assets and consequently, the cost of each asset as at 31 December 20X6.
Solution
Acruni Co had the following loans in place at the beginning and end of 20X6.
On 1 January 20X6, Acruni Co began construction of a qualifying asset, a piece of machinery for
a hydro-electric plant, using existing borrowings. Expenditure drawn down for the construction
was: $30 million on 1 January 20X6, $20 million on 1 October 20X6.
Required
Calculate the borrowing costs that can be capitalised for the hydro-electric plant machinery.
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Solution
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Chapter summary
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Borrowing costs (IAS 23)
Accounting treatment
• Borrowing costs relating to a qualifying
asset must be capitalised as part of the
cost of that asset
– A qualifying asset is one that
necessarily takes a long period of
time to be ready for its intended use
or sale
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Knowledge diagnostic
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Further study guidance
Question practice
You should attempt the following question from the Further question practice bank (available in
the digital edition of the Workbook):
5 Gains Co
Further reading
Accounting for property, plant and equipment (key areas of IAS 16)
Property, plant and equipment and tangible fixed assets – part 1 (focus on IAS 16)
Property, plant and equipment and tangible fixed assets – part 2 (revaluations)
www.accaglobal.com
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Activity answers
The depreciation for each of the next three years will be $12,000 / 3 = $4,000, compared to
depreciation on cost of $10,000 / 5 = $2,000. So each year, the extra $2,000 can be treated as
part of the surplus that has become realised (this can also be calculated by taking the revaluation
surplus of $6,000 over the remaining useful life of three years):
This is a movement on owners’ equity only and it will be shown in the statement of changes in
equity. It is not an item in profit or loss.
Working
Property, plant and equipment
$
Cost (8,550 – 855 + 105 + 356) 8,156
Accumulated depreciation (8,156 – 2,000)/12 years (513)
7,643
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Workings
1 Plant and equipment
$
Revalued amount (Working) 10,800
Accumulated depreciation (0)
10,800
$
Gross replacement cost 15,200
Depreciation (15,200 – 2,000) × 4/12 (4,400)
Depreciated replacement cost 10,800
Workings
1 Revalued amount (depreciated replacement cost)
$
Gross replacement cost 15,200
Depreciation (15,200 – 2,000) × 4/12 (4,400)
Depreciated replacement cost 10,800
$
Cost 8,156
Accumulated depreciation (8,156 – 2,000) × 4/12 (2,052)
6,104
5
5 $ 587
Working
Revaluation surplus
$
Depreciation on new revalued amount (10,800 – 2,000)/8-year remaining life 1,100
Depreciation on historic cost (6,014 – 2,000)/8 years (513)
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$
Difference transferred to retained earnings each year 587
or $
Balance on revaluation surplus at 30.9.X8 (4,696/8 years) 587
$
Original cost 250,000
Depreciation 1.1.X0 – 1.1.X9 (250/50 × 9) (45,000)
Depreciation to 30.6.X9 (250/50 × 6/12) 2,500
Carrying amount at 30.6.X9 202,500
Revaluation surplus 147,500
Fair value at 30.6.X9 350,000
The difference between the carrying amount and fair value at the date of transfer is taken to the
revaluation surplus. After the date of transfer, the building is accounted for as an investment
property and will be subjected to a fair value exercise at each year end and these gains or losses
will go to profit or loss. If at the end of the following year, the fair value of the building is found to
be $380,000, then $30,000 will be credited to profit or loss.
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Intangible assets
4
4
Learning objectives
On completion of this chapter, you should be able to:
Describe the criteria for the initial recognition and measurement B2(c)
of intangible assets.
Exam context
Intangible assets are increasingly important in modern business where the trend is away from
investment in property, plant and equipment and inventory and towards building businesses
around brands, data intelligence, software or workforce talent. IAS 38 considers how intangible
assets can be recognised and measured in an entity’s financial statements, although there is
some criticism as to whether the standard reflects the true value of modern businesses. In the
ACCA Financial Reporting exam, intangible assets could feature as an objective test question
(OTQ) in Section A or B, or as an adjustment in a preparation question in Section C.
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Intangible assets
Identifiable
Monetary assets
Revaluation model
Amortisation/Impairment Derecognition
Point of derecognition
Revaluation model
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1 Definitions
Intangible asset: ‘An identifiable non-monetary asset without physical substance.’ (IAS 38:
KEY
TERM para. 8)
1.1 Identifiable
Monetary assets: ‘Money held and assets to be received in fixed or determinable amounts of
KEY
TERM money.’ (IAS 38: para. 8)
• Cash and receivables are both examples of monetary assets and therefore do not meet the
definition of an intangible asset.
• Property, plant and equipment and inventories are examples of non-monetary assets.
However, they have physical substance and therefore also do not meet the definition of
intangible assets.
• Computer software, brands, licences and patents are all examples of intangible assets.
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Essential reading
Chapter 4, Section 1 of the Essential reading discusses the recognition criteria in more detail. You
will find that it is generally consistent with that covered for tangible non-current assets in Chapter
3.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
Which THREE of the following are likely to meet the recognition criteria of IAS 38 Intangible Assets?
(Tick the correct answers.)
Expenditure of $300,000 on increasing the skills of staff
$250,000 acquiring a licence to operate in a new geographical location
$28,000 spend on advertising a new product which is expected to generate economic benefits
for the entity
$100,000 on computer software acquired from a supplier
A brand, valued at $500,000 acquired as part of the purchase of a new subsidiary
An internally developed brand name, estimated to be worth $100,000
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3.1.1 Business combination
A business combination is defined by IFRS 3 Business Combinations as:
A business combination usually results in the need to prepare group accounts, as covered in
Chapters 7–10 of this Workbook.
3.2 Goodwill
Goodwill reflects an entity’s value over and above its recorded value in the financial statements.
It is often referred to as representing the reputation of a business.
There are two types of goodwill:
Research: ‘Original and planned investigation undertaken with the prospect of gaining new
KEY
TERM scientific or technical knowledge and understanding.’ (IAS 38: para. 8)
Development: ‘Application of research findings to a plan or design for the production of new or
substantially improved materials, products, processes, systems or services before the start of
commercial production or use.’ (IAS 38: para. 8)
Essential reading
You should be familiar with the research and development phases and the PIRATE criteria from
your previous studies. A recap has been included in Chapter 4, Section 2 of the Essential reading.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
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Internally generated
intangible assets
Research Development
'original and planned investigation 'application of research findings to a
undertaken with the prospect of plan or design for the production of
gaining new scientific or technical new or substantially improved
knowledge and understanding' materials, products, processes,
systems or services before the start of
commercial production or use'
NO YES
(IAS 8: para. 8)
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5 Initial measurement
Intangible asset Intangible asset acquired Internally generated
acquired separately as part of a business intangible asset
combination
Apricot Co purchases an operating licence from an overseas supplier for $180,000 plus non-
refundable purchase taxes of $18,000. The supplier’s normal list price is $200,000 but it has
awarded Apricot Co a 10% trade discount. Apricot Co has to pay import duties on the purchase of
this licence of $20,000.
As part of the purchase process, Apricot Co seeks advice from a lawyer and incurs legal fees of
$15,000.
Required
Calculate the initial cost of the intangible asset that Apricot Co should recognise in relation to this
licence.
Solution
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Activity 3: Initial measurement of an internally generated intangible asset
Dopper Co is developing a new production process. During 20X3, expenditure incurred was
$100,000, of which $90,000 was incurred before 1 December 20X3 and $10,000 between 1
December 20X3 and 31 December 20X3. Dopper Co can demonstrate that, at 1 December 20X3,
the production process met the criteria for recognition as an intangible asset. The recoverable
amount of the know-how embodied in the process is estimated to be $50,000.
Required
Explain how the expenditure should be treated in Dopper Co’s financial statements for the year
ended 31 December 20X3.
Solution
6 Subsequent measurement
After initial recognition, an intangible asset can either be measured using the cost or the
revaluation model.
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6.2.1 Active market
If the revaluation model is followed, fair value shall be measured by reference to an active market.
All other assets in the same class must also be accounted for using the revaluation model unless
there is no active market for them in which case the cost model is used for those assets.
Active market: ‘A market in which transactions for the asset or liability take place with
KEY
TERM sufficient frequency and volume to provide pricing information on an ongoing basis.’ (IFRS 13:
Appendix A)
It is uncommon for an active market to exist for intangible assets, although this may happen for
some intangible assets, eg freely transferable taxi licences or nut production quotas.
The revaluation surplus may be amortised to retained earnings if the entity has a policy of making
such a reserves transfer.
7 Amortisation/impairment tests
An entity shall assess whether the useful life of an intangible asset is finite or indefinite. (IAS 38:
para. 88); (IAS 38: paras. 97, 99, 100, 104, 107–109)
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Activity 4: Intangible assets
Stauffer plc has a year end of 30 September 20X6. The following transactions occurred during the
year:
(1) The Stauffer brand has become well known and has developed a lot of customer loyalty since
the company was set up eight years ago. Recently, valuation consultants valued the brand
for sale purposes at $14.6 million. Stauffer’s directors are delighted and plan to recognise the
brand as an intangible asset in the financial statements. They plan to report the gain in the
revaluation surplus as they feel that crediting it to profit or loss would be imprudent.
(2) The company undertook an expensive, but successful, advertising campaign during the year
to promote a new product. The campaign cost $1 million, but the directors believe that the
extra sales generated by the campaign will be $3.6 million over its four-year expected useful
life.
(3) Stauffer owns a 30-year patent that it acquired on 1 April 20X4 for $8 million, which is being
amortised over its remaining useful life of 16 years from acquisition. The product sold is
performing much better than expected. Stauffer’s valuation consultants have valued its
current market price at $14 million.
(4) Stauffer has been developing a new piece of technology over the past 18 months. Costs
incurred and expensed in the year ended 30 September 20X5 were $1.6 million; further costs
of $0.4 million were incurred up to 31 December 20X5 when the project met the criteria for
capitalisation. Costs incurred after 1 January 20X6 were $0.9 million.
Required
1 In accordance with IAS 38, which of the following is the correct treatment of the brand?
Recognise an intangible asset of $14.6m with the gain to the profit or loss
Recognise an intangible asset of $14.6m with the gain to other comprehensive income
Recognise an intangible asset of $14.6m with the gain direct to the revaluation surplus
Do not recognise the brand
2 What is the carrying amount of the advertising campaign in the statement of financial
position at 30 September 20X9?
Nil
$750,000
$1,000,000
$3,600,000
3 Which TWO of the following are TRUE regarding revaluing intangibles?
Revaluations should be carried out with reference to an active market
Revaluations should take place every three to five years
All assets in the same class should be revalued
Active markets are very common for intangible assets
4 What is the carrying amount of the patent in the statement of financial position at 30
September 20X6?
$6.5m
$6.75m
$8m
$14m
5 What amount should be capitalised as an intangible asset for the development project?
$ million
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8 Derecognition
8.1 Point of derecognition
An intangible asset is derecognised:
(a) On disposal; or
(b) When no future economic benefits are expected from its use or disposal.
(IAS 38: para. 112)
$
Net disposal proceeds (proceeds less selling costs) X
Less: Carrying amount of intangible asset (X)
Gain/loss on derecognition (recognise in profit or loss) X/(X)
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Chapter summary
Intangible assets
Monetary assets
• Money held
• Assets to be received in fixed/determinable
amounts of money
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Initial measurement Subsequent measurement
Revaluation model
• Revalue to fair value by reference to an
active market
• Revalue all assets of that class unless no
active market
• Revalue sufficiently often that carrying amount
does not differ materially from fair value
• Increase in value: to OCI (unless reverses
previous revaluation loss in P/L)
• Decrease in value: (1) to OCI (2) to P/L
Amortisation/Impairment Derecognition
Revaluation model
Balance on revaluation surplus transferred to
retained earnings
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Knowledge diagnostic
1. Definitions
‘An intangible asset is an identifiable non-monetary asset without physical substance.’ (IAS 38:
para. 8)
5. Initial measurement
(a) Intangible assets separately acquired – purchase price plus directly attributable costs
(b) Intangible assets acquired as part of a business combination – at fair value (IFRS 13)
(c) Internally generated – at expenditure incurred after criteria satisfied plus directly attributable
costs
6. Subsequent measurement
Cost model or revaluation model: Revaluation model only permitted if an active market exists for
the asset, eg licences, quota.
7. Amortisation/impairment
If the intangible asset has a finite useful life, it should be amortised on a systematic basis across
that useful life.
8. Derecognition
Intangible asset should be derecognised on disposal or when no further benefits are expected. A
gain or loss on disposal should be calculated by comparing proceeds on disposal with the
carrying amount of the asset. Any revaluation surplus should be released to retained earnings.
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Further study guidance
Question practice
You should attempt the following from the Further question practice (available in the digital
edition of the Workbook):
6 Biogenics Co
Further reading
For further reading on the problems on the treatment of intangible assets, there is a useful
technical article on the CPD area of the ACCA webpage from February 2018:
Reporting on intangibles is all a bit of a muddle
www.accaglobal.com
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Activity answers
$
Purchase price:
Purchase price (net of trade discount) 180,000
Non-refundable purchase taxes 18,000
Import duties 20,000
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3 The correct answers are:
• Revaluations should be carried out with reference to an active market
• All assets in the same class should be revalued
Revaluations should take place with reference to an active market and all assets in the same
class should be revalued.
There is not often an active market for intangible assets as they are not frequently traded. IAS
38 does not specify a three- to five-year time frame for revaluations, but instead says that
‘revaluations should be carried out with sufficient regularity to ensure that the carrying
amount does not differ materiality from its fair value’. (IAS 38, para. 75)
4 The correct answer is: $6.75m
The patent is amortised to a nil residual value at $500,000 per annum based on its acquisition
cost of $8m and remaining useful life of 16 years.
The patent cannot be revalued under the IAS 38 rules as there is no active market as a patent
is unique. IAS 38 does not permit revaluation without an active market, as the value cannot be
reliably measured in the absence of a commercial transaction.
5 $ 0.9 million
All costs prior to the project meeting the criteria for capitalisation should be expensed through
the profit or loss.
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Impairment of assets
5
5
Learning objectives
On completion of this chapter, you should be able to:
Exam context
It is important that assets are not carried in the financial statements at more than they are worth.
An impairment arises when the carrying amount of an asset exceeds its value to an entity. Entities
must consider whether there have been any internal events or external factors that would indicate
that the carrying amount of assets is too high. Impairment is an important concept and applies
mainly to non-current tangible and intangible assets. It is frequently examined as an objective
test question (OTQ) in Section A and B of the ACCA Financial Reporting exam, and could be an
adjustment you are required to make when preparing the primary financial statements in Section
C.
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Chapter overview
Impairment of assets
Minimum value
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1 Principle of impairment
1.1 Basic principle
There is an established principle that assets should not be carried above their recoverable
amount. IAS 36 Impairment of Assets requires an entity to write down the carrying amount of an
asset to its recoverable amount if the carrying amount of an asset is not recoverable in full. (IAS
36: paras. 18–24)
Note that assets in this case include all tangible and intangible assets. It does not include assets
such as inventories, deferred tax assets, assets arising under IAS 19 Employee Benefits and
financial assets within the scope of IFRS 9 Financial Instruments as these standards already have
rules for recognising and measuring impairment. Note also that IAS 36 does not apply to non-
current assets held for sale, which are dealt with under IFRS 5 Non-current Assets held for Sale
and Discontinued Operations.
1.2 Definitions
Impairment loss: The amount by which the carrying amount of an asset or a cash-generating
KEY
TERM unit exceeds its recoverable amount.
Carrying amount: The amount at which the asset is recognised after deducting accumulated
depreciation and any impairment losses in the statement of financial position.
Recoverable amount: The higher of the fair value less costs of disposal of an asset (or cash-
generating unit) and its value in use.
Cash-generating unit: The smallest identifiable group of assets that generates cash inflows
that are largely independent of the cash inflows from other assets or groups of assets.
Fair value less costs of disposal: The price that would be received to sell the asset in an
orderly transaction between market participants at the measurement date (IFRS 13 Fair Value
Measurement), less the direct incremental costs attributable to the disposal of the asset.
Value in use of an asset: The present value of estimated future cash flows expected to be
derived from the use of an asset.
(IAS 36: para. 6)
Recoverable amount =
Higher of
Henry Co holds an item of machinery which it believes is impaired. The following information is
relevant:
• The fair value of the machinery is $10,000, the cost of selling is $500.
• The value in use of the machinery is estimated to be $9,000.
It is the company’s intention to continue to use the asset for the remainder of its useful life.
Required
Determine the recoverable amount of the machinery.
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Solution
Recoverable amount =
Higher of
Therefore, the recoverable amount is $9,500. Note that the company’s intention to continue to use
the asset is not a relevant factor.
Essential reading
Chapter 5, Section 1 of the Essential reading provides detail on measuring the recoverable amount
of an asset.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
Recoverable amount
An impairment loss is the amount by which the carrying amount of an asset or cash-generating
unit exceeds its recoverable amount.
Following on from Illustration 1, further information has been provided about the carrying amount
of the asset:
• The machinery is held at historical cost
• The carrying amount of the machinery is $10,500
Required
Using the recoverable amount determined in Illustration 1, calculate the impairment loss.
Solution
The carrying amount of the machinery must be compared to its recoverable amount.
The recoverable amount was determined in Illustration 1 as $9,500.
The carrying amount of the machinery is therefore greater than its recoverable amount, so the
machinery is impaired.
The impairment loss charged is: $10,500 – $9,500 = $1,000.
Section 4 of this chapter will consider how to account for the impairment.
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2 Impairment indicators
An entity must assess at the end of each reporting period whether there is any indication that an
asset may be impaired.
Minimart Co belongs to a retail store chain, Magnus Co. Minimart Co makes all its retail
purchases through Magnus Co’s purchasing centre. Pricing, marketing, advertising and human
resources policies (except for hiring Minimart Co’s cashiers and salesmen) are decided by Magnus
Co. Magnus Co also owns five other stores in the same city as Minimart Co (although in different
neighbourhoods) and 20 other stores in other cities. All stores are managed in the same way as
Minimart Co. Minimart Co and four other stores were purchased five years ago and goodwill was
recognised.
Required
What is the cash-generating unit for Magnus Co?
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Solution
Brix Co owns a building which it uses as its offices, warehouse and garage. The land is carried as
a separate non-current tangible asset in the statement of financial position.
Brix Co has a policy of regularly revaluing its non-current tangible assets. The original cost of the
building in October 20X2 was $1,000,000; it was assumed to have a remaining useful life of 20
years at that date, with no residual value. The building was revalued on 30 September 20X4 by a
professional valuer at $1,800,000. Brix Co does not make transfers between revaluation surplus
and retained earnings. The economic climate had deteriorated during 20X5, causing Brix Co to
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carry out an impairment review of its assets at 30 September 20X5. Brix Co’s recoverable amount
was calculated as $1,500,000 on 30 September 20X5.
Required
At 30 September 20X5, what is the impairment loss AND where in the financial statements should
it be presented?
1 What is the amount of the impairment loss?
$200,000
$300,000
2 Where is the impairment loss presented in the financial statements?
Other comprehensive income
Profit or loss
$m
Building 30
Plant and equipment 6
Goodwill 10
Current assets 20
66
Following a recession, an impairment review has estimated the recoverable amount of the cash-
generating unit to be $50 million.
Required
Allocate the impairment loss to the assets in the CGU.
Solution
There is an impairment of $16 million as the recoverable amount of $50 million is less than the
carrying amount of $66 million.
$10 million of the impairment is allocated to goodwill. The remaining $6 million will be allocated to
the other non-current assets on a pro-rata basis based on their carrying amounts.
• Impairment allocated to building is 30/36 × $6 million
• Impairment allocated to plant and equipment is 6/36 × $6 million
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Plant and Current
Building equipment Goodwill assets Total
$m $m $m $m $m
Carrying amount 30 6 10 20 66
Impairment – goodwill — — (10) — (10)
30 6 — 20 56
Impairment – other assets (5) (1) — — (6)
Carrying amount after
impairment 25 5 — 20 50
On 31 December 20X1, Invest Co purchased all the shares of Mash Co for $2 million. The net fair
value of the identifiable assets acquired and liabilities assumed of Mash Co at that date was $1.8
million. Mash Co made a loss in the year ended 31 December 20X2 and at 31 December 20X2, the
net assets of Mash Co – based on fair values at 1 January 20X2 – were as follows:
$’000
Property, plant and equipment 1,300
Development expenditure 200
Net current assets 250
1,750
An impairment review on 31 December 20X2 indicated that the recoverable amount of Mash Co at
that date was $1.5 million. The capitalised development expenditure has no ascertainable external
market value and the current fair value less costs of disposal of the property, plant and
equipment is $1,120,000. Value in use could not be determined separately for these two items.
Required
Calculate the impairment loss that would arise in the consolidated financial statements of Invest
as a result of the impairment review of Mash Co at 31 December 20X2 and show how the
impairment loss would be allocated.
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Solution
1
1
Goodwill
Development expenditure
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5.2.2 Subsequent depreciation and amortisation
Depreciation of the asset should now be based on its new revalued amount, its estimated residual
value (if any) and its estimated remaining useful life.
5.2.3 Goodwill
An exception to the rule above is for goodwill. An impairment loss for goodwill should not be
reversed in a subsequent period. (IAS 36, para. 124)
A head office building with a carrying amount of $140 million is estimated to have a recoverable
amount of $90 million due to falling property values in the area. An impairment loss of $50 million
is recognised.
After three years, property prices in the area have risen, and the recoverable amount of the
building increases to $120 million. The carrying amount of the building, had the impairment not
occurred, would have been $110 million.
Required
Calculate the reversal of the impairment loss
Solution
Essential reading
Chapter 5, Section 2 of the Essential reading contains two further activities to allow you to
practise calculating impairment loss for an individual asset and a CGU.
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The Essential reading is available as an Appendix of the digital edition of the Workbook.
PER alert
One of the competences you require to fulfil Performance Objective 6 of the PER is the ability
to record and process transactions and events, using the right accounting treatments for
those transactions and events. The treatment of impairment losses for both assets and cash-
generating units is one that is non-routine, but increasingly important in the current economic
climate. The information in this chapter will give you knowledge to help you demonstrate this
competence.
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Chapter summary
Impairment of assets
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Knowledge diagnostic
1. Principle of impairment
Assets should not be measured at more than their value to an entity. An asset’s recoverable
amount is the higher of value in use (net cash flows) and fair value less costs of disposal.
Impairment losses occur where the carrying amount of an asset is above its recoverable amount.
2. Impairment indicators
An entity must do an impairment test when there are impairment indicators. These can be
internal, such as physical damage to an asset or external, such as significant technological
advances.
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Activity answers
$
Carrying amount at 1 October 20X2 1,000,000
Accumulated depreciation 20X2 to 20X4
(1,000,000 × 2/20 years) (100,000)
$
Valuation at 30 September 20X4 1,800,000
Depreciation 20X5 (1,800,000/18 years) (100,000)
Carrying amount 1,700,000
Recoverable amount at 30 September 20X5 1,500,000
Impairment loss 200,000
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Activity 3: Calculation and allocation of impairment loss
Workings
1 Impairment loss
$’000
Carrying amount 1,950
Recoverable amount 1,500
Impairment loss 450
Carrying
amount if Actual
Initial Impairment fully loss Impaired
value pro-rated allocated Reallocation allocated value
$’000 $’000 $’000 $’000 $’000 $’000
PPE (250 ×
1,300/1,
500) 1,300 217 1,083 (37) 180 1,120
Dev exp
(250 ×
200/1,5
00) 200 33 167 37 70 130
The amount not allocated to the PPE because the assets cannot be taken below their
recoverable amount is allocated to other remaining assets pro-rata, in this case all against the
development expenditure.
Hence the development expenditure is reduced by a further $37,000 (217,000 – 180,000),
making the total impairment $70,000 (33,000 + 37,000).
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The net current assets are not included when pro-rating the impairment loss. As current assets
are not intended to be held as assets in future periods, they are more likely to be measured at
their recoverable amount and therefore are less likely to be impaired.
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Skills checkpoint 1
Approach to objective test
(OT) questions
Chapter overview
cess skills
Exam suc
Answer planning
c FR skills C
n Specifi o
tio
rr req
a
ec ui
of
m
t i rem
or
nt
inf
erp ents
ng
Approach to Application
reta
agi
tion l y si s
Spreadsheet Interpretation
Go od
skills skills
ana
ti m
c al
Approach
em
to Case
e ri
OTQs
an
um
ag
tn
em
en
en
t ci
Effi
Effective writing
and presentation
Introduction
Sections A and B of the FR exam consist of objective test questions (OTQs).
The OTQs in Section A are single, short questions that are auto-marked and worth two marks
each. You must answer the whole question correctly to earn the two marks. There are no partial
marks.
The OTQs in Section A aim for a broad coverage of the syllabus, and so all areas of the syllabus
need to be carefully studied. You need to work through as many practice OTQs as possible,
reviewing the answers carefully to understand how the correct answers are derived.
The OTQs in Section B are a series of short questions that relate to a common scenario, or case.
Section B questions are also auto-marked and must be answered correctly to gain the credit.
There are no partial marks.
The types of OTQ and approach to answering the questions is the same as for the Section A
questions.in both Section A and Section B.
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Multiple response These are a kind of multiple choice question, except you need to select
(MR) more than one answer from a number of given options. The question will
specify how many answers need to be selected, but the system won’t
stop you from selecting more answers than this. It is important to read
the requirement carefully.
Fill in the blank (FIB) This question type requires you to type a numerical answer into a box.
The unit of measurement (eg $) will sit outside the box, and if there are
specific rounding requirements these will be displayed.
Drag and drop Drag and drop questions involve you dragging an answer and dropping
it into the correct place. Some questions could involve matching more
than one answer to a response area and some questions may have
more answer choices than response areas, which means not all
available answer choices need to be used.
Drop down list This question type requires you to select one answer from a drop down
list. Some of these questions may contain more than one drop down list
and an answer has to be selected from each one.
Hot spot For hot spot questions, you are required to select one point on an image
as your answer. When the cursor is hovered over the image, it will
display as an ‘X’. To answer, place the X on the appropriate point on the
diagram.
Hot area These are like hot spot questions, but instead of selecting a specific
point you are required to select one or more areas in an image.
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Approach to OTQs
A step-by-step technique for approaching OTQs is outlined below. Each step will be explained in
more detail in the following sections as we work through a range of OTQs.
STEP 4: Apply your technical knowledge to the data presented in the question.
Work through calculations taking your time and read through each answer option
with care. OT questions are designed so that each answer option is plausible. Work
through each response option and eliminate those you know are incorrect
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Skill activity
1. Which TWO of the following are acceptable methods of accounting for a government grant
relating to an asset in accordance with IAS 20 Accounting for Government Grants and
Disclosure of Government Assistance?
Note. This is an MCQ requiring you to select two valid statements. IAS 20 is being examined here.
• Set up the grant as deferred income
• Credit the full amount received to profit or loss
• Deduct the grant from the carrying amount of the asset
• Add the grant to the carrying amount of the asset
(2 marks)
3. Lichen Ltd owns a machine that has a carrying amount of $85,000 at the year end of 31
March 20X9. The market value of the machine at 31 March 20X9 is $78,000 and costs of disposal
are estimated at $2,500. Lichen Ltd has calculated that the value in use of the asset is $77,000.
Note. This is a FIB question. This is testing your knowledge of impairment and a calculation of the
loss to be recognised on the machine.
What is the impairment loss on the machine to be recognised in the financial statements at 31
March 20X9? (provide you answer to the nearest $000)
$_______’000
(2 marks)
$m
Total contract price 12
Costs incurred to date 4
Amounts invoiced to date 4
Certified as complete by surveyor 40%
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Identify, by clicking on the relevant boxes below, whether a contract asset or contract liability
should be recognised and at what carrying amount in the statement of financial position of
Springthorpe Co as at 31 December 20X2?
Note. This is a hot area question. You should click to select whether this is a contract asset or
liability and the appropriate carrying amount.
(2 marks)
5. On 1 September 20X7, Jack Co entered into a contract for the right to use a machine for a
period of 5 years from that date. The contract meets the definition of a lease under IFRS 16
Leases. The machinery has a useful life of 8 years. Jack Co incurred costs of $4,000 to arrange
the lease. Under the terms of the lease, Jack Co was required to pay $100,000 on commencement
of the lease followed by five annual payments of $200,000 commencing 31 August 20X8. The
present value of the future lease payments has been correctly calculated as $790,000 on the
commencement date. The rate of interest implicit in the lease is 8.4%.
Using the picklist provided, what should be the carrying amount of the machine following at 31
August 20X8?
Note. This is a picklist question, very similar to the MCQ except the selection is taken from a drop
down box.
Picklist
$894,000
$715,200
$656,360
$782,250
STEP 1 Answer the questions you know first.
If you’re having difficulty answering a question, move on and come back to tackle it once you’ve answered
all the questions you know. It is often quicker to answer discursive style OTQs first, leaving more time for
calculations.
Questions 1 and 2 are discursive style questions. It would make sense to answer these questions
first as it is likely that you will be able to complete them comfortably within the 3.6 minutes per
question allocated to them. Any time saved could then be spent on the more complex calculations
required to answer Questions 3, 4 and 5.
STEP 2 Answer all questions.
There is no penalty for an incorrect answer in ACCA exams, there is nothing to be gained by leaving an OTQ
unanswered. If you are stuck on a question, as a last resort, it is worth selecting the option you consider
most likely to be correct and moving on. Use your scratch pad or the ‘flag for review’ option within the exam
software to make a note of the question, so if you have time after you have answered the rest of the
questions, you can revisit it.
Of the questions here, you could have a guess for four out of five questions as there are
alternative answers given. With an MCQ or picklist question, you have a 25% chance of getting
the question correct so don’t leave any unanswered. It is obviously more difficult to get a fill in the
blank question (like Question 3) correct by guessing.
STEP 3 Read the requirement first!
The requirement will be stated in bold text in the exam. Identify what you are being asked to do, any
technical knowledge required and what type of OTQ you are dealing with. Look for key words in the
requirement such as “Which TWO of the following” and “ Which of the following is NOT” etc.
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Questions 1 and 2 ask you to identify which statements are correct. Read through each statement
carefully knowing that you are looking to identify the statement that is correct.
Question 3 is a FITB question, you need to follow the instructions carefully and provide your
answer in $000 as requested.
Question 4 is a hot area question, which ask you to click on the image to identify whether there is
a contract asset or liability and the carrying amount. Ensure you answer both parts of the
requirement.
Question 5 is a picklist. You need to be careful to ensure you scroll through the options to get to
your intended answer.
STEP 4 Apply your technical knowledge to the data presented in the question.
Work through calculations taking your time and read through each answer option with care. OTQs are
designed so that each answer option is plausible. Work through each response option and eliminate those
you know are incorrect.
Question 1
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The property intended for sale and the property being
constructed would be classified as inventory and WIP.
The property leased out to a subsidiary would be
regarded as an investment property in the single entity
financial statements of Build Co but is treated as owner
occupied in the consolidated financial statements (as it
is occupied by a subsidiary not a third party).
You should start by pulling out the key data from the
question:
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The calculation of the impairment is $85,000 – $77,000
= $8,000.
Working
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A contract asset arises as the entity has transferred
goods or services to the customer with a value of $4.8
million but has only charged $4 million to date for those
goods or services.
$
Initial measurement of right of use asset 894,000
Depreciation (over 5 years) (178,800)
Carrying amount at 31 August 20X8 715,200
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Exam success skills Your reflections/observations
carefully so that you answer the question
being asked (not the one you think or hope is
being asked!)
Good time management Remember that each OTQ is worth two marks,
regardless of how hard it is or how long it
takes you to answer. You are aiming for to
spend 3.6 minutes on each question (180
minutes/100 marks × 2 marks).
Some questions will be quicker than others,
due to their nature (narrative) or how
confident you are on a certain topic.
Ensure you don’t overrun, but equally, don’t
rush your answers and make mistakes.
Most important action points to apply to your next question – Read the scenario and
requirement carefully.
Summary
60% of the FR exam consist of OTQs. Key skills to focus on throughout your studies will therefore
include:
• Always read the requirements first to identify what you are being asked to do and what type of
OTQ you are dealing with.
• Actively read the scenario highlighting key data needed to answer each requirement.
• Answer OTQs in a sensible order dealing with any easier discursive style questions first.
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Revenue and government
6 grants
Learning objectives
On completion of this chapter, you should be able to:
Explain and apply the criteria for recognising revenue generated B10(b)
from contracts where performance obligations are satisfied over
time or at a point in time
Explain and apply the criteria for the recognition of contract costs B10(d)
Exam context
Revenue is usually the single largest figure in a statement of profit or loss, so it is important that it
is recognised in the financial statements at the correct point in time and is measured correctly.
Understanding the rules of revenue recognition using IFRS 15, Revenue from Contracts with
Customers, is vital in your Financial Reporting studies, as it can be examined across all parts of
the exam.
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6
Chapter overview
Revenue and government grants
Warranties
5. Recognise revenue when (or as)
performance obligation is satisfied
Repayment of grants
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1 Revenue recognition
Revenue is normally the main component of a company’s income.
Income
Revenue does not include sales taxes, value added taxes or goods and service taxes which are
only collected for third parties, because these do not represent an economic benefit flowing to the
entity.
Contract: An agreement between two or more parties that creates enforceable rights and
KEY
TERM obligations.
Performance obligation: A promise in a contract with a customer to transfer to the customer
either:
(a) A good or service (or a bundle of goods or services) that is distinct; or
(b) A series of distinct goods or services that are substantially the same ad that have the
same pattern of transfer to the customer.
Transaction price: The amount of consideration to which an entity expects to be entitled in
exchange for transferring promised goods or services to a customer, excluding amounts
collected on behalf of third parties.
(IFRS 15, Appendix A)
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Some indicators of the transfer of control are:
(a) The entity has a present right to payment for the asset.
(b) The customer has legal title to the asset.
(c) The entity has transferred physical possession of the asset.
(d) The significant risks and rewards of ownership have been transferred to the customer.
(IFRS 15: para. 38)
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4 Identify the performance obligations
4.1 Performance obligation
At the start of a contract, the goods or services promised to the customer should be assessed.
Each transfer of a distinct good/service is a performance obligation within the contract. There
may be more than one performance obligation within the same contract.
IFRS 15 states that a good or service that is promised to a customer is distinct if both of the
following criteria are met:
(a) The customer can benefit from the good or service either on its own or together with other
resources that are readily available to the customer (ie the good or service is capable of
being distinct); and
(b) The entity’s promise to transfer the good or service to the customer is separately identifiable
from other promises in the contract (ie the good or service is distinct within the context of the
contract). (IFRS 15, para. 27)
Office Solutions Co, a limited company, has developed a communications software package
called CommSoft. Office Solutions Co has entered into a contract with Logisticity Co to supply
the following:
(1) Licence to use Commsoft
(2) Installation service; this may require an upgrade to the computer operating system, but the
software package does not need to be customised
(3) Technical support for three years
(4) Three years of updates for Commsoft
Office Solutions Co is not the only company able to install CommSoft, and the technical support
can also be provided by other companies. The software can function without the updates and
technical support.
Required
Explain whether the goods or services provided to Logisticity Co are distinct in accordance with
IFRS 15 Revenue from Contracts with Customers.
Solution
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5 Determine the transaction price
The transaction price is the amount of consideration a company expects to be entitled to from
the customer in exchange for transferring goods or services.
In determining the transaction price, consider the effects of:
• Variable consideration
• The existence of a significant financing component
• Non-cash consideration
• Consideration payable to a customer
Cod Co sold goods to Eel Co on 1 January 20X2 for $200,000, payable on 31 December 20X3.
Eel Co cannot return the goods.
The relevant discount rate is 6%.
Required
What amount of revenue and finance income should be recognised in Cod Co’s statement of
profit or loss for the year ended 31 December 20X2?
Solution
Revenue is measured based on the $200,000 payable by Eel Co on 31 December 20X3 as
discounted to its present value at 1 January 20X2.
Revenue = $200,000 × 0.890 (2 year 6% discount rate) = $178,000
Finance income in 20X2 = $178,000 × 6% = $10,680
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5.3 Non-cash consideration
This will be measured at fair value (where this cannot be easily determined, then it will be
compared to the selling price of the goods being sold by the entity)
Taplop Co supplies laptop computers to large businesses. On 1 July 20X5, Taplop Co entered into
a contract with TrillCo, under which TrillCo was to purchase laptops at $500 per unit. The
contract states that if TrillCo purchases more than 500 laptops in a year, the price per unit is
reduced retrospectively to $450 per unit. Taplop’s year end is 30 June.
(1) As at 30 September 20X5, TrillCo had bought 70 laptops from Taplop. Taplop Co therefore
estimated that TrillCo’s purchases would not exceed 500 in the year to 30 June 20X6, and
TrillCo would therefore not be entitled to the volume discount.
(2) During the quarter ended 31 December 20X5, TrillCo expanded rapidly as a result of a
substantial acquisition, and purchased an additional 250 laptops from Taplop Co. Taplop Co
then estimated that TrillCo’s purchases would exceed the threshold for the volume discount in
the year to 30 June 20X6.
Required
Calculate the revenue Taplop Co would recognise in:
1 Quarter ended 30 September 20X5
2 Quarter ended 31 December 20X5
Solution
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6 Allocating transaction price to performance obligations
Where a contract contains more than one distinct performance obligation a company allocates
the transaction price to all separate performance obligations in proportion to the stand-alone
selling price of the good or service underlying each performance obligation
A mobile phone company, Deltawave Co, gives customers a free handset when they sign a two-
year contract for the provision of network services. The handset has a stand-alone price of $100
and the contract is $20 per month.
Required
Allocate the transaction price between the handset and the network services contract.
Solution
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• The entity’s performance does not create an asset with an alternative use to the entity and the
entity has an enforceable right to payment for the performance completed to date.
Many service contracts are satisfied over time, for example the provision of streaming services
over a two-year period. There are also examples of contracts for the construction of assets on
behalf of a customer, including, for example, the construction of a:
• Bridge
• Building
• Dam
• Ship
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Statement of financial position Description
Contract asset If the entity transfers goods or services before
the customer pays, it should present the
contract as a ‘contract asset’ if the entity’s right
to consideration is conditional on something
other than the passage of time (eg the entity’s
performance) (IFRS 15, para. 107).
Contract asset: A contract asset is recognised when revenue has been earned but not yet
KEY
TERM invoiced (revenue that has been invoiced is a receivable).
Contract liability: A customer has paid prior to the entity transferring control of the good or
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TERM service to the customer.
This is calculated as above. However, if the answer is a net amount due to the customer, then this
is included as a contract liability. The amount of revenue the entity is entitled to corresponds to
the amount of performance complete to date.
James Co entered into a contract to build an office building for a customer commencing on 1
January 20X5, with an estimated completion date of 31 December 20X6. Control of the asset is
passed to the customer as construction takes place and James Co does not have an alternative
use for the asset. Satisfaction of performance obligations is measured by reference to work
completed to date. In the first year, to 31 December 20X5:
(1) Certificates of work completed have been issued, to the value of $750,000.
(2) The final contract price is $1,500,000.
(3) Amounts invoiced to the customer as at 31 December 20X5 is $625,000.
(4) No payments had been received in respect of the receivable at year end.
Required
What is the amount of revenue recognised in the financial statements of James Co at 31
December 20X5, and what entries would be made for the contract on the statement of financial
position at 31 December 20X5?
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Solution
Build Co entered into a four-year contract to build a sports stadium, the customer takes control of
the stadium as construction takes place and Build Co has no alternative view for the stadium.
Details of the contract activity at 31 December 20X1, 20X2 and 20X3 are as follows:
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9 Common types of transactions
IFRS 15 has specific guidance on different transactions, here we look at some of the most
common.
• Principal versus agent
• Sales with a right of return
• Consignment arrangements
• Bill and hold arrangements
• Warranties
Principal v agent
Principal Agent
Indicators that an entity controls the goods or services before transfer and therefore is classified
as a principal include (IFRS 15, para. B37):
(a) The entity is primarily responsible for fulfilling the promise to provide the specified good or
service;
(b) The entity has inventory risk; and
(c) The entity has discretion in establishing the price for the specified good or service.
TicketsRUS Co, a ticket agency, sells tickets to a theatre show for $100. TicketsRUS Co is entitled
to a commission of 5% of the ticket price and passes the remainder to the theatre. The tickets are
non-refundable and there is no sales tax.
Required
Calculate the revenue to be recognised for the current financial period.
Solution
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9.2 Sales with a right of return
Where products are sold with a right of return, IFRS 15 requires an entity to recognise all of the
following:
(a) Revenue for the transferred products in the amount of consideration to which the entity
expects to be entitled (ie revenue is not recognised for products expected to be returned);
(b) A refund liability; and
(c) An asset (and corresponding adjustment to cost of sales) for its right to recover products from
customers on settling the refund liability.
(IFRS 15: para. B21)
Quirky Co is an online clothing retailer. Customers are entitled to return items within 28 days of
purchase for a full refund if they do not fit or are otherwise not suitable. In the last week of
December 20X8, Quirky Co sold 200 dresses for $400 each. The dresses cost $250 each. Quirky
Co has an expected average level of returns of 25%. None of the dresses sold in the final week of
December 20X8 have been returned by the end of the month.
Required
What are the accounting entries required to record the sale of the dresses in Quirky Co’s financial
statements for the year ended 31 December 20X8?
Solution
Quirky receives cash of $80,000 (200 dresses × $400).
Quirky expects 25% of dresses to be returned so should only recognise revenue for the 75% of
dresses not expected to be returned: 200 dresses × 75% × $400 = $60,000.
Quirky should recognise a refund liability for the 25% of dresses expected to be returned: 200
dresses× 25% × $400 = $20,000.
The above should be recorded with this accounting entry:
$ $
DR Cash 80,000
CR Revenue 60,000
CR Refund liability 20,000
The 200 dresses sold had a purchase cost of $50,000 (200 dresses × $250). This amount will be
included in purchases, within cost of sales. As none of these 200 dresses are held at the year end,
none of them will be included in closing inventory. Therefore, the total amount in cost of sales
relating to the dresses is an expense of $50,000.
However, 25% of these dresses are expected to be returned so no revenue has been recognised in
relation to 25% of the dresses. Therefore, the purchase expense in relation to these dresses within
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cost of sales needs to be reversed and an asset should be recognised for the right to recover the
dresses likely to be returned: 200 dresses × 25% × $250 = $12,500.
$ $
DR Asset for right to recover dresses 12,500
CR Cost of sales 12,500
This leaves a correct expense within cost of sales for the 75% of the dresses which are not
expected to be returned: 200 dresses × 75% × $250 = $37,500. This can also be calculated as total
purchases of $50,000 less cost of dresses expected to be returned of $12,500.
A wholesaler sells goods to a retailer for $42,000 on credit on 31 December 20X1 and accounts for
them as a sale recognising the revenue immediately. The wholesaler sells at a mark-up of 20% on
cost.
The retailer will sell the goods to the final customer, but can return any unsold goods for a refund.
No goods were sold to the final customer on 31 December 20X1.
Required
What are the adjustments needed to correct the wholesaler’s financial statements for the year
ended 31 December 20X1?
Solution
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9.4 Bill and hold arrangements
Goods are sold but remain in the possession of the seller for a specified period of time. An entity
will need to determine at what point the customer obtains control of the product.
For a customer to have obtained control of a product in a bill and hold arrangement the following
criteria must be met:
(a) The reason for the bill and hold must be substantive.
(b) The product must be separately identified as belonging to the customer.
(c) The product must be ready for physical transfer to the customer.
(d) The entity cannot have the ability to use the product or transfer it to another customer.
9.5 Warranties
Products are often sold with a warranty. IFRS 15 identifies three types of warranty and explains
the required accounting treatment for each:
In assessing whether the warranty is an additional warranty that provides an additional service
beyond the assurance that the product will function as intended, the entity should consider
factors such as:
(a) Whether the warranty is required by law (if so, it is likely to be a standard warranty);
(b) The length of the warranty coverage period (the longer the cover, the more likely that it is an
additional warranty); and
(c) The nature of the tasks that the entity promises to perform (whether they relate to providing
assurance that the product will function as intended).
Illustration 3: Warranties
Lavender Co sells a machine to a customer on credit for $392,000. The sales contract includes a
standard warranty that provides assurance that the machine complies with agreed-upon
specifications and will operate as promised for one year from the date of purchase. The sales
contract also includes an additional warranty that provides the customer with the right to an
annual service of the machine for four years from the date of purchase. An annual service is
usually charged at $2,000 per annum. However, as this customer represents new business, the
servicing is offered at no additional cost to the customer. Therefore, the provision of servicing is
not reflected in the $392,000 transaction price, which is the normal standalone selling price of the
machine.
Required
Explain how the two warranties and the sale of the machine should be accounted for (ignore the
effect of any discounting).
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Solution
Standard warranty
The warranty that provides assurance that the machine complies with agreed-upon specifications
and will operate as promised one year from the date of purchase is a standard warranty at no
cost to the customer.
Therefore, it should be accounted for in accordance with IAS 37 Provisions, Contingent Liabilities
and Contingent Assets. This will be explained in further detail in Chapter 13.
Additional warranty
The additional warranty is provided at no cost to the customer and provides an additional service
(four years of servicing) beyond assurance that the machine will function as intended per the
agreed-upon specifications.
This additional warranty should be treated as a separate performance obligation and revenue will
not be recognised until the performance obligation is satisfied, which will be when the annual
services are performed.
Sale of the machine
The transaction price of $392,000 should be allocated to the two performance obligations in
accordance with their standalone selling prices:
Revenue of $384,160 from the sale of the machine will be recognised when control of the machine
is transferred to the customer which is likely to be on delivery. Revenue from the servicing will be
recognised when each annual service is performed.
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Grants related to assets: Government grants whose primary condition is that an entity quali-
KEY
TERM fying for them should purchase, construct or otherwise acquire non-current assets. Subsidiary
conditions may also be attached restricting the type or location of the assets or the periods
during which they are to be acquired or held (IFRS 15: para. 3).
Government grants relating to assets are presented in the statement of financial position either:
(a) As deferred income (Dr Cash, Cr Deferred income), this is then released to the profit or loss
account over the useful life of the asset (effectively over the same period as the asset is being
depreciated); or
(b) By deducting the grant in calculating the carrying amount of the asset.
Grant conditions
In the case of grants for non-depreciable assets, certain obligations may need to be fulfilled, in
which case the grant should be recognised as income over the periods in which the cost of
meeting the obligation is incurred. For example, if a piece of land is granted on condition that a
building is erected on it, then the grant should be recognised as income over the useful life of the
building.
There may be a series of conditions attached to a grant, in the nature of a package of financial
aid. An entity must take care to identify precisely those conditions which give rise to costs that in
turn determine the periods over which the grant will be earned. When appropriate, the grant may
be split and the parts allocated on different bases.
Maddoc purchased a new item of plant for $800,000 on 1 January 20X2, and expected to use it
for five years with a zero residual value. The Government awarded Maddoc a grant of $300,000
towards the cost of the plant on the same date.
Maddoc treated the grant as deferred income and has a 30 June year end.
Required
How much is recognised in non-current liabilities in respect of the grant as at 30 June 20X2?
$60,000
$30,000
$210,000
$270,000
Essential reading
There are a number of additional activities to apply your knowledge obtained in this chapter,
which are in addition to the Further question practice bank (available in the digital edition of the
Workbook) and the Practice and Revision Kit. Please see Chapter 6 of the Essential reading.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
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Chapter summary
Revenue is income arising in the course of an entity’s Revenue is recognised when there is transfer of
ordinary activities (IFRS 15: Appendix A) control to the customer from the entity supplying the
goods or services
Consignment arrangements
4. Allocate transaction price to performance
obligations • The customer does not obtain control of the product
at the delivery date
Based on standalone selling prices ↓
• The inventory remains in the books of the entity and
5. Recognise revenue when (or as) performance revenue is not recognised until control passes
obligation is satisfied
When entity transfers control of a promised good or Bill and hold arrangements
service to a customer An entity will need to determine at what point the
customer obtains control of the product
Warranties
• IFRS 15: If separate performance obligation
• IAS 37: If legal and constructive obligation
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Performance IAS 20 Accounting for
obligations Government Grants and Disclosure
of Government Assistance
• A contract includes a promise to transfer Grants are not recognised until there is
goods or services to a customer reasonable assurance that the conditions will
• This is the performance obligation within the be complied with and the grants will be received
contract
• An entity must be able to reasonably measure
the outcome of a performance obligation Grants relating to income
before the revenue can be recognised Grants relating to income are shown in profit or
loss either separately or as part of 'other
income' or alternatively deducted from the
Performance obligations satisfied over time related expense
• An entity may transfer a good or service over
time with the revenue being recognised over
time Grants relating to assets
• A performance obligation is satisfied when Government grants relating to assets are
the entity transfers a promised good or presented in the statement of financial position
service (ie an asset) to a customer either:
↓ • As deferred income; or
• An asset is considered transferred when (or • By deducting the grant in calculating the
as) the customer obtains control of that asset carrying amount of the asset
↓ • Any deferred credit is amortised to profit or
• Control of an asset refers to the ability to loss over the asset's useful life
direct the use of, and obtain substantially all
of the remaining benefits from, the asset
Repayment of grants
• A government grant that becomes repayable
Methods of measuring performance is accounted for as a change in accounting
• Output methods estimate in accordance with IAS 8 Accounting
– Units produced Policies, Changes in Accounting Estimates
– Survey of completion to date and Errors
• Input methods • Repayment of grants relating to income are
– Resources consumed applied first against any unamortised
– Costs incurred deferred credit and then in profit or loss
• A contract asset is recognised when revenue • Repayments of grants relating to assets are
has been earned but not yet invoiced (revenue recorded by increasing the carrying amount
that has been invoiced is a receivable) of the asset or reducing the deferred income
• A contract liability is recognised when a balance
customer has paid prior to the entity • Any resultant cumulative extra depreciation is
transferring control of the good or service to recognised in profit or loss immediately
the customer
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Knowledge diagnostic
1. Revenue recognition
• Revenue is recognised when there is a transfer of control to the customer from the entity
supplying the goods or services.
• Five step model for recognition:
Step 1 Identify the contract with the customer
Step 2 Identify the separate performance obligations
Step 3 Determine the transaction price
Step 4 Allocate the transaction price to the performance obligations
Step 5 Recognise revenue when a performance obligation is satisfied.
• Where the outcome cannot be estimated reliably, revenue is only recognised to the extent of
expenses recognised that are recoverable, ie no profit is recognised until the outcome can be
estimated reliably.
• Where performance obligations are satisfied over time, for example with a construction
contract, revenue and costs are recognised by reference to the stage of completion of the
construction contract where its outcome can be estimated reliably. However, any expected
losses are recognised immediately on the grounds of prudence.
• Where the outcome cannot be estimated reliably, revenue is recognised only to the extent of
contract costs incurred that are recoverable, consistent with the treatment of service revenue.
2. Government grants
• An entity should not recognise grant income unless:
(i) The conditions attached to the grant will be complied with; and
(ii) The entity will receive the money
• Grants relating to income are shown in profit or loss either separately or as part of ‘other
income’ or alternatively deducted from the related expense
• Government grants relating to assets are presented in the statement of financial position
either:
(i) As deferred income; or
(ii) By deducting the grant in calculating the carrying amount of the asset.
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Further study guidance
Question practice
Now try the following from the Further question practice bank (available in the digital edition of
the Workbook):
20 Jenson Co
21 Trontacc Co
22 Crayzee Co
Further reading
There are articles on the ACCA website, written by the FR examining team, which are relevant to
the topics studied in this chapter and which you should read:
Revenue revisited
www.accaglobal.com
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Activity answers
$ %
Handset 100 17
Contract – two years 480 83
Total value 580 100
As the total receipts are $480, this is the amount that must be allocated to the separate
performance obligations. Revenue will be recognised as follows (rounded to nearest $).
$
Year 1
Handset (480 × 17%) 82
Contract (480 – 82)/2 199
281
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$
Year 2
Contract as above 199
1 The correct answer is: 20X1: $76m, 20X2: $171m, 20X3: $133m
Working
Statement of profit or loss (extract)
2 The correct answer is: Trade receivable $30m; Contract asset $180m
Workings
1 Trade receivables
20X3
$m
Amounts billed to the customer 200
Cash received from the customer (170)
Trade receivable 30
2 Contract asset
20X3
$m
Revenue recognised (cumulative) 380
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20X3
$m
Less: amounts billed to the customer (200)
Contract asset 180
DR Inventories
DR Revenue $42,000 and (42,000 × 100%/120%) $35,000
CR Trade receivables $42,000 CR Cost of sales $35,000
$
1 January 20X2 Cash received 300,000
Credited to profit or loss
20X1–20X2 year (300,000/5 × 6/12) (30,000)
The $27,000 deferred income at 30 June 20X2 must be split into current and non-current
elements.
$
Credited to profit or loss
(300,000/5) = current
20X2–20X3 year amount (60,000)
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Skills checkpoint 2
Approach to Case OTQs
Chapter overview
cess skills
Exam suc
Answer planning
c FR skills C
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inf
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ng
Approach to Application
reta
agi
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Spreadsheet Interpretation
Go od
skills skills
ana
ti m
c al
Approach
em
to Case
e ri
OTQs
an
um
ag
tn
em
en
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t ci
Effi
Effective writing
and presentation
Introduction
Section B of the FR exam consists of three OTQ case questions.
Each case contains a group of five OT questions focused on a single scenario (which may
describe two connected themes, such as government grants and revenue recognition). These can
be any combination of the single OT question types and they are auto-marked in the same way
as the single OT questions.
OT Cases are worth 10 marks (each of the five OTs within it are worth two marks), and as with the
OT questions described above, candidates will score either two marks or zero marks for those
individual questions). Your skills from practising the Section A questions will be relevant in this
section.
OT cases are written so that there are no dependencies between the individual questions. So, if
you did get the first question in the case wrong, this does not affect your ability to get the other
four correct. The OT Case scenario remains on screen so you can see it while answering the
questions.
Each OT case normally consists of a range of numerical (calculation-based) questions and
narrative questions. It is often quicker to tackle the narrative questions first leaving some
additional time to tackle calculations.
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Fill in the blank (FIB) This question type requires you to type a
numerical answer into a box. The unit of
measurement (eg $) will sit outside the box,
and if there are specific rounding
requirements these will be displayed.
Drag and drop Drag and drop questions involve you dragging
an answer and dropping it into place. Some
questions could involve matching more than
one answer to a response area and some
questions may have more answer choices
than response areas, which means not all
available answer choices need to be used.
Drop down list This question type requires you to select one
answer from a drop down list. Some of these
questions may contain more than one drop
down list and an answer has to be selected
from each one.
Hot area These are like hot spot questions, but instead
of selecting a specific point you are required
to select one or more areas in an image.
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Approach to OT Case questions
A step-by-step technique for approaching OT case questions is outlined below. Each step will be
explained in more detail in the following sections as the OT case question ‘Dearing Co’ is
answered in stages.
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• Good time management. Complete all OTQ’s in the time available. Each OT case is worth 10
marks and should be allocated 18 minutes.
Skill activity
The following scenario relates to questions 1 to 5.
On 1 October 20X5 Dearing Co acquired a machine under the following terms.
$
Cost 1,050,000
Trade discount (applying to cost only) 20%
Freight charges 30,000
Electrical installation cost 28,000
Staff training in use of machine 40,000
Pre-production testing 22,000
Purchase of a three-year maintenance contract 60,000
On 1 October 20X7 Dearing Co decided to upgrade the machine by adding new components at a
cost of $200,000. This upgrade led to a reduction in the production time per unit of the goods
being manufactured using the machine.
1. What amount should be recognised under non-current assets as the initial cost of the
machine? (enter your answer to the nearest $000)
$_____000
Note. This is FIB question which requires the calculation of the total cost of the machine to be
capitalised under IAS 16 is required.
3. Every five years the machine will need a major overhaul in order to keep running. How should
this be accounted for?
Note. This is an MCQ question requiring you to select one valid statement.
• Set up a provision at year 1
• Build up the provision over years 1–5 capitalising the cost in year 1 and releasing it over five
years.
• Capitalise the cost when it arises in year 5 and amortising over five years
• Write the overhaul off to maintenance costs in the year they are incurred
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4. By 27 September 20X7 internal evidence had emerged suggesting that Dearing Co’s
machine was impaired. Select whether the following are internal indicators or external
indicators of impairment.
Note. This is a hot area question, requiring you to select the correct responses by clicking on the
box (the software in the exam will shade the box). You need to select whether the statement
represents an internal or an external indicator of impairment.
The performance of the machine had declined Internal indicator External indicator
leading to reduced economic benefits.
There were legal and regulatory changes Internal indicator External indicator
affecting the operating of the machine.
There was an unexpected fall in the market Internal indicator External indicator
value of the machine.
5. On 30 September 20X7 the impairment review was carried out. The following amounts were
established in respect of the machine:
$
Carrying amount 850,000
Value in use 760,000
Fair value 840,000
Costs of disposal 30,000
Use the picklist below to identify the carrying amount of the machine following the impairment
review.
Note. This is Picklist question, which is similar to an MCQ. Ensure you correctly scroll to your
intended answer in the exam.
Picklist options
$850,000
$760,000
$840,000
$810,000
STEP 1 Read the introduction to the question carefully, ensuring you understand what the questions are asking you
to do. Skimming the questions requirement will help you to identify whether the questions are narrative or
numerical in style.
Question 1 is a FIB question, you need to follow the instructions carefully and ensure you enter
your answer to the nearest $000 as required. Questions 2 and 3 are narrative questions which ask
you to identify which statements are correct. Read through each statement carefully knowing
that you are looking to identify the statement that is correct. Question 4 is a hot area question,
which ask you to select the correct indicator for each statement. Question 5 is a picklist question,
the approach for which is very similar to an MCQ.
STEP 2 Attempt the narrative questions first as this will allow you to use any remaining time to focus on the
numerical questions. The case will always have some narrative questions.
Questions 2, 3, and 4 are discursive style ‘narrative’ questions that do not require any
calculations. It would make sense to answer these three questions first as it is likely that you will be
able to complete them comfortably within the 10.8 minutes allocated to them. Any time saved
could then be spent on the more complex calculations required to answer Questions 1 and 5.
STEP 3 Apply your technical knowledge to the data presented in the question.
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Work through calculations taking your time and read through each answer option with care. OT questions
are designed so that each answer option is plausible. Work through each response option and eliminate
those you know are incorrect.
To answer Questions 1 and 5 you need to analyse the data given in the question.
Let’s look at Question 1 in detail. The question asks you to calculate the cost of Dearing Co’s asset
based on the information provided. You need to use your knowledge of IAS 16 Property, Plant and
Equipment, to identify which of the costs stated may be capitalised.
IAS 16 specifies the costs which must be included in the capitalised plant:
• Purchase price
• Import duties
• Directly attributable costs (including site preparation, professional fees and testing costs.
• Any estimates of costs to be incurred for dismantling the machine at the end of its life.
In summary, these are defined by IAS 16 as those costs which bring ‘the asset to the location and
working conditions necessary for it to be capable of operating in the manner intended by
management’ (IAS 16: para. 16). Even if you cannot remember the list above, then bear the
guidance in mind as to whether the asset would be able to operate without the cost being
incurred.
$ Note
Cost 1,050,000
Trade discount (applying to cost only) 20% 1
Freight charges 30,000 2
Electrical installation cost 28,000 3
Staff training in use of machine 40,000 4
Pre-production testing 22,000 5
Purchase of a three-year maintenance contract 60,000 6
Notes
1. You will need to calculate the discount value.
2. Freight charges (allowable as part of the initial delivery costs, and capitalised under IAS 16).
3. Electrical costs (allowable as part of the initial delivery costs, and capitalised under IAS 16).
4. These costs should be expensed as the company does not have control over the benefits
generated.
5. Testing is specifically allowed, as without it, the asset would not be able to function. Therefore,
allowable capitalised cost.
6. Not allowable, as the asset would be able to function without the maintenance contract (it
would be classed as repairs and maintenance cost, therefore expensed).
Therefore, the cost calculation should look like this:
$
Cost 1,050,000
Trade discount (1,050,000 × 20%) (210,000)
840,000
Freight charges 30,000
Electrical installation cost 28,000
Pre-production testing 22,000
920,000
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The correct answer is therefore $920,000, which you should enter in the fill in the blank box as
920 as you are asked to provide your answer to the nearest $000.
Question 5 is the other numerical question, requiring knowledge of impairment recoverable
amounts of an asset. A reminder from IAS 36 Impairment of Assets:
An asset is impaired if its carrying amount ($850,000) exceeds its recoverable amount.
The recoverable amount of an asset should be measured as the higher of:
(a) The asset’s fair value less costs of disposal of $810,000 ($840,000 fair value less $30,000
costs of disposal)
(b) The value in use ($760,000)
The recoverable amount is therefore $810,000.
As the carrying amount exceeds the recoverable amount, the asset is impaired. The asset is
therefore carried at $810,000 after impairment.
Question 2 is answered by applying your knowledge of the accounting standards covered in this
question, namely IAS 16.
• Added to the carrying amount of the machine
• Charged to profit or loss
• Capitalised as a separate asset
• Debited to accumulated depreciation
You need to eliminate the responses that are incorrect by referring to the guidance in the
standard.
The correct answer is:
Added to the carrying amount of the machine.
They should be added to the carrying amount of the machine as they cannot be capitalised as a
separate asset (as per IAS 16 para. 8) they should be capitalised with the relevant PPE to which
they relate). Spare parts will normally be expensed. However, upgrades and major spare parts
that will be used over more than one period should be capitalised. They would not be debited to
accumulated depreciation as they increase the cost of the item, rather than reducing the
depreciation to date.
To answer Question 3 you can start by eliminating the response options that do not correctly
identify the treatment required by IAS 16.
3. Every five years the machine will need a major overhaul in order to keep running. How should
this be accounted for?
• Set up a provision at year 1
• Build up the provision over years 1–5, capitalising the cost in year 1 and releasing it over five
years
• Capitalise the cost when it arises in year 5 and amortising over five years
• Write the overhaul off to maintenance costs in the year they are incurred
In this case, there is no other alternative but to incur the cost otherwise the machine would not be
able to function.
Consider the requirement to apply the principle of accrual accounting. In this respect, writing the
overhaul off to expenditure would be wrong, as the company benefits from the revenues
generated by the asset for five years, and the costs are only incurred in year five. This would be
acceptable for minor repairs. However, a significant overhaul requires capitalisation of the cost.
The options remain of setting up a provision in year one or over five years, or capitalising the cost.
Again, the accruals concept would not be met if the provision was fully set up in year 1.
It is important to read the question information carefully. Although capitalising the cost in year 5
looks correct, it is actually taking the costs incurred in year 5 and then capitalising them (and
amortising them over the next five years). This is not matching the costs of the asset with the
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same revenues (revenues are being generated years 1–5, and the costs incurred, capitalised and
amortized years 5–10).
Therefore, building up the provision over the five years is correct. IAS 16 requires the provision to
be capitalised and then released to the profit or loss account over the next five years (in line with
the revenue being generated) as amortisation and finance costs.
Question 4 requires an understanding of the indicators of impairment. In each given scenario,
state whether these are internal or external indicators.
The performance of the machine (Note 1) had declined Internal indicator
leading to reduced economic benefits
Notes
1. The machine is used and maintained by the company, it therefore has influence over its use and
state of repair. This is deemed to be an internal factor.
2. The laws are made external to the company.
3. The company cannot dictate market prices, so this is external.
4. There is no indication in the question that the company has R&D costs, so it is assumed that it is
‘general technological updates’ and therefore external to the company.
STEP 4 Stick to your time carefully, as each question is worth two marks, so spending more than the allocated time
of 3.6 minutes on each individual element of the case question is an inefficient use of your time, as you will
need to move onto the Section C questions. If you are running out of time, or you cannot answer any of the
questions, guess the answer from the options provided. You do not lose marks for incorrect answers.
Be strict with your time keeping, if you feel that you are getting stuck on one question, select an
answer and move onto to the next question. With the exception of the FIB (fill in the box)
questions, all OTQs can be attempted by guessing one of the given answers. If your revised
carefully and know the key knowledge areas of the standards, then the statement questions
should be a case of selecting the correct answer. The calculation questions require application of
your knowledge.
Remember each OTQ gives you two marks regardless of the style of question. It is important to
practice OTQs as this question practice will develop your skills and improve your timekeeping (as
you will know, from experience, how long it will take you to complete a style of question).
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Exam success skills Your reflection/observations
the required answer of the carrying amount of
an asset.
Good time management Remember that each OTQ is worth two marks,
regardless of how hard it is. You are aiming to
spend 3.6 minutes on each question (180
minutes/100 marks × 2 marks). Some
questions will be quicker than others, due to
their nature (narrative) or how confident you
are on a certain topic. Ensure you don’t
overrun, but equally, don’t rush your answers
and make mistakes.
Summary
60% of the FR exam consist of OTQs. Key skills to focus on throughout your studies will therefore
include:
• Always read the requirements first to identify what you are being asked to do and what type of
OT question you are dealing with.
• Actively read the scenario highlighting key data needed to answer each requirement.
• Answer OT questions in a sensible order dealing with any easier discursive style questions first.
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Introduction to groups
7
7
Learning objectives
On completion of this chapter, you should be able to:
Using IFRS Standards and other regulation, identify and outline the A4(c)
circumstances in which a group is required to prepare consolidated
financial statements.
Explain the need for using coterminous year ends and uniform A4(f)
accounting policies when preparing consolidated financial
statements.
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7
Chapter overview
Introduction to groups
Definitions
Subsequent measurement
Mid-year acquisitions
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1 Introduction and definitions
1.1 Acquisition of another entity
A company may expand or diversify its operations by acquiring another entity. There are different
ways in which an entity might acquire another business:
We will only consider the situation where the entity acquires a company by the acquisition of its
ordinary shares. We can summarise the different types of investment that result from the
acquisition of a company’s shares and the required accounting treatment in the group accounts
as follows:
This chapter, along with Chapter 8 and Chapter 9 of this Workbook, consider the accounting
requirements for a subsidiary. Chapter 10 looks at accounting for an associate and Chapter 11,
the accounting for an investment.
1.2 Definitions
The following definitions are important for group accounting:
Control: An investor controls an investee when the investor is exposed, or has rights, to variable
KEY
TERM returns from its involvement with the investee and has the ability to affect those returns
through power over the investee.
Power: Existing rights that give the current ability to direct the relevant activities of the
investee.
Subsidiary: An entity that is controlled by another entity.
Parent: An entity that controls one or more subsidiaries.
Group: A parent and all its subsidiaries.
Associate: An entity over which an investor has significant influence and which is neither a
subsidiary nor an interest in a joint venture.
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(IFRS 10: App. A)
Significant influence: The power to participate in the financial and operating policy decisions
of an investee but it is not control or joint control over those policies. (IAS 28: para. 3)
2 Control
We noted above that the acquired company is a subsidiary if control exists. It is important that
you do not simply consider the percentage ownership of the acquired company’s shares to
determine whether a subsidiary exists and instead focus on the criteria for control.
Control
Activity 1: Control
Alpha acquired 4,000 of the 10,000 equity voting shares and 8,000 of the 10,000 non-voting
preference shares in Crofton.
Alpha acquired 4,000 of the 10,000 equity voting shares in Element and had a signed agreement
giving it the power to appoint or remove all of the directors of Element.
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Required
Which investment would be classified as a subsidiary of Alpha?
Both Crofton and Element
Crofton only
Element only
Neither Crofton nor Element
Portus Co Sanus Co
$’000 $’000
Non-current assets
Property, plant and equipment 56,600 16,200
Investment in Sanus Co (at cost) 13,800 –
70,400 16,200
Current assets
Inventories 2,900 1,200
Trade receivables 3,300 1,100
Cash 1,700 100
7,900 2,400
78,300 18,600
Equity
Share capital ($1 shares) 8,000 2,400
Reserves 54,100 10,600
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Portus Co Sanus Co
$’000 $’000
62,100 13,000
Non-current liabilities
Long-term borrowings 13,200 4,800
Current liabilities
Trade and other payables 3,000 800
78,300 18,600
On 31 December 20X4, Portus Co purchased a 100% holding in Sanus Co for $13.8 million in cash.
It shows investment in Sanus Co at cost. This will remain unchanged from year to year, ie post-
acquisition increases in value are not evident from the parent’s separate statement of financial
position.
The assets and liabilities shown are only those held by the parent (Portus Co) directly.
Essential reading
Chapter 7 Section 1 of the Essential reading considers the exemptions that are available from
preparing consolidated financial statements.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
Present the results and financial position Are issued to the shareholders
of a group of companies as if it was of the parent
a single business entity
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5 Goodwill
5.1 Recognition and initial measurement
Essential reading
Chapter 7, Section 2 of the Essential reading discusses goodwill under IFRS 3 Business
Combinations in detail.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
$
Consideration transferred (cost of investment) X
Non-controlling interests (NCI) X
Less net acquisition-date fair value of identifiable assets
acquired and liabilities assumed (X)
Goodwill X
Activity 2: Goodwill
At 31 December 20X4, the statements of financial position of Portus Co and Sanus Co were as
follows:
Portus Co Sanus Co
$’000 $’000
Non-current assets
Property, plant and equipment 56,600 16,200
Investment in Sanus (at cost) 13,800 –
70,400 16,200
Current assets
Inventories 2,900 1,200
Trade receivables 3,300 1,100
Cash 1,700 100
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Portus Co Sanus Co
$’000 $’000
7,900 2,400
78,300 18,600
Equity
Share capital ($1 shares) 8,000 2,400
Reserves 54,100 10,600
62,100 13,000
Non-current liabilities
Long-term borrowings 13,200 4,800
Current liabilities
Trade and other payables 3,000 800
78,300 18,600
Note. On 31 December 20X4, Portus Co purchased a 100% holding in Sanus Co for $13.8 million in
cash.
Required
Prepare the consolidated statement of financial position of the Portus Group as at 31 December
20X4
Method:
(1) Cancel the investment in Sanus Co in Portus’s books with the shares and reserves (at the date
of acquisition) in Sanus Co’s books. Any difference is goodwill.
(2) Aggregate the two statements of financial position.
Solution
1
1
1
1
1
1
1
PORTUS GROUP
CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20X4
$’000
Non-current assets
Goodwill (W1)
Current assets
Inventories
Trade receivables
Cash
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$’000
Reserves (W2)
Non-current liabilities
Long-term borrowings
Current liabilities
Workings
1 Group structure
Portus Co
31.12.X4
100%
Cost $13.8m
Sanus Co
Pre-acq'n reserves $10.6m
2 Goodwill
$’000 $’000
Consideration transferred
Share capital
Reserves
Goodwill
Portus Co Sanus Co
$’000 $’000
Per question
Pre-acquisition reserves
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Portus Co Sanus Co
$’000 $’000
Sanus Co
6 Non-controlling interests
6.1 What are non-controlling interests?
Parent (P)
Subsidiary (S)
Non-controlling interests are the 'equity in a subsidiary not attributable, directly or indirectly, to a
parent' (IFRS 3: App. A), ie the non-group shareholders' interest in the net assets of the subsidiary
7 Mid-year acquisitions
7.1 Net assets of subsidiary
So far, we have considered acquisitions only at the end of a reporting period. Since companies
produce statements of financial position at that date anyway, there has been no special need to
establish the net assets of the acquired company at that date.
With a mid-year acquisition, a statement of financial position will not exist at the date of
acquisition, as required. Accordingly, we have to estimate the net assets at the date of acquisition
using various assumptions. Any profits made after acquisition – post-acquisition reserves – must
be consolidated in the group financial statements.
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7.2 Subsidiary profits pre- and post-acquisition
1 Jan 20X5 1 Jul 20X5 31 Dec 20X5
Date of acquisition,
becomes subsidiary of P
At 31 December 20X4, the statements of financial position of Portus Co and Sanus Co were as
follows:
Portus Co Sanus Co
$’000 $’000
Non-current assets
Property, plant and equipment 56,600 16,200
Investment in Sanus Co (at cost) 13,800 –
70,400 16,200
Current assets
Inventories 2,900 1,200
Trade receivables 3,300 1,100
Cash 1,700 100
7,900 2,400
78,300 18,600
Equity
Share capital ($1 shares) 8,000 2,400
Reserves 54,100 10,600
62,100 13,000
Non-current liabilities
Long-term borrowings 13,200 4,800
Current liabilities
Trade and other payables 3,000 800
78,300 18,600
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Notes.
1 On 1 April 20X4, Portus Co purchased an 80% holding in Sanus Co for $13.8 million in cash.
Sanus Co’s total comprehensive income for the year ended 31 December 20X4 was $2.0
million, accruing evenly over the year. Sanus Co did not pay any dividends in the year.
2 The non-controlling interest in Sanus Co is to be valued at its fair value of $3.2 million at the
date of acquisition.
Required
Prepare the consolidated statement of financial position of the Portus Group as at 31 December
20X4.
Solution
1
1
1
1
1
1
1
PORTUS GROUP
CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20X4
$’000
Non-current assets
Goodwill (W2)
Current assets
Inventories
Trade receivables
Cash
Reserves (W3)
Non-current liabilities
Long-term borrowings
Current liabilities
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Workings
1 Group structure
Portus Co
Sanus Co
Pre-acq'n reserves
2 Goodwill
$’000 $’000
Consideration transferred
Share capital
Reserves
Goodwill
3 Consolidated reserves
Portus Co Sanus Co
$’000 $’000
Per question
Pre-acquisition reserves
Sanus Co
4 Non-controlling interests
$’000
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$’000
Essential reading
Chapter 7 Section 3 of the Essential reading considers the accounting policies and year-end date
of the subsidiary.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
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Chapter summary
Introduction to groups
Important features
• Investment remains at cost, unchanged over time Features of the consolidated statement of financial
• Assets and liabilities are those of parent only position
• Present results as single economic entity
• No investment in subsidiary
• Subsidiary assets and liabilities included
• Share capital that of parent only
• Show the assets and liabilities controlled by
the group
• Shows the equity of the owners of the net assets
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Goodwill Non-controlling interest (NCI)
Points to note
Calculation of goodwill • Don't need to own 100% of S to control it
$ $ • NCI in equity section to reflect ownership
Consideration transferred X
Non-controlling interests X
Less fair value of net assets at acquisition:
Share capital X
Share premium X
Retained earnings X
Revaluation surplus X
(X)
X
Subsequent measurement
Test annually for impairment
Mid-year acquisitions
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Knowledge diagnostic
2. Control
Control exists when the acquiring company:
• Has the power to direct relevant activities of the other entity
• Has exposure or the right to variable returns
• Ability to use power to direct the amount of those returns
5. Goodwill
Goodwill arises when the value of a business as a whole exceeds the fair value of the net asset
acquired. It is subsequently tested for impairment annually.
6. Non-controlling interests
Non-controlling interests own any interest in a subsidiary that the parent does not own.
7. Mid-year acquisitions
The net assets of a subsidiary need to be established at the date of acquisition. Any profits
earned by the subsidiary pre-acquisition are included in its retained earnings, and therefore its
net assets, at the date of acquisition. Any post-acquisition profits of the subsidiary are included
within the consolidated financial statements.
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Further study guidance
Question practice
As this is an introductory chapter, there are no recommended questions from the Further question
practice bank at this stage. Questions will be recommended in Chapters 8–10 which build on the
concepts covered in this chapter.
Further reading
ACCA have produced a number of technical articles which look at key areas of the FR syllabus.
IFRS 3, Business combinations
www.accaglobal.com
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Activity answers
Activity 1: Control
The correct answer is: Element only
Alpha does not have power over Crofton as the non-voting preference shares do not give it power
and they only own 40% of the voting shares. The agreement regarding Element affords Alpha with
power, thus Element is a subsidiary.
Activity 2: Goodwill
PORTUS GROUP
CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20X4
$’000
Non-current assets
73,600
Current assets
10,300
83,900
62,100
Non-current liabilities
Current liabilities
83,900
Workings
1 Group structure
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Portus Co
31.12.X4
100%
Cost $13.8m
Sanus Co
Pre-acq'n reserves $10.6m
2 Goodwill
$’000 $’000
Reserves 10,600
(13,000)
Goodwill 800
Portus Co Sanus Co
$’000 $’000
Sanus Co (0 × 100%) 0
54,100
$’000
Non-current assets
78,300
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$’000
Current assets
10,300
88,600
63,300
66,800
Non-current liabilities
Current liabilities
88,600
Workings
1 Group structure
Portus Co
31.12.X4
100%
Cost $13.8m
Sanus Co
Pre-acq'n reserves $10.6m
2 Goodwill
$’000 $’000
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$’000 $’000
(11,500)
Goodwill 5,500
3 Consolidated reserves
Portus Co Sanus Co
$’000 $’000
1,500
55,300
4 Non-controlling interests
$’000
3,500
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The consolidated
8 statement of financial
position
8
Learning objectives
On completion of this chapter, you should be able to:
Explain why it is necessary to use fair values for the consideration A4(i)
for an investment in a subsidiary together with the fair values of a
subsidiary’s identifiable assets and liabilities when preparing
consolidated financial statements.
Explain and account for other reserves (eg share premium and D2(c)
revaluation surplus).
Account for the effects of fair value adjustments (including their D2(e)
effect on consolidated goodwill) to:
(a) depreciating and non-depreciating non-current assets
(b) inventory
(c) monetary liabilities
(d) assets and liabilities not included in the subsidiary’s own
statement of financial position, including contingent assets
and liabilities
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8
Exam context
The consolidated statement of financial position is one of the key financial statements you need to
be able to prepare and/or interpret in Section C of the ACCA Financial Reporting exam. It is
important that you understand the approach to preparing the consolidated statement of financial
position and that you can apply that approach efficiently in an exam question.
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8
Chapter overview
The consolidated statement of financial position
Reconciliation of
intragroup balances
Method
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1 Approach to the consolidated statement of financial
position
In Chapter 7, we introduced group accounting, including some of the key features of the
consolidated statement of financial position. This chapter builds on that knowledge by looking in
more detail at the procedures and adjustments required on consolidation.
Step 3 Transfer figures from the parent and subsidiary financial statements to the
proforma:
• Include the parent plus 100% of the subsidiary’s assets/liabilities
controlled at the year end on a line by line basis
• Include only the parent’s share capital and share premium in the equity
section
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Step Procedure/exam technique
• Non-controlling interests
• Retained earnings and any other reserves of the subsidiary
• Dividends paid by the subsidiary
• Intragroup trading
• Inventories transferred within the group
• Non-current assets transferred within the group
Step 5 Transfer your workings to the proforma and complete your answer
Goodwill
$
Consideration transferred (cost of investment) X
Non-controlling interests (NCI) X
Less the fair value of identifiable assets acquired and liabilities
assumed at the acquisition date (X)
Goodwill X
Goodwill
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Activity 1: Basic goodwill calculation
Sing Co gained control of Wing Co on 31 March 20X5 when it acquired 80% of its ordinary shares.
The draft statements of financial position of each company were as follows:
SING CO
STATEMENT OF FINANCIAL POSITION AS AT 31 MARCH 20X5
$
Assets
Non-current assets
Investment in 40,000 shares of Wing Co at cost 80,000
Current assets 40,000
Total assets 120,000
Equity and liabilities
Equity
Ordinary shares 75,000
Retained earnings 45,000
Total equity and liabilities 120,000
WING CO
STATEMENT OF FINANCIAL POSITION AS AT 31 MARCH 20X5
$
Current assets 60,000
Equity
50,000 ordinary shares of $1 each 50,000
Retained earnings 10,000
60,000
The fair value of the non-controlling interest in Wing Co as at 31 March 20X5 has been determined
as $12,500.
Required
Prepare the consolidated statement of financial position of the Sing Group as at 31 March 20X5.
Solution
1
1
SING GROUP
CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 MARCH 20X5
Assets
Non-current assets
Current assets
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$
Total assets
Ordinary shares
Retained earnings
Non-controlling interests
Consideration
A liability of $100,000 is to be paid in two years’ time. The discount rate of 6%.
Required
At what amount should the liability be recorded?
Solution
The liability should be recorded at $100,000 × 1/1.062 = $89,000.
Essential reading
Chapter 8, Section 1 of the Essential reading provides more detail on the types of consideration
that may be used to acquire a subsidiary.
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The Essential reading is available as an Appendix of the digital edition of the Workbook.
Activity 2: Consideration
ABC acquired 300,000 of DEF’s 400,000 ordinary shares during the year ending 28 February
20X5. DEF was purchased from its directors who will remain in their current roles in the business.
The purchase consideration comprised:
• $250,000 in cash payable at acquisition
• $88,200 payable two years after acquisition
• $100,000 payable in two years’ time if profits exceed $2 million
• New shares issued in ABC at acquisition on a 1 for 3 basis
The consideration payable in two years after acquisition is a tough target for the directors of DEF,
which means its fair value (taking into account the time value of money) has been measured at
only $30,750.
The market value of ABC’s shares on the acquisition date was $7.35.
An appropriate discount rate for use where relevant is 5%.
Required
1 How much is the consideration that has been/will be paid in cash to include in the calculation
of goodwill on acquisition?
$
2 How much is the consideration payable in shares that will be included in the calculation of
goodwill on acquisition?
$
However, this is complicated when there is NCI at fair value at the date of acquisition.
When NCI is valued at fair value the goodwill in the statement of financial position includes
goodwill attributable to the NCI. In this case, the double entry will reflect the NCI proportion
based on their shareholding as follows:
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Illustration 2: Goodwill impairment
Using the information in Activity 1 above, assume that in the year ending 31 March 20X6, the
goodwill of Wing Co is impaired by 20%.
Required
Prepare the journal entry to record the goodwill impairment of Wing Co in the year ended 31
March 20X6.
Solution
The goodwill impairment is $32,500 × 20% = $6,500.
$5,200 ($6,500 × 80%) of this will be allocated to the group and the remaining $1,300 ($6,500 ×
20%) will be allocated to the NCI.
2 Fair values
In order to calculate goodwill, we need to establish
• The fair value of the non-controlling interest; and
• The fair value of the net assets acquired
2.1 Definition
Fair value: The price that would be received to sell an asset or paid to transfer a liability in an
KEY
TERM orderly transaction between market participants at the measurement date (IFRS 13: para. 9).
Essential reading
Chapter 8 Section 2 of the Essential reading provides more detail regarding the interaction of IFRS
3 and IFRS 13.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
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2.2 Fair value of non-controlling interests
IFRS 3 allows the non-controlling interests in a subsidiary to be measured at the acquisition date
in one of two ways:
NCI at acquisition
Note that a parent can choose which method to use on a transaction by transaction basis.
Prominent Note
You should note that the term ‘full goodwill’ is sometimes used to refer to measuring NCI at fair
value and the term ‘partial goodwill’ is sometimes used when referring to NCI at proportionate
share of net assets. These terms are not used in IFRS 3 and are not used in this Workbook,
however you may be familiar with them from your workplace.
On 31 December 20X8, Penn acquired four million of the five million $1 ordinary shares of
Sylvania, paying $10 million in cash. On that date, the fair value of Sylvania’s net assets was $7.5
million.
Required
Calculate the goodwill arising on acquisition assuming:
1 Penn has elected to value the non-controlling interest at acquisition at fair value. The market
price of the shares held by the non-controlling shareholders immediately before the
acquisition was $2.00.
2 Penn has elected to value the non-controlling interest at acquisition at its proportionate share
of the fair value of the subsidiary’s identifiable net assets.
Solution
1 NCI at fair value
$’000
Consideration transferred 10,000
Non-controlling interest: 1m × $2 2,000
12,000
Net assets acquired (7,500)
Goodwill 4,500
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2 NCI at proportion of net assets
$’000
Consideration transferred 10,000
Non-controlling interest: 20% × $7.5m 1,500
11,500
Net assets acquired (7,500)
Goodwill 4,000
You can see from the above illustration that measuring NCI at fair value at acquisition results in an
increased amount of goodwill. The additional amount of goodwill represents goodwill attributable
to the shares held by non-controlling shareholders. It is not necessarily proportionate to the
goodwill attributed to the parent as the parent may have paid more to acquire a controlling
interest.
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Item Valuation basis
transferring the consideration.
At 31 December 20X4, the statements of financial position of Portus Co and Sanus Co were as
follows:
Portus Co Sanus Co
$’000 $’000
Non-current assets
Property, plant and equipment 56,600 16,200
Investment in Sanus Co (at cost) 13,800 –
70,400 16,200
Current assets
Inventories 2,900 1,200
Trade receivables 3,300 1,100
Cash 1,700 100
7,900 2,400
78,300 18,600
Equity
Share capital ($1 shares) 8,000 2,400
Reserves 54,100 10,600
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Portus Co Sanus Co
$’000 $’000
13,000
62,100
Non-current liabilities
Long-term borrowings 13,200 4,800
Current liabilities
Trade and other payables 3,000 800
78,300 18,600
Notes.
1 On 1 April 20X4, Portus Co purchased an 80% holding in Sanus Co for $13.8 million in cash.
Sanus Co’s total comprehensive income for the year ending 31 December 20X4 was $2.0
million, accruing evenly over the year. Sanus Co did not pay any dividends in the year.
2 At the date of acquisition, the fair value of Sanus Co’s assets was equal to their carrying
amounts with the exception of the items listed below which exceeded their carrying amounts
as follows (see table below). Sanus Co. has not adjusted the carrying amounts as a result of
the fair value exercise. The inventories were sold by Sanus Co before the year end.
3 The non-controlling interest in Sanus Co is to be valued at its fair value of $3.2 million at the
date of acquisition. An impairment test conducted at the year-end revealed that the
consolidated goodwill of Sanus Co was impaired by $150,000.
£’000
Inventories 300
Plant and equipment (10-year remaining useful life) 1,200
1,500
Required
1 Prepare the consolidated statement of financial position of the Portus Group as at 31
December 20X4.
2 Show how the goodwill and non-controlling interests would change if the non-controlling
interests were measured at acquisition at the proportionate share of the fair value of the
acquiree’s identifiable net assets.
3 Explain how the goodwill would have been treated if the calculation had resulted in a negative
figure, and how such a negative figure may arise.
Solution
1
1 PORTUS GROUP
CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20X4
$’000
Non-current assets
Goodwill (W2)
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$’000
Current assets
Inventories
Trade receivables
Cash
Reserves (W3)
Non-current liabilities
Long-term borrowings
Current liabilities
Workings
1 Group structure
Portus Co
1.4.X4
80%
Cost $13.8m
Sanus
Pre-acq'n reserves $9.1m
($10.6m – ($2.0m × 9/12))
or ($10.6m – $2.0m + ($2.0 × 3/12))
2 Goodwill
$’000 $’000
Consideration transferred
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$’000 $’000
Share capital
Reserves
3 Consolidated reserves
Portus Co Sanus Co
$’000 $’000
Per question
Pre-acquisition reserves
Sanus Co
4 Non-controlling interests
$’000
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5 Fair value adjustments
Inventories
2 Changes:
Workings
1 Goodwill
$’000 $’000
Consideration transferred
Non-controlling interests
Share capital
Reserves
2 Non-controlling interests
$’000
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$’000
Elderberry Co acquired 750,000 of Apricot Co’s 1,000,000 $1 ordinary shares on 1 January 20X2
for $3,800,000 when Apricot Co’s retained earnings were $4,200,000. Elderberry Co elected to
measure non-controlling interests in Apricot Co at its fair value of $1,600,000 at the date of
acquisition.
At 1 January 20X2, Apricot Co had not recognised the following in its financial statements:
• Apricot Co had a customer list which it had not recognised as an intangible asset because it
was internally generated. However, on acquisition, external experts managed to establish a fair
value for the list of $150,000. Customers are typically retained for an average of 5 years.
• Apricot Co had a contingent liability with a fair value of $220,000 at the date of acquisition.
There is a present obligation in respect of this contingent liability.
Required
Calculate the goodwill arising on the acquisition of Apricot Co on 1 January 20X2.
Solution
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(b) Profits earned after acquisition (post acquisition profits)
The assumption can be made that profits accrue evenly whenever it is impracticable to arrive at
an accurate split of pre- and post‑acquisition profits. You should make this assumption in the FR
exam unless you are told otherwise.
Essential reading
Chapter 8, Section 3 of the Essential reading is an activity in which a subsidiary is acquired mid-
way through the year.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
The total reserves of Portus Co and Sanus Co in Activity 3 can be broken down as follows:
Portus Co Sanus Co
$’000 $’000
Equity
Share capital ($1 shares) 8,000 2,400
Retained earnings 42,700 9,000
Revaluation surplus 11,400 1,600
62,100 13,000
At acquisition, the retained earnings of Sanus Co were $7.8 million and its revaluation surplus
stood at $1.3 million (coming to a total of $9.1 million as before).
Required
Calculate the consolidated retained earnings, consolidated revaluation surplus and non-
controlling interests for the Portus Group as at 31 December 20X4.
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Solution
1
1
PORTUS GROUP
CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20X4 (EXTRACT)
$’000
Workings
1 Consolidated retained earnings
Portus Co Sanus Co
$’000 $’000
Per question
Sanus Co ( × 80%)
Portus Co Sanus Co
$’000 $’000
Per question
Sanus Co ( × 80%)
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3 Non-controlling interests
$’000
NCI share of impairment losses (Activity 1(a) (W2) 150 × 20%) (30)
3,392
Subsidiary Co, a 60% subsidiary of Parent Co, pays a dividend of $1,000 on the last day of its
accounting period. Its total reserves before paying the dividend stood at $5,000.
Required
Explain how the dividend paid by Subsidiary Co should be accounted for.
Solution
(1) $400 (40%) of the dividend is paid to non-controlling shareholders. The cash leaves the group
and will not appear anywhere in the consolidated statement of financial position.
(2) The parent company receives $600 of the dividend, debiting cash and crediting profit or loss.
This will be cancelled on consolidation.
(3) The remaining balance of retained earnings in Subsidiary Co’s statement of financial position
($4,000) will be consolidated in the normal way. The group’s share (60% × $4,000 = $2,400)
will be included in group retained earnings in the statement of financial position; the non-
controlling interest share (40% × $4,000 = $1,600) is credited to the non-controlling interest
account in the statement of financial position.
5 Intragroup trading
5.1 IFRS 10 requirement
IFRS 10 Consolidated Financial Statements states ‘Intragroup balances, transactions, income and
expenses shall be eliminated in full’ (IFRS 10: para. B86).
The purpose of consolidation is to present the parent and its subsidiaries as if they are trading as
one entity.
Therefore, only amounts owing to or from outside the group should be included in the statement
of financial position, and any assets should be stated at cost to the group.
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5.2 Intragroup balances
Trading transactions will normally be recorded via a current account between the trading
companies, which would also keep a track of amounts received and/or paid.
The current account receivable in one company’s books should equal the current account
payable in the other. These two balances should be cancelled on consolidation as intragroup
receivables and payables should not be shown.
5.3 Method
Make the adjustments for in transit items on your proforma answer after consolidating the assets
and liabilities.
• Cash in transit
DEBIT Cash
CREDIT Receivables
• Goods in transit
DEBIT Inventories
CREDIT Payables
• Eliminate intragroup receivables and payables
DEBIT Intragroup payable
CREDIT Intragroup receivable
6.2 Method
Calculate the unrealised profit included in inventories and mark the adjustment to inventories on
your proforma answer and to retained earnings in your workings.
To eliminate the unrealised profit from retained earnings and inventories a provision is usually
made in the books of the company making the sale (IFRS 10 is not specific). This only happens on
consolidation. Following this approach, the entries required are:
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Sale by P to S Adjust in P’s accounts
DEBIT Cost of sales/Retained earnings of P
CREDIT Consolidated inventories
At 31 December 20X4, the statements of financial position of Portus Co and Sanus Co were as
follows:
Portus Co Sanus Co
$’000 $’000
Non-current assets
Property, plant and equipment 56,600 16,200
Investment in Sanus Co (at cost) 13,800 –
70,400 16,200
Current assets
Inventories 2,900 1,200
Trade receivables 3,300 1,100
Cash 1,700 100
7,900 2,400
78,300 18,600
Equity
Share capital ($1 shares) 8,000 2,400
Reserves 54,100 10,600
62,100 13,000
Non-current liabilities
Long-term borrowings 13,200 4,800
Current liabilities
Trade and other payables 3,000 800
78,300 18,600
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Notes.
1 On 1 April 20X4, Portus Co purchased an 80% holding in Sanus Co for $13.8 million in cash.
Sanus’s total comprehensive income for the year ending 31 December 20X4 was $2 million,
accruing evenly over the year. Sanus Co did not pay any dividends in the year.
2 At the date of acquisition, the fair value of Sanus Co’s assets was equal to their carrying
amounts with the exception of the items listed below which exceeded their carrying amounts
as follows (see table below). Sanus Co has not adjusted the carrying amounts as a result of
the fair value exercise. The inventories were sold by Sanus Co before the year end.
3 The non-controlling interest in Sanus Co is to be valued at its fair value of $3.2 million at the
date of acquisition. An impairment test conducted at the year end revealed that the
consolidated goodwill of Sanus Co was impaired by $150,000.
4 On 1 October 20X4, Sanus Co sold goods to Portus Co for $200,000 at a gross profit margin
of 40%. The goods were still in Portus Co’s inventories at the year end. No other sales were
made between Portus Co and Sanus Co in the year. At 31 December 20X4, Portus Co’s
current account with Sanus Co was $130,000 (credit). This did not agree with the equivalent
balance in Sanus’s books due to cash in transit of $70,000 which was not received by Sanus
Co until after the year end.
$’000
Inventories 300
Plant and equipment (10-year remaining useful life) 1,200
1,500
Required
Prepare the consolidated statement of financial position of the Portus Group as at 31 December
20X4 (incorporating the changes from the previous example identified in bold text).
Solution
1
1
PORTUS GROUP
CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20X4
$’000
Non-current assets
77,760
Current assets
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$’000
Reserves (W3)
Non-current liabilities
Current liabilities
Workings
1 Group structure
Portus Co
1.4.X4
80%
Cost $13.8m
Sanus
Pre-acq'n reserves $9.1m
($10.6m – ($2.0m × 9/12))
or ($10.6m – $2.0m + ($2.0 × 3/12))
2 Goodwill
$’000 $’000
(13,000)
4,000
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$’000 $’000
(150)
3,850
3 Consolidated reserves
Portus Co Sanus Co
$’000 $’000
Sanus Co ( × 80%)
4 Non-controlling interests
$’000
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At Movement At year end
acquisition
date
6 Intragroup trading
(1) Cash in transit
$’000 $’000
$’000 $’000
$’000 $’000
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7.2 Method
(a) Calculate the unrealised profit on the transfer of the item of property, plant and equipment
(PPE).
(b) Calculate the amount of this unrealised profit that has been depreciated by the year-end.
This is the ‘excess depreciation’ that must be added back to group PPE.
(c) Adjust for these amounts in your consolidation workings.
DEBIT PPE
CREDIT Retained earnings (subsidiary’s column in retained earnings working)
With the excess depreciation
DEBIT PPE
CREDIT Retained earnings (group’s column in retained earnings working)
With the excess depreciation
Percy Co owns 60% of the equity shares of Edmund Co, giving Percy Co control over Edmund Co.
On 1 January 20X1, Edmund Co sold a machine with a carrying amount of $10,000 to Percy Co
for $12,500.
The reporting date of the group is 31 December 20X1 and the balances on the retained earnings of
Percy Co and Edmund Co at that date are:
$
Percy Co, after charging depreciation of 10% on the machine 27,000
Edmund Co, including profit on the sale of the machine to Percy Co 18,000
Required
Show the working for consolidated retained earnings.
Solution
Consolidated retained earnings
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Percy Co Edmund Co
$ $
Per question 27,000 18,000
Disposal of plant
Profit (2,500)
Excess depreciation: 10% × $2,500 250
15,500
Share of Edmund Co: $15,500 × 60% 9,300
Retained earnings 36,550
Notes.
1 The NCI in the retained earnings of Edmund Co is 40% × $15,500 = $6,200.
2 The profit on the transfer of $2,250 ($2,500 – $250) will be deducted from the carrying
amount of the machine to write it down to cost to the group.
Sanus Co sells plant with a remaining useful life of four years and a carrying amount of $120,000
to Portus Co for $200,000 on 1 October 20X4.
Required
Using the options below, select the correct entries for the journals to remove the unrealised profit
in the consolidated statement of financial position as at 31 December 20X4.
Debit Credit
Retained earnings
Debit Credit
Retained earnings
Essential reading
Chapter 8 Section 4 of the Essential reading provides a further activity relating to the
consolidated statement of financial position.
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The Essential reading is available as an Appendix of the digital edition of the Workbook.
PER alert
One of the competences you require to fulfil Performance Objective 7 of the PER is the ability
to classify information in accordance with the requirements for external financial statements
or for inclusion in disclosure notes in the statements. You can apply the knowledge you obtain
from this chapter to help to demonstrate this competence.
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Chapter summary
Fair values
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Pre- and post-acquisition Dividends paid
profits and other reserves by subsidiary
Other reserves
• Include in goodwill working
• Include parent + group share of subsidiary post-acquisition
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Knowledge diagnostic
2. Goodwill
Positive goodwill is capitalised and tested annually for impairment. ‘Negative’ goodwill (once
reassessed to ensure it is accurate) is recognised as a bargain purchase in profit or loss.
The consideration transferred comprises any assets or equity transferred at the date of
acquisition, less any liabilities incurred, deferred consideration and any contingent consideration.
3. Fair values
Non-controlling interests at acquisition can be measured either at their fair value or at their
proportionate share of the fair value of the acquiree’s identifiable net assets.
The fair value of the assets acquired and liabilities assumed must be recognised at fair value at
the date of acquisition. Internally generated intangible assets and contingent liabilities not
recognised in the individual financial statements of the subsidiary are recognised on acquisition,
provided criteria satisfied.
6. Intragroup trading
In the consolidated accounts (only), items in transit must be accounted for and intragroup
balances cancelled.
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Further study guidance
Question practice
Now try the following from the Further question practice bank (available in the digital edition of
the Workbook):
9 Barcelona Co and Madrid Co
10 Reprise Group
14 Highveldt Co
Further reading
There is a useful article written by the examining team on the calculation of goodwill, which can
be found on the ACCA website.
The use of fair values in the goodwill calculation
www.accaglobal.com
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Activity answers
Assets
Non-current assets
Working
Goodwill
$ $
Consideration transferred 80,000
Non-controlling interest 12,500
Net assets acquired as represented by:
Ordinary share capital 50,000
Retained earnings on acquisition 10,000
(60,000)
Goodwill 32,500
Activity 2: Consideration
1 $ 360,750
$
Cash 250,000
Deferred consideration (88,200 × (1/1.052)) 80,000
Contingent consideration 30,750
360,750
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2 $ 735,000
1 PORTUS GROUP
CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20X4
$’000
Non-current assets
77,760
Current assets
10,300
88,060
62,868
66,260
Non-current liabilities
Current liabilities
88,060
Workings
1 Group structure
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Portus Co
1.4.X4
80%
Cost $13.8m
Sanus
Pre-acq'n reserves $9.1m
($10.6m – ($2.0m × 9/12))
or ($10.6m – $2.0m + ($2.0 × 3/12))
2 Goodwill
$’000 $’000
(13,000)
4,000
3,850
3 Consolidated reserves
Portus Co Sanus Co
$’000 $’000
1,110
54,868
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4 Non-controlling interests
$’000
2 Changes:
Workings
1 Goodwill
$’000 $’000
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$’000 $’000
(13,000)
3,400
3,280
2 Non-controlling interests
$’000
2,822
3 Where the goodwill calculation results in a negative figure (ie where the fair value of net assets
at acquisition exceeds the consideration paid and value attributed to non-controlling
interests), the full amount is treated as a ‘bargain purchase’. It is credited directly to profit or
loss (and retained earnings) attributable to the parent. There is no non-controlling interest
effect.
This situation could arise for several reasons:
(1) The seller needed to make a quick/forced sale (eg due to liquidity or regulatory reasons)
resulting in a bargain purchase of the net assets at less than their fair value.
(2) An expectation that losses will be made lowering the value of the net assets acquired
before the business can be turned around.
(3) An expectation that the business will need to be broken up and sold off with significant
break-up costs.
(4) The existence of liabilities that did not meet the recognition criteria for recognition in the
fair value of the net assets acquired (for this reason, IFRS 3 actually requires a review of
the calculations of net assets acquired to ensure no contingent liabilities that can be
recognised have been missed before a credit is allowed to be made to profit or loss).
$’000 $’000
Consideration 3,800
NCI at FV 1,600
Fair value of identifiable net assets:
Share capital 1,000
Retained earnings 4,200
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$’000 $’000
FV adjustment - intangible asset 150
FV adjustment - contingent liabilities (220)
(5,130)
Goodwill 270
$’000
66,260
Workings
1 Consolidated retained earnings
Portus Co Sanus Co
$’000 $’000
810
43,228
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Portus Co Sanus Co
$’000 $’000
11,640
3 Non-controlling interests
$’000
NCI share of impairment losses (Activity 1(a) (W2) 150 × 20%) (30)
3,392
$’000
Non-current assets
77,760
Current assets
10,090
87,850
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$’000
62,804
66,180
Non-current liabilities
Current liabilities
87,850
Workings
1 Group structure
Portus Co
1.4.X4
80%
Cost $13.8m
Sanus
Pre-acq'n reserves $9.1m
($10.6m – ($2.0m × 9/12))
or ($10.6m – $2.0m + ($2.0 × 3/12))
2 Goodwill
$’000 $’000
(13,000)
4,000
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$’000 $’000
3,850
3 Consolidated reserves
Portus Co Sanus Co
$’000 $’000
1,030
54,804
4 Non-controlling interests
$’000
3,376
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6 Intragroup trading
(1) Cash in transit
$’000 $’000
$’000 $’000
$’000 $’000
Debit Credit
Retained earnings $80,000
Property, plant and equipment $80,000
With the unrealised profit on disposal
Debit Credit
Retained earnings $5,000
Property, plant and equipment $5,000
With the excess depreciation
Working
Unrealised profit
$
Profit on transfer (200 – 120) 80,000
Excess depreciation (80 × 3/12 × ¼) 5,000
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The consolidated statement
9 of profit or loss and other
comprehensive income
9
Learning objectives
On completion of this chapter, you should be able to:
Explain the need for using coterminous year-ends and uniform A4(f)
accounting polices when preparing consolidated financial
statements.
Exam context
The group accounting question in Section C of the ACCA Financial Reporting exam may ask you
to prepare and/or interpret a consolidated statement of profit or loss and other comprehensive
income (SPLOCI). This chapter builds on the knowledge gained in Chapters 7 and 8, focusing on
the inclusion of a subsidiary in the group financial statements. As with Chapter 8, it is important
that you develop an approach to preparing the SPLOCI and that you can apply that approach
efficiently in an exam question.
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Chapter overview
The consolidated statement of profit or loss and other comprehensive income (SPLOCI)
Basic procedure
Impairment
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1 Approach to the consolidated statement of profit or loss
and other comprehensive income (SPLOCI)
1.1 Aim of the consolidated SPLOCI
The aim of the consolidated SPLOCI is to show the results of the group for an accounting period
as if it were a single economic entity. The same logic is used as for the statement of financial
position, ie all income and expenses controlled by the parent are reported in the consolidated
statement of profit or loss and other comprehensive income.
Total
comprehensive
Profit for the income for the
year (PFY) year (TCI)
$ $
S’s PFY/S’s TCI per the question X X
Consolidation adjustments affecting the subsidiary’s
profit:
• Impairment loss on goodwill for the year (Non-
controlling interest (NCI) is measured at fair value at
acquisition) (X) (X)
• Provision for unrealised profit (if the subsidiary is the
seller) (X) (X)
• Interest on intragroup loans (X)/X (X)/X
• Fair value adjustments – movement in the year (X)/X (X)/X
A B
NCI share NCI % × A NCI % × B
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1.3 Basic procedure
Step 3 Transfer figures from the parent and subsidiary financial statements to the
proforma:
• 100% of all income/expenses (or if acquired in the year, time apportioned
if appropriate)
• Exclude dividends from subsidiary (Section 1.7)
Step 4 Go through question, calculating the necessary adjustments to profit for the
year in respect of:
• Intragroup trading (Section 2)
• Intragroup loans and interest (Section 3)
• Fair value adjustments (Essential reading Chapter 9, available in the
digital edition of the Workbook)
• Remember to make the adjustments in the NCI working where the
subsidiary’s profit is affected
Step 5 Complete NCI in subsidiary’s PFY and TCI calculation (Section 1.2).
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Assessment focus point
The July 2020 Examiner’s Report noted that accounting correctly for mid-year acquisitions is
an area of weakness among candidates. Many candidates fail to time-apportion the figures
of a subsidiary with a mid-year acquisition. This is a regularly tested area and one which we
would expect students to know. Failure to time-apportion is a fundamental error by not
recognising the principle of only consolidating the results from the date of acquisition.
Essential reading
Chapter 9, Section 1 of the Essential reading provides further detail and an Activity on the pre-
and post-acquisition profits.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
The statements of profit or loss and other comprehensive income of Portus Co and its subsidiary
Sanus Co for the year ended 31 December 20X4 are as follows:
Portus Co Sanus Co
$’000 $’000
Revenue 28,500 11,800
Cost of sales (17,100) (7,000)
Gross profit 11,400 4,800
Expenses (4,400) (2,200)
Finance costs (400) (200)
Profit before tax 6,600 2,400
Income tax expense (2,100) (800)
PROFIT FOR THE YEAR 4,500 1,600
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Portus Co Sanus Co
$’000 $’000
Other comprehensive income:
Gains on property revaluation 900 400
TOTAL COMPREHENSIVE INCOME FOR THE YEAR 5,400 2,000
Note. On 1 April 20X4, Portus Co purchased an 80% holding in Sanus Co for $13.8 million in cash.
Sanus’s total comprehensive income for the year ended 31 December 20X4 was $2.0 million,
accruing evenly over the year. Sanus Co did not pay any dividends in the year. Portus Co paid
dividends of $3 million in the year.
Required
Using the proformas provided, prepare the consolidated statement of profit or loss and other
comprehensive income for the Portus Group for the year ended 31 December 20X4 (excluding
consolidation adjustments).
Solution
1
PORTUS GROUP
CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR
THE YEAR ENDED 31 DECEMBER 20X4
$’000
Revenue
Cost of sales
Gross profit
Expenses
Finance costs
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$’000
Workings
1 Group structure
$’000 $’000
PFY/TCI per
× % × %
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2 Intragroup trading
2.1 Issue
There are two issues caused by intragroup trading to address in the consolidated SPLOCI.
Consider the following:
Example
3rd party
supplier
P sells goods on to S
80% for $2,000, making a
profit of $400
S holds inventories of
S
$2,000 at the year end
After this transaction, the individual company and consolidated statements of profit or loss
(before cancellation of intragroup trading) look like this:
P S Consolidated
$ $ $ $ $ $
Revenue 2,000 – 2,000
Cost of sales:
Opening inventory – – –
Purchases 1,600 2,000 3,600
Closing inventory (–) (2,000) (2,000)
(1,600) (–) (1,600)
Gross profit 400 – 400
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After these adjustments, the consolidated statement of profit or loss is now as follows:
P S Adj Consolidated
$ $ $ $ $ $ $
Revenue 2,000 – (2,000) –
Cost of sales:
Opening inventory – – –
Purchases 1,600 2,000 (2,000) 1,600
Closing inventory (–) (2,000) 400 (1,600)
(1,600) (–) (–)
Gross profit 400 – –
Note. The intragroup revenue and purchase of $2,000 have been eliminated leaving the $1,600
purchase from the third-party supplier. Closing inventory has been reduced to the cost to the
group of $1,600 and the unrealised profit of $400 has been eliminated.
2.2 Method
There are two potential adjustments needed when group companies trade with each other:
With the total amount of the intragroup sales between the companies. This adjustment is needed
regardless of whether any of the goods are still in inventories at the year end or not.
An adjustment will also need to be made in the NCI calculation if it is the subsidiary that makes
the sale.
Continuing from the previous example, the statements of profit or loss and other comprehensive
income of Portus Co and its subsidiary, Sanus Co, for the year ended 31 December 20X4 are as
follows:
Portus Co Sanus Co
$’000 $’000
Revenue 28,500 11,800
Cost of sales (17,100) (7,000)
Gross profit 11,400 4,800
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Portus Co Sanus Co
$’000 $’000
Expenses (4,400) (2,200)
Finance costs (400) (200)
Profit before tax 6,600 2,400
Income tax expense (2,100) (800)
PROFIT FOR THE YEAR 4,500 1,600
Other comprehensive income:
Gains on property revaluation 900 400
TOTAL COMPREHENSIVE INCOME FOR THE YEAR 5,400 2,000
Notes.
1 On 1 April 20X4 Portus Co purchased an 80% holding in Sanus Co for $13.8 million in cash.
Sanus’s total comprehensive income for the year ended 31 December 20X4 was $2.0 million,
accruing evenly over the year. Sanus Co did not pay any dividends in the year. Portus Co paid
dividends of $3 million in the year.
2 At the date of acquisition, the fair value of Sanus’s assets were equal to their carrying amounts
with the exception of the items listed below which exceeded their carrying amounts by the
following amounts (see table below). Sanus Co has not adjusted the carrying amounts as a
result of the fair value exercise. The inventories were sold by Sanus Co before the year end.
3 The NCI in Sanus Co is to be valued at its fair value of $3.2 million at the date of acquisition.
An impairment test conducted at the year-end revealed that the consolidated goodwill of
Sanus Co was impaired by $150,000.
4 On 1 October 20X4, Sanus Co sold goods to Portus Co for $200,000 at a gross profit margin
of 40%. The goods were still in Portus Co’s inventories at the year end. No other sales were
made between Portus Co and Sanus Co in the year. At 31 December 20X4, Portus Co’s current
account with Sanus Co was $130,000 (credit). This did not agree with the equivalent balance
in Sanus’s books due to cash in transit of $70,000 which was not received by Sanus Co until
after the year end.
$’000
Inventories 300
Plant and equipment (10-remaining useful life) 1,200
1,500
Required
1 Prepare the consolidated statement of profit or loss and other comprehensive income for the
Portus Group for the year ended 31 December 20X4.
2 Explain how the statement of profit or loss and other comprehensive income would differ if
Portus Co had sold the goods in Note (d) to Sanus.
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Solution
1
1 PORTUS GROUP
CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME
FOR THE YEAR ENDED 31 DECEMBER 20X4
$’000
Revenue
Cost of sales
Gross profit
Expenses
Finance costs
NCI (W2)
NCI (W2)
Workings
1 Group structure
1.1.X4 1.4.X4 1.7.X4 31.12.X4
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2 Non-controlling interests (SPLOCI)
$’000 $’000
× 20% × 20%
Inventories –
4 Intragroup trading
(1) Cancel intragroup trading
$’000 $’000
$’000 $’000
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$’000 $’000
seller)
3.2 Method
3.2.1 Cancel the loan in the consolidated statement of financial position
Adjustment is required to cancel the loans in the consolidated statement of financial position:
The loan balance will be a receivable in the statement of financial position of the provider of the
loan and a payable to the recipient of the loan. The balances need to be cancelled in the
consolidated statement of financial position:
$ $
DEBIT Loan payable X
CREDIT Loan receivable X
3.2.2 Cancel the finance cost and finance income in the consolidated statement of profit or
loss and other comprehensive income
The provider of the loan will present finance income in its statement of profit or loss and the
recipient of the loan will show a finance cost. This is an intragroup income and expense which
must be cancelled in the consolidated statement of profit or loss and other comprehensive
income:
$ $
DEBIT Group finance income X
CREDIT Group finance costs X
Example
P acquired 100% of S on its incorporation. On the same date, P made a fixed rate 4% loan to S.
The loan has not been repaid at the year end. The loan is eliminated on consolidation as follows:
STATEMENTS OF FINANCIAL POSITION
P S Adjustment Consolidated
$’000 $’000 $’000 $’000
Non-current assets
Property, plant and
equipment 6,200 3,050 9,250
Investment in S 1,000 – –
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P S Adjustment Consolidated
$’000 $’000 $’000 $’000
4% loan to S 400 – (400) –
7,600 3,050 9,250
Current assets 1,350 850 2,200
8,950 3,900 11,450
Equity
Share capital 800 1,000 800
Retained earnings 6,900 1,800 8,700
7,700 2,800 9,500
Non-current liabilities
Bank loan 200 – 200
4% loan from P – 400 (400) –
200 400 200
Current liabilities 1,050 700 1,750
8,950 3,900 11,450
P S Adjustment Consolidated
$’000 $’000 $’000 $’000
Revenue 2,200 1,100 3,300
Cost of sales and expenses (1,540) (770) (2,310)
Profit before interest and
tax 660 330 990
Finance income (from S) 16 – (16) –
Finance costs (20) (16) (16) (20)
Profit before tax 656 314 970
Income tax expense (196) (94) (290)
PROFIT FOR THE YEAR 460 220 680
4 Disposal of a subsidiary
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4.1 Control boundary
When a parent sells its interest in a subsidiary, the control boundary is passed:
0% (20%) (50%) 100%
SIG INFLUENCE
CONTROL
0% 80%
If the profit or loss is significant, the profit or loss should be disclosed separately (IAS 1
Presentation of Financial Statements).
$
Fair value of consideration received X
Less carrying amount of investment disposed of (X)
Profit/(loss) X/(X)
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Activity 3: Disposal of subsidiary
Pelmer Co acquired 80% of Symta Co’s 100,000 $1 shares on 1 January 20X2 for $600,000 when
the net assets of Symta Co were $410,000. In addition to its net assets, Symta Co had a brand
name valued at $50,000 which was recognised on acquisition. It is group policy to measure non-
controlling interests at fair value at acquisition. The fair value of the non-controlling interests in
Symta Co at acquisition was $150,000. No impairment has been necessary.
On 1 June 20X6, Pelmer Co disposed of its shareholding for $1,500,000. At that date, Symta Co’s
statement of financial position showed net assets with a carrying amount of $660,000. The value
of the brand name which is not recognised in the individual financial statements of Symta Co, has
not changed since acquisition.
Required
What is the group profit or loss on disposal of Symta Co to be shown in the consolidated accounts
for the year ended 31 December 20X6?
$610,000
$800,000
$808,000
$858,000
Essential reading
Chapter 9, Section 2 of the Essential reading contains a further activity relating to the disposal of
a subsidiary.
Chapter 9, Section 3 of the Essential reading considers the impact of fair value adjustments on the
consolidated statement of profit or loss.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
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Chapter summary
The consolidated statement of profit or loss and other comprehensive income (SPLOCI)
Basic procedure
• Draw up group structure, % ownership, date of acquisition
• Create proforma
• Transfer parent and 100% sub to proform (pro-rate mid year)
• Adjust for intragroup trading, loans, fair value adjustments
• Complete NCI calculations
Impairment
Only current year impairment losses included
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Intragroup loans Disposal of
and interest subsidiary
Method
• Cancel the loan Calculation of profit or loss on disposal (in consolidated accounts)
DEBIT (↓) Loan payable Fair value of consideration received X
CREDIT (↓) Loan receivable Less share of consolidated carrying amount at date
• Eliminate the interest control lost:
DEBIT (↓) Finance income Net assets X
CREDIT (↓) Finance expense Goodwill X
Less NCI (X)
(X)
Group profit/(loss) X/(X)
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Knowledge diagnostic
1. Approach to the consolidated statement of profit or loss and other comprehensive income
The purpose of the consolidated statement of profit or loss and other comprehensive income is to
show the results of the group as a single business entity.
Where an acquisition occurs part way through an accounting period, income and expenses are
only consolidated for the number of months that the subsidiary is controlled by the parent.
2. Intragroup trading
In order not to overstate group revenue and costs, intragroup trading is cancelled. Similarly,
unrealised profits on intragroup trading are eliminated.
4. Disposals
When a disposal occurs where control is lost, the subsidiary is derecognised in the group financial
statements and a gain/loss on disposal is calculated, being the difference between the fair value
of the consideration received plus the fair value of any remaining investment less the consolidated
share of the subsidiary disposed.
In the consolidated statement of profit or loss and other comprehensive income, the subsidiary is
consolidated for the period up to the disposal.
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Further study guidance
Question practice
You should attempt the following questions from the Further question practice (available in the
digital edition of the Workbook):
11 Fallowfield Co and Rusholme Co
12 Panther Group
Further reading
You should make time to read this article, which is available in the study support resources section
of the ACCA website:
The use of fair values in the goodwill calculation
www.accaglobal.com
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Activity answers
$’000
5,700
6,900
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Workings
1 Group structure
1.1.X4 1.4.X4 1.7.X4 31.12.X4
$’000 $’000
× 20% × 20%
240 300
1 PORTUS GROUP
CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME
FOR THE YEAR ENDED 31 DECEMBER 20X4
$’000
Cost of sales (17,100 + (7,000 × 9/12) + 390 (W3) – 200 (W4) + 80 (W4)) (22,620)
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$’000
5,080
6,280
Workings
1 Group structure
$’000 $’000
580 880
× 20% × 20%
116 176
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At Movement At year end
acquisition
date
4 Intragroup trading
(1) Cancel intragroup trading
$’000 $’000
$’000 $’000
2 If Portus Co (the parent) sold the inventories rather than Sanus Co, there would be no change
on the top half of the statement of profit or loss and other comprehensive income. However, in
the reconciliation of profit and total comprehensive income attributable to owners of the
parent and to non-controlling interests, unrealised profit would no longer affect profit
attributable to non-controlling interests. Non-controlling interests would therefore be:
Profit and total comprehensive income attributable to owners of the parent would therefore
decrease by the amount of the increase in the respective non-controlling interest, as they are
calculated as residual figures.
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Activity 3: Disposal of subsidiary
The correct answer is: $808,000
$’000 $’000
Consideration transferred 1,500
Less share of consolidated
carrying amount at date
control lost:
Net assets (660 + 50) 700
Goodwill (W1) 190
Non-controlling interests (W2) (198)
(692)
Gain 808
Workings
1 Goodwill
$’000
Consideration 600
NCI at fair value 150
Less: Net assets acquisition 410
Fair value adjustment 50
190
2 Non-controlling interests
$’000
NCI at acquisition 150
Add NCI share of post-acquisition reserves
(20% × (660 - 410) 48
198
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Accounting for
10 associates
10
Learning objectives
On completion of this chapter, you should be able to:
Exam context
When investing in another company, a parent may not wish to buy a controlling stake. It may
instead buy a smaller stake but still obtain significant influence over another entity, resulting in
the group having an associate. Section C of the exam may require you to prepare and/or
interpret group financial statements that contain an associate. The approach to accounting for
an associate is very different to that for a subsidiary and you must be clear on the correct
approach.
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Chapter overview
Associates and joint arrangements
Significant influence
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1 Definitions
Associate: An associate is an entity over which the investor has significant influence. (IAS 28:
KEY
TERM para. 3)
Significant influence: ‘The power to participate in the financial and operating policy decisions
of the investee but is not control or joint control over those policies.’ (IAS 28: para. 3)
1.1 Presumptions
If an investor holds, directly or indirectly:
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2 Parent’s separate financial statements
As we covered in Chapter 7, under IAS 27 Separate Financial Statements, the investment can be
recorded in the parent’s separate financial statements either:
3 Accounting treatment
3.1 Consolidated financial statements
An investment in an associate is accounted for in consolidated financial statements using the
equity method.
Equity method: ‘A method of accounting whereby the investment is initially measured at cost
KEY
TERM 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.’ (IAS 28: para. 3)
Essential reading
Chapter 10, Section 1 of the Essential reading provides more detail on the requirement to apply
equity accounting.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
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CONSOLIDATED STATEMENT OF FINANCIAL POSITION
Non-current assets
Investment in associate (Working) X
Working
Cost of associate X
Share of post-acquisition retained reserves X/(X)
Less impairment losses on associate to date (X)
Less group share of unrealised profit (X)
X
Profit or loss $
Share of profit of associate:
A’s profit for the year × Group % X
Less Impairment losses (X)
Less Group share of unrealised profit (X)
Other comprehensive income
Share of other comprehensive income of the associate
A’s other comprehensive income for the year × Group % X
Holly Co owns 35% of Hock Co, its only associate. During the year to 31 December 20X4, Hock Co
made a profit for the year of $721,000. Holly Co considers its investment in Hock to have suffered
a $20,000 impairment during the year.
Required
At what amount should ‘share of profit of associate’ be stated in the consolidated statement of
profit or loss of Holly Co for the year ended 31 December 20X4?
$
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However, IAS 28 states that the investor’s share of unrealised profits and losses on transactions
between investor and associate should be eliminated in the same way as for transactions between
a parent and its subsidiaries (para. 28). It is important to remember that only the group’s share is
eliminated.
This is done as follows:
Note that this journal entry will be used regardless of whether this is a sale from a parent to the
associate, or from the associate to parent.
Beta purchased a 60% holding in Delta’s ordinary shares on 1 January 20X0 for $6.1 million when
the retained earnings of Delta were $3.6 million. The retained earnings of Delta at 31 December
20X4 were $10.6 million. Since acquisition, there has been no impairment of the goodwill in Delta.
Beta also has a 30% holding in Kappa’s ordinary shares, which it acquired on 1 July 20X1 for $4.1
million when the retained earnings of Kappa were $6.2 million. The retained earnings of Kappa at
31 December 20X4 were $9.2 million.
An impairment test conducted at the year end revealed that the investment in the associate
(Kappa) was impaired by $500,000.
During the year, Kappa sold goods to Beta for $3 million at a profit margin of 20%. One-third of
these goods remained in Beta’s inventories at the year end. The retained earnings of Beta at 31
December 20X4 were $41.6 million.
Required
1 State the accounting adjustment required in respect of the unrealised profit on the sale of
goods from Kappa to Beta.
2 Calculate the following amounts for inclusion in the consolidated statement of financial
position of the Beta group as at 31 December 20X4:
(a) Investment in associate
(b) Consolidated retained earnings
Solution
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Activity 4: Consolidated statement of financial position
At 31 December 20X4, the statements of financial position of Portus Co, Sanus Co and Allus Co
were as follows:
(1) On 1 April 20X4, Portus Co purchased an 80% holding in Sanus Co for $13.8 million in cash.
Sanus Co’s total comprehensive income for the year ended 31 December 20X4 was $2.0
million, accruing evenly over the year. Sanus Co did not pay any dividends in the year.
(2) Portus Co also acquired a 30% holding in Allus Co on 1 July 20X4 for 500,000 of its own
shares. The stock market value of Portus Co’s shares at the date of this share exchange was
$9.40 each. Portus Co has not yet recorded the investment in Allus Co. Allus Co ‘s reserves
were $8.6 million on 1 July 20X4.
(3) At the date of acquisition, the fair value of Sanus Co’s assets were equal to their carrying
amounts, with the exception of the items listed below which exceeded their carrying amounts
as follows:
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$’000
Inventories 300
Plant and equipment (10-year remaining useful life) 1,200
1,500
Sanus Co has not adjusted the carrying amounts as a result of the fair value exercise. The
inventories were sold by Sanus Co before the year end.
(4) The non-controlling interest in Sanus Co is to be valued at its fair value of $3.2 million at the
date of acquisition.
An impairment test conducted at the year end revealed that the consolidated goodwill of
Sanus Co was impaired by $150,000.
Additionally, an impairment loss of $40,000 is to be recognised in respect of Portus Co’s
investment in Allus Co in the group financial statements.
(5) On 1 October 20X4, Sanus Co sold goods to Portus Co for $200,000 at a gross profit margin
of 40%. The goods were still in Portus Co’s inventories at the year end. No other sales were
made between Portus Co and Sanus Co in the year.
After the acquisition, Allus Co sold goods to Portus Co for $400,000 at a mark-up on cost of
25%. A quarter of these goods remained in Portus Co’s inventories at the year end.
(6) At 31 December 20X4, Portus Co’s current account with Sanus Co was $130,000 (credit). This
did not agree with the equivalent balance in Sanus Co’s books due to cash in transit of
$70,000 which was not received by Sanus Co until after the year end.
Required
Prepare the consolidated statement of financial position of the Portus Group as at 31
December20X4.
Solution
1
PORTUS GROUP
CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20X4
$’000
Non-current assets
Goodwill (W2)
Current assets
Inventories
Trade receivables
Cash
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$’000
Reserves (W4)
Non-current liabilities
Long-term borrowings
Current liabilities
Workings
1 Group structure
2 Goodwill
$’000 $’000
Consideration transferred
Share capital
Reserves
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3 Investment in associate
$’000
Cost of associate
4 Consolidated reserves
Per question
Pre-acquisition reserves
Sanus Co
Allus Co
Allus Co
$’000
NCI at acquisition (W2) 3,200
NCI share of post-acquisition reserves (W4) 206
NCI share of impairment losses (W2) 30
3,376
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6 Fair value adjustments
At acquisition At year
date Movement end
$’000 $’000 $’000
Inventories 300 (300) -
Plant and equipment 1,200 (90)* 1,110
*Extra depreciation (1,200 × 10% × 9/12) 1,500 (390) 1,110
Take to
COS & Take to
Goodwill reserves SOFP
7 Intragroup trading
(1) Cash in transit
$’000 $’000
DEBIT Group cash 70
CREDIT Trade receivables 70
$’000 $’000
DEBIT Group revenue 200
CREDIT Group purchases (cost of sales) 200
$’000 $’000
DEBIT Group payables 130
CREDIT Group receivables 130
$’000 $’000
DEBIT Cost of sales (& reserves) (of Sanus Co the seller) 80
CREDIT Group inventories 80
Allus Co:
Profit element in inventories: $400,000 × 25/125 × 1/4 = $20,000
Associate share: $20,000 × 30% = $6,000
$’000 $’000
DEBIT 6
CREDIT 6
1
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Activity 5: Consolidated statement of profit or loss
The statements of profit or loss and other comprehensive income of Portus Co, its subsidiary
Sanus Co and its associate Allus Co for the year ended 31 December 20X4 are as follows:
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME
(1) On 1 April 20X4, Portus Co purchased an 80% holding in Sanus Co for $13.8 million in cash.
Sanus Co’s total comprehensive income for the year ended 31 December 20X4 was $2.0
million, accruing evenly over the year. Sanus Co did not pay any dividends in the year.
(2) Portus Co also acquired a 30% holding in Allus Co on 1 July 20X4 for 500,000 of its own
shares. The stock market value of Portus Co’s shares at the date of this share exchange was
$9.40 each. Portus Co has not yet recorded the investment in Allus Co. Allus Co ‘s reserves
were $8.6 million on 1 July 20X4.
(3) At the date of acquisition, the fair value of Sanus Co’s assets were equal to their carrying
amounts, with the exception of the items listed below which exceeded their carrying amounts
as follows:
$’000
Inventories 300
Plant and equipment (10-year remaining useful life) 1,200
1,500
Sanus Co has not adjusted the carrying amounts as a result of the fair value exercise. The
inventories were sold by Sanus Co before the year end.
(4) The non-controlling interest in Sanus Co is to be valued at its fair value of $3.2m at the date
of acquisition. An impairment test conducted at the year end revealed that the consolidated
goodwill of Sanus Co was impaired by $150,000. Additionally, an impairment loss of $40,000
is to be recognised in respect of Portus Co’s investment in Allus Co in the group financial
statements.
(5) On 1 October 20X4, Sanus Co sold goods to Portus Co for $200,000 at a gross profit margin
of 40%. The goods were still in Portus Co’s inventories at the year end. No other sales were
made between Portus Co and Sanus Co in the year. After the acquisition, Allus Co sold goods
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to Portus Co for $400,000 at a mark-up on cost of 25%. A quarter of these goods remained
in Portus Co’s inventories at the year end.
(6) At 31 December 20X4, Portus Co’s current account with Sanus Co was $130,000 (credit). This
did not agree with the equivalent balance in Sanus Co’s books due to cash in transit of
$70,000 which was not received by Sanus Co until after the year end.
Required
Prepare the consolidated statement of profit or loss and other comprehensive income for the
Portus Group for the year ended 31 December 20X4.
Solution
1
PORTUS GROUP
CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR
THE YEAR ENDED 31 DECEMBER 20X4
$’000
Revenue
Cost of sales
Gross profit
Expenses
Finance costs
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Workings
1 Timeline
1.1.X4 1.4.X4 1.7.X4 31.12.X4
PUP
adjustment
$’000 $’000
× 20% × 20%
Essential reading
Chapter 10, Section 2 of the Essential reading contains a further Activity to allow you to practise
preparing consolidated financial statements containing an Associate.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
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Chapter summary
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Knowledge diagnostic
1. Definition
An associate relationship exists where there is significant influence. Significant influence is ‘the
power to participate in the financial and operating policy decisions of the investee but is not
control or joint control over those policies’ (IAS 28: para. 3). This is presumed where a parent holds
20% or more of voting shares, but also can be demonstrated in other ways.
3. Accounting treatment
In the group financial statements, an associate is equity accounted as a one-line entry
‘investment in associate’ in the statement of financial position and the share of the associate’s
profit and other comprehensive income are shown on two separate lines in the statement of profit
or loss and other comprehensive income.
The following adjustment is required for unrealised profits in inventory:
$’000 $’000
DEBIT Group share of profit in associate Group % × unrealised
(SOPL) profit
Group % × unrealised
CREDIT Investment in associate (SOFP) profit
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Further study guidance
Question practice
Now try the following from the Further question practice bank (available in the digital edition of
the Workbook):
13 Hever Co
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Activity answers
$’000
Cost of associate 4,100
Share of post-acquisition retained earnings (9,200 – 6,200) × 30% 900
5,000
Less impairment losses on associate to date (500)
Less: adjustment for unrealised profit (60)
4,440
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Beta Delta Kappa
$’000 $’000 $’000
At the year end 41,600 10,600 9,200
Unrealised profit (part (a)) (60) – –
At acquisition (3,600) (6,200)
7,000 3,000
Note. Even though the associate was the seller for the intragroup trading, PUP is adjusted
in the parent’s column so as not to multiply it by the group share twice.
Working
Group structure
Beta
Delta Kappa
$’000
Non-current assets
82,654
Current assets
10,090
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$’000
92,684
67,638
71,014
Non-current liabilities
Current liabilities
92,684
Workings
1 Group structure
Portus Co
1.4.X4 1.7.X4
80% 30%
Cost $13.8m (W8) $4.7m
Sanus Co Allus
Pre-acq'n reserves $9.1m $8.6m
($10.6m – ($2.0m × 9/12))
or ($10.6m – $2.0m + ($2.0 × 3/12))
2 Goodwill
$’000 $’000
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$’000 $’000
(13,000)
4,000
3,850
3 Investment in associate
$’000
4,834
4 Consolidated reserves
1,030 600
Allus Co (40)
54,938
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5 Non-controlling interests (SOFP)
$’000
NCI at acquisition (W2) 3,200
NCI share of post-acquisition reserves (W4) 206
NCI share of impairment losses (W2) 30
3,376
At acquisition At year
date Movement end
$’000 $’000 $’000
Inventories 300 (300) -
Plant and equipment 1,200 (90)* 1,110
*Extra depreciation (1,200 × 10% × 9/12) 1,500 (390) 1,110
Take to
COS & Take to
Goodwill reserves SOFP
7 Intragroup trading
(1) Cash in transit
$’000 $’000
DEBIT Group cash 70
CREDIT Trade receivables 70
$’000 $’000
DEBIT Group revenue 200
CREDIT Group purchases (cost of sales) 200
$’000 $’000
DEBIT Group payables 130
CREDIT Group receivables 130
$’000 $’000
DEBIT Cost of sales (& reserves) (of Sanus Co the seller) 80
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$’000 $’000
CREDIT Group inventories 80
Allus Co:
Profit element in inventories: $400,000 × 25/125 × 1/4 = $20,000
Associate share: $20,000 × 30% = $6,000
$’000 $’000
DEBIT 6
CREDIT 6
$’000
Cost of sales (17,100 + (7,000 × 9/12) + (W6) 390 – (W7) 200 + (W7) 80) (22,620)
Share of profit of associate [(1,300 × 30% × 6/12) – Activity 1(W7) 6 – 40 imp 149
losses)]
5,229
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$’000
6,474
Workings
1 Timeline
1.1.X4 1.4.X4 1.7.X4 31.12.X4
PUP
adjustment
$’000 $’000
580 880
× 20% × 20%
116 176
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Skills checkpoint 3
Using spreadsheets
effectively
Chapter overview
cess skills
Exam suc
Answer planning
c FR skills C
n Specifi o
tio
rr req
a
ec ui
of
m
t i rem
or
nt
inf
erp ents
ng
Approach to Application
reta
agi
tion
l y si s
Spreadsheet Interpretation
Go od
skills skills
ana
ti m
c al
Approach
em
to Case
e ri
OTQs
an
um
ag
tn
em
en
en
t ci
Effi
Effective writing
and presentation
Introduction
Section C of the FR exam will have two longer questions worth a total of 40 marks. One question
will require you to prepare extracts from the financial statements (this may be for a single entity
or for a group, and it may be any of the primary financial statements). You will be required to use
a spreadsheet to prepare your answer to the accounts preparation question and must be
prepared to use spreadsheets effectively in your exam.
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The ACCA FR Examining Team has stated that some candidates are poorly prepared to use the
spreadsheet software used in the FR exam. It is essential that you attempt questions using the
exam software as part of your preparation for the FR exam. You should ensure that you use the
ACCA Practice Platform (https://www.accaglobal.com/gb/en/student/exam-support-
resources/fundamentals-exams-study-resources/f7/cbe-question-practice.html) to practice exam
standard questions prior to the exam.
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This is especially important in a question that may have lots of information, such as one which
requires you to prepare a set of financial statements based on a draft trial balance, and a
series of further elements of information.
• Correct interpretation of requirements. The requirement clearly has two separate parts. The
calculation of goodwill and, separately, the preparation of a consolidated statement of profit
or loss.
• Efficient numerical analysis. The key to success here is applying a sensible proforma for the
calculation of goodwill and for key figures within the consolidated statement of profit or loss,
such as non-controlling interest. (You must show all workings and use the formula facility in the
spreadsheet tool to link your workings to the consolidated statement of profit or loss where
appropriate).
• Good time management. Complete all tasks in the time available, being careful not to overrun
the calculation of goodwill at the expense of the second part of the question.
Skill activity
STEP 1 Understanding the data in the question.
Where a question includes a significant amount of data, read the requirements carefully to make sure that
you understand clearly what the question is asking you to do. You can use the highlighting function to pull
out important data from the question. Use the data provided to think about what formula you will need to
use. For example, if the company calculates the allowance for receivables as a percentage of the balance,
use the percentage function.
The question scenario will appear here. The question requirement will appear here.
Edit Format
100%
11
A1
A B C D E F G H I
1
2
3
4
5
6
7
8
9
10
11
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In the ribbon across the top, there are tools you can use
to highlight and mark up the question.
Viagem Co Greca Co
$’000 $’000
Revenue 64,600 38,000
Cost of sales (51,200) (26,000)
Gross profit 13,400 12,000
Distribution costs (1,600) (1,800)
Administrative expenses (3,800) (2,400)
Investment income 500 –
Finance costs (420) –
Profit before tax 8,080 7,800
Income tax expense (2,800) (1,600)
Profit for the year 5,280 6,200
Equity as at 1 October 20X1
Equity shares of $1 each 30,000 10,000
Retained earnings 54,000 35,000
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(i) An item of plant had a fair value of $1.8 million
above its carrying amount. The remaining life
of the plant at the date of acquisition was
three years. Depreciation is charged to cost of
sales.
Required
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(b) Prepare the consolidated statement of profit or loss
for Viagem Co for the year ended 30 September
20X2. (14 marks)
(Total = 20 marks)
STEP 2 Use a standard proforma working.
You are likely to be asked for prepare an extract or a set of financial statements. Set out your statement of
profit or loss or the statement of financial position before you start to work through the question. This will
give you the basic structure from where you can enter the data in the question.
Format your cells to ensure the workings look consistent, for example, using the comma function to mark
the thousands in numerical answers.
In this example, the question is calling for two parts to be answered. Firstly, the calculation of
goodwill and secondly, preparation of the consolidated statement of profit or loss.
Start with part (a) first, setting out the key elements of the goodwill calculation. Give your work a
title ((a) Goodwill calculation) and reference it to the question so that the Examining Team can see
clearly what part of the question you are answering:
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11
C1
A B C D E F
1
2 (a) Goodwill calculaon $΄000 $΄000
3
4 Consideraon transferred:
5 Shares
6 Deferred consideraon
7
8
9
10
11
Columns C and D have been highlighted. At this point, it is a sensible idea to format the cells so
that they show thousand dividers. This makes the numbers easier to read and means you are less
likely to start answering in, for example thousands and later change to millions or full numbers,
which can be confusing.
Edit Format
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11
C4 45200 General
A B C
Custom D E F
1 0.00
2 (a) Goodwill calculaon $΄000 $΄000
#,##0
3
#,##0.00
4 Consideraon transferred:
5 Shares
6 Deferred consideraon
By highlighting the whole two columns, this speeds up the formatting process. This is where you
will insert the figures.
If you feel you will need more columns highlighting and formatting, then select more columns.
Once you have completed part (a) of the question, the second part calls for a proforma of a
consolidated statement of profit or loss. You may also want to consider setting up proforma some
of the sub-calculations you may require such as non-controlling interests.
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It is important to make your work clear to the Examining team using headings, referencing and
formatting the cells. Set out your proforma under a suitable heading, you may wish to use bold
text or underline to make your headings clearer.
STEP 3 Use spreadsheet formulae to perform basic calculations.
Ensure you are showing your workings by using the spreadsheet formula for simple calculations, for
example, the cost of sales figure will be made up of different balances, so add them together using the
formula.
One issue that repeatedly comes up in the Examiner’s Report, is that students do not show where
their figures have come from. This makes it difficult for marks to be awarded, as the workings are
often key to ensuring that students understand the process. Also, if a mistake is made in the
calculations, then marks cannot be awarded for the method or the parts which were correct.
There are some useful tools that will assist in both your calculation and presentation of your
answer:
Use the formula in the spreadsheet tool. This may be simple addition or subtraction formula, such
as adding numbers together to get the administrative costs figure or to calculate the subtotals:
11
C13 =C11-C12
A B C D
9 (b) Consolidated statement of profit or loss
10 $΄000 $΄000
11 Revenue 85,900
12 Cost of sales 64,250
13 Gross profit =C11-C12
14 Distribu"on costs
15 Administra"on costs
16
Here, the gross profit is calculated by subtracting the cost of sales figure from the revenue figure.
This does three things:
• It ensures that the arithmetic is correct
• It shows the Examining team where the numbers have come from
• Future proofs the answer. If you later change the revenue figure, the subtotals will
automatically update.
If the working is more complex, then set up a new working below the proforma and cross reference
it. It is also recommended (in order to ensure updates if you make changes later) that you link the
cells together:
B25 =(14400*.1)*(9/12)
A B C
20 Profit for the year
21
22 Workings
23 (W1) Finance costs $΄000
24 Viagem Co per statement of profit or loss 420
25 Unwinding of discount on deferred considera"on 1080
26 1500
27
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Then link the answer back to the consolidated statement of profit or loss:
5 Administraon costs -7,600
6 Finance costs (W1) =-B26
7 Share of profit of associate
8 Profit before tax
9 Income tax expense
10 Profit for the year
11
12 Workings $΄000
13 (W1) Finance costs 420
14 Viagem Co per statement of profit or loss 1080
15 Unwinding of discount on deferred consideraon 1500
16
17
Correct interpretation of The question is asking for a calculation of goodwill and then
requirements preparation of the consolidated statement of profit or loss. It is
important to make sure that all parts of the question are
answered, and the relevant information taken from the
information given in the question.
Efficient numerical analysis The answer needs to be presented neatly, and all information
easily readable by the Examining team.
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Exam success skills Your reflections/observations
Ensure that formula is used to show where the numbers have
come from, and to ensure accuracy in the calculation
(provided the formula has been correctly inserted).
Good time management The question is worth 20 marks but split into two sections. The
calculation of goodwill is worth six marks, so you should allow
no more than 10–11 minutes for this section, and then move
onto the consolidated statement of profit or loss. It is
important not to linger too long on one section as you may
miss easy marks in the next question at the expense of
spending longer than allowed to gain an additional mark or
two.
Most important action points to apply to your next question: show all workings.
Summary
Section C of the FR exam will contain questions that require proformas and calculations to be
carried out using the spreadsheet facility in the exam.
Make sure you are familiar with the tool (the ACCA website allows access both in completing an
online example paper, and also just to practice using the spreadsheet functionality).
It is also important to be aware that in the exam you are dealing with detailed calculations under
timed exam conditions and time management is absolutely crucial. You therefore need to ensure
that you:
• Interpret the date given in the question correctly.
• Use clear proformas (where appropriate) for your workings and your financial statement
extracts.
• Use spreadsheet formula to perform basic calculations.
• Show clear workings using a combination of formula and linking separate workings (such as
goodwill calculation that can be linked into your statement of financial position).
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Financial instruments
11
11
Learning objectives
On completion of this chapter, you should be able to:
Exam context
Financial instruments are frequently examined in all sections of the Financial Reporting exam. It is
a technical area which students sometimes find challenging. The December 2018 examiner’s
report stated that students need to avoid a superficial understanding of this subject area and the
June 2019 examiner’s report identified that financial instruments is one of the more technical
areas of the course that students struggle with.
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Chapter overview
Financial instruments
Measurement
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1 The need for a standard
The dynamic nature of international financial markets and the increasing number and variety of
financial instruments that have been introduced in recent years have meant the standard setters
struggled to keep pace with the rate of change in the market. As a result, there was a lack of
guidance as to how financial instruments should be accounted for. This caused problems such as:
• Inconsistencies in the way in which financial instruments were recognised and measured,
leading to comparability problems for international companies who reported under different
accounting regimes
• Criticism about the accounting and disclosure requirements following high-profile scandals
relating to financial instruments
• A lack of understanding from the users of financial statements, for example, one of the key
user ratios is the gearing ratio, ie the measure of the proportion of debt to equity. In order for
this measure to be meaningful, there must be consistency in the allocation of financial
instruments between these two categories.
In response to the issues with the accounting for financial instruments, the IASB has developed
and implemented the following standards relating to financial instruments:
2 Classification
2.1 Definitions
In order to understand how to account for financial instruments, we must first understand what we
mean by financial instruments.
Financial instruments
Financial instrument: Any contract that gives rise to both a financial asset of one entity and a
KEY
TERM financial liability or equity instrument of another entity.
Financial asset: Any asset that is:
(a) Cash
(b) An equity instrument of another entity
(c) A contractual right to receive cash or another financial asset from another entity; or to
exchange financial instruments with another entity under conditions that are potentially
favourable to the entity.
Financial liability: Any liability that is:
(a) A contractual obligation:
(i) To deliver cash or another financial asset to another entity, or
(ii) To exchange financial instruments with another entity under conditions that are
potentially unfavourable.
Equity instrument: Any contract that evidences a residual interest in the assets of an entity
after deducting all of its liabilities. (IAS 32: para. 11)
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2.2 Liability v equity
The classification of a financial instrument as a liability or as equity depends on:
• The substance of the contractual arrangement on initial recognition
• The definitions of a financial liability and an equity instrument
(IAS 32: para. 15)
The critical feature of a liability is an obligation to transfer economic benefit.
Solution
Although we may first think of shares as equity, in substance, redeemable preference shares meet
the definition of a financial liability as they contain an obligation to pay a fixed amount of interest
and are redeemable at a fixed future date. Accordingly, the redeemable shares will be reported
under non-current liabilities in the statement of financial position (unless they are repayable
within one year, in which case they are considered to be current liabilities).
Compound instrument
Eg convertible debt
IAS 32 requires the component parts of the compound instrument, ie the liability element and the
equity element, to be classified separately. (IAS 32: para. 28)
The following method should be used to initially measure the liability and equity elements:
Rathbone Co issues 2,000 convertible bonds at the start of 20X2. The bonds have a three-year
term, and are issued at par with a face value of $1,000 per bond, giving total proceeds of
$2,000,000. Interest is payable annually in arrears at a nominal annual interest rate of 6%. Each
bond is convertible into 250 ordinary shares.
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The carrying amount of the liability element of the compound instrument can be measured based
on an interest rate of 9%, which is the prevailing market interest rate for similar debt without
conversion options.
Relevant discount rates:
• Present value of 9% interest rate after 3 years is 0.772
• Cumulative present value of 9% interest rate after 3 years is 2.531
Required
Calculate the carrying amount of the liability and equity components of the bond.
Solution
Essential reading
Chapter 11, Section 1 of the Essential reading provides more detail and a further activity relating
to compound financial instruments.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
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3 Recognition and derecognition
3.1 Recognition
A financial asset or financial liability should be initially recognised in the statement of financial
position when the reporting entity becomes a party to the contractual provisions of the
instrument. (IFRS 9: para. 3.1.1)
In practical terms, this usually means:
Shares On issue
3.2 Derecognition
A financial instrument should be derecognised as follows:
You need to apply the principles of derecognition only in respect of the factoring of trade
receivables.
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The transaction is in substance a
genuine sale of the debts for less than Trade receivable
market price, with the entity retaining no is derecognised
continuing interest in the debts
Freddo Co sold its trade receivables balance of $300,000 to a debt factor for $270,000 on 1 July
20X1.
The factor charges interest of 5% per annum on amounts advanced.
The factor collected $150,000 of the amounts due on 31 December 20X1. No other amounts were
collected in 20X1, but the amounts due are still considered recoverable.
Under the terms of the agreement, any unpaid debts will be returned to Freddo Co for a cash
repayment on 1 July 20X2.
Required
Explain how Freddo should account for the debt factoring arrangement as at 31 December 20X2.
Solution
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4 Measurement
The following definitions are important for measurement:
Amortised cost: The amount at which the financial asset (financial liability) is measured at
KEY
TERM initial recognition, minus the principal repayments, plus (minus) the cumulative amortisation
using the effective interest.
Effective interest rate: The rate that exactly discounts estimated future cash receipts
(payments) through the expected life of the financial asset (financial liability) to the gross
carrying amount of a financial asset (amortised cost of a financial liability).
(IFRS 9: Appendix A)
(b) Held to collect Fair value + transaction Fair value through other
contractual cash flows and costs comprehensive income (with
to sell; and cash flows are reclassification to P/L on
solely principal and interest derecognition)
NB: interest revenue
calculated on amortised
cost basis recognised in P/L
3 All other financial assets Fair value (transaction costs Fair value through profit or
(eg derivate financial assets expensed in P/L) loss
not covered further in ACCA
Financial Reporting)
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Exam focus point
Applying the business model test, the entity’s intention to hold the financial instrument to
collect the contractual cash flows is most common in exam scenarios, as it allows the examiner
to test the principles of amortised cost accounting.
Essential reading
In the Essential reading, Chapter 11, Section 2 provides more detail on the business model test and
Chapter 11, Section 3 provides more detail on the contractual cash flow test.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
An entity holds an investment in shares in another company, which cost $45,000. At the date of
purchase the election was made to record changes in value in other comprehensive income for
this asset. At the year end, their value has risen to $49,000.
Required
How should the increase in value be accounted for?
Solution
The following adjustment would need to be made in an accounts preparation question:
The amount presented in other comprehensive income is NOT subsequently recycled to profit or
loss. If the shares were held at fair value through profit or loss, the gain would be reported in profit
or loss.
In either case, dividends received on the share are reported as income.
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Activity 3: Financial assets at fair value
Grafton Co’s draft statement of financial position as at 31 March 20X8 shows financial assets at
fair value through profit or loss with a carrying amount of $9.5 million as at 1 April 20X7.
These financial assets are held in a fund whose value changes directly in proportion to a specified
market index. At 1 April 20X7, the relevant index was 1,100 and at 31 March 20X8, it was 1,187.
Required
What amount of gain or loss should be recognised at 31 March 20X8 in respect of these assets?
$827,000 gain
$751,000 gain
$1,000,000 loss
$827,000 loss
$ Accounting entries:
DEBIT (↑) Financial asset
CREDIT (↓) Cash
Balance b/d X (if initial recognition at start of year)
DEBIT (↑) Financial asset
Finance income (effective interest × b/d) X SPL CREDIT (↑) Finance income
DEBIT (↑) Cash
Interest received (coupon × par value) (X) CREDIT (↓) Financial asset
Balance c/d X SOFP
Zebidee Co purchases a deep discount bond with a par value of $500,000 on 1 January 20X1 for
proceeds of $440,000 with the intention of holding it until the redemption value is received.
Annual coupon payments of 5% are payable on 31 December. Zebidee Co incurred transaction
costs of $5,867. The bond will be redeemed on 31 December 20X3 at par.
The effective interest rate on the bond has been calculated at 9.3%.
Required
What is the interest income in the profit or loss for the year ended 31 December 20X2?
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Solution
1
$ $ $
Cash received
c/d at 31 December
Essential reading
Chapter 11, Section 4 of the Essential reading provides further activities relating to the
measurement of amortised cost financial assets.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
2 Financial liabilities at fair Fair value (transaction costs Fair value through profit or
value through profit or loss expensed in P/L) loss
• ‘Held for trading’ (short-
term profit making)
• Derivatives that are
liabilities
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4.2.1 Financial liabilities at amortised cost
The amortised cost approach for a financial liability is consistent with that for a financial asset:
Dire Co issued 3,000 convertible bonds at par on 1 January 20X1. The bonds are redeemable on
31 December 20X4 at their par value of $100 per bond.
The bonds pay interest annually in arrears at an interest rate (based on nominal value) of 5%.
Each bond can be converted at the maturity date into five $1 shares.
The prevailing market interest rate for four-year bonds that have no right of conversion is 8%.
The present value at 8% of $1 receivable at end of each year is as follows:
Year 1 0.926
Year 2 0.857
Year 3 0.794
Year 4 0.735
Required
Show the accounting treatment of the:
Note. The examining team has stated that they will not test the treatment of the equity
component after inception.
1 Bond at inception
2 Finance cost for the year ended 31 December 20X1 and financial liability component at 31
December 20X1 using amortised cost
Solution
1
1 Bond at inception:
At 1 January 20X1 $
Non-current liabilities
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Working
Financial liability component
2 Finance cost:
At 31 December 20X1 $
Non-current liabilities
Working
Amortised cost financial liability
Essential reading
Chapter 11, Section 5 of the Essential reading includes detail on the disclosure requirements of
IFRS 7.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
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Chapter summary
Financial instruments
• When entity becomes party to • Financial assets – rights to • In substance a genuine sale
contractual provisions of the cashflows expire or – Derecognise trade receivable
instrument • Substantially all risks and • In substance a secured loan
• Usually: rewards transferred – Continue to recognise a
– Trade receivable/payable • Financial liabilities – trade receivable and
◦ On transfer of promised discharged, cancelled, expires recognise a financial liability
goods/services
– Loans
◦ On issue
– Shares
◦ On issue
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Measurement
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Knowledge diagnostic
2. Classifications
Financial assets are cash, the right to receive cash under a contract or derivative assets. Similarly,
financial liabilities are an obligation to deliver cash under a contract or derivative liabilities.
Financial instruments are classified in accordance with their substance. Redeemable preference
shares are, in substance, debt and are shown as a non-current liability in the statement of
financial position.
Compound instruments must be split into its financial liability and equity components. This is
done by measuring the financial liability (debt) component, first by discounting the debt’s cash
flows, and then assigning the residual cash received to the equity component.
4. Measurement
Financial assets are measured depending upon their classification.
Financial assets that are investments in debt instruments held for the purpose of collecting cash
flows that are solely interest and principal cash flows are held at amortised cost.
Investments in debt instruments held to collect cash flows that are solely payments of principals
and interest and the intention is to sell the instrument are accounted for at fair value through
other comprehensive income (FVTOCI) with no reclassification to profit or loss.
All other financial instruments (including all derivatives) are held at fair value through profit or loss
(FVTPL). An exception is permitted for investments in equity instruments of another entity (eg an
investment in shares) that are not held for trading which can be accounted for as FVTOCI with
reclassification to profit or loss if an election is made to use that treatment at the original date of
purchase.
Most financial liabilities are accounted for as amortised cost.
Financial liabilities held for trading are accounted for as FVTPL.
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Further study guidance
Question practice
Now try the following from the Further question practice bank (available in the digital edition of
the Workbook):
18 Financial assets and liabilities
Further reading
There is a useful article regarding this subject on the ACCA website:
Financial Instruments
www.accaglobal.com
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Activity answers
£
Step 1: Calculate the value of the whole instrument 2,000,000
Step 2: Calculate the carrying amount of the liability element (which is the
present value of the future cash flows discounted using the 9% interest
rate for equivalent bonds without conversion rights)
1,544,000
PV of the principal ($2m × 0.772) 303,720
PV of the interest ($120,000* × 2.531) 1,847,720
Step 3:
Calculate the residual value of the equity component
(balancing figure) 152,280
$’000
$9,500 × 1,187/1,100 10,251
Carrying amount (9,500)
Gain 751
$ $ $
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DEBIT Financial asset 445,867
CREDIT Cash 445,867
1 Bond at inception:
At 1 January 20X1 $
Non-current liabilities
Working
Financial liability component
49,680
270,180
2
2 Finance cost:
At 31 December 20X1 $
Non-current liabilities
Working
Amortised cost financial liability
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1.1.X1 Liability b/d 270,180
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Leasing
12
12
Learning objectives
On completion of this chapter, you should be able to:
Explain the exemption from the recognition criteria for leases in B6(b)
the records of the lessee.
Exam context
Leasing is an important area both in the Financial Reporting exam and in the wider business
context., You will be considering leasing from the perspective of the lessee only for your FR exam.
It is vital that you understand how to account for right of use assets and lease liabilities before
going on to account for sale and leasebacks. Question practice is key in order to consolidate your
knowledge and application in this important topic.
Leasing questions could be asked in any section of the FR exam. In Section C questions, you
should be prepared to see leasing as an adjustment in a single entity accounts preparation
question or you may be asked to comment on the impact of leasing as opposed to the outright
purchase of assets as part of an interpretation of financial statements question.
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Chapter overview
Leases (IFRS 16)
Definitions
Right-of-use asset
Transfer is NOT in
substance a sale
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1 Issue
1.1 Objective
Under IFRS 16 Leases, lessees must recognise a right of use asset and a lease liability for all
leases with a term of more than 12 months, unless the underlying asset is of low value. IFRS 16
was developed in response to criticism of the previous standard which required lease agreements
meeting certain criteria to be accounted for as expenses in profit or loss. The leased asset and
lease liability were not presented in the statement of financial position, which did not represent
the underlying reality of the agreement.
2 Identifying a lease
2.1 Definitions
Lease: A contract is, or contains, a lease if there is an identifiable asset and the contract
KEY
TERM conveys the right to control the use of the identified asset for a period of time in exchange for
consideration (IFRS 16: para. 9).
Underlying asset: An asset that is the subject of a lease, for which the right to use that asset
has been provided by a lessor to a lessee (IFRS 16: Appendix A).
The contract has to meet the definition of a lease contract to be within the scope of IFRS 16. A
lessee does not control the use of an identified asset if the lessor can substitute the underlying
asset for another asset during the lease term and would benefit economically from doing so.
Some contracts may contain elements that are not leases, such as service contracts. These must
be separated out from the lease and accounted for separately (IFRS 16: para. 13).
Entity must have the • Stated in the contract • Period of use in time or
right to: • May be part of a larger in units produced
• Obtain substantially all asset • Lease may only be for
economic benefits from • The lessor has no a portion of the term
the use of the asset; and substitution rights (a of the contract (if the
• Direct the use of the similar asset cannot be right to control the
asset used instead of the asset exists for part of
original leased asset) the term)
Coketown Council has entered into a five-year contract with Carefleet Co, under which Carefleet
Co supplies the council with ten vehicles for the purposes of community transport. Carefleet Co
owns the relevant vehicle, all ten of which are specified in the contract. Coketown Council
determines the routes taken for community transport and the charges and eligibility for discounts.
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The council can choose to use the vehicles for purposes other than community transport. When
the vehicles are not being used, they are kept at the council’s offices and cannot be retrieved by
Carefleet Co, unless Coketown Council defaults on payment. If a vehicle needs to be serviced or
repaired, Carefleet Co is obliged to provide a temporary replacement vehicle of the same type.
Required
Explain whether this contract contains a lease under the definition of IFRS 16?
Solution
This is a lease. There is an identifiable asset, the ten vehicles specified in the contract. The council
has a right to use the vehicles for the period of the contract. Carefleet Co does not have the right
to substitute any of the vehicles unless they are being serviced or repaired. Therefore, Coketown
Council would need to recognise a right-of-use asset and a lease liability in its statement of
financial position.
Activity 1: Is it a lease?
Outandabout Co provides tours around places of interest in the tourist city of Sightsee. While
these tours are mainly within the city, it does the occasional day trip to visit tourist sites further
away. Outandabout Co has entered into a three-year contract with Fastcoach Co for the use of
one of its coaches for this purpose. The coach must seat 50 people, but Fastcoach Co can use
any of its 50-seater coaches when required.
Required
Explain whether this agreement constitutes a lease.
Solution
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3 Lease liability
3.1 Initial measurement of the lease liability
On commencement of the lease, the lease liability is measured at the present value of future
lease payments, including any expected payments at the end of the lease, discounted at the
interest rate implicit in the lease (IFRS 16, para. 26).
If that rate cannot be readily determined, use the lessee’s incremental borrowing rate.
The rate will be given to you in your exam.
Note. The present value of future lease payments excludes any payments made on or before
commencement of the lease. Any deposits paid to secure the lease, or instalments paid in
advance on the first day of the lease, are not, by definition, future payments and should not be
included.
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Payments in arrears
$
1.1.X1 Lease liability (PVFLP) X
1.1.X1-31.12.X1 Interest at X% X
31.12.X1 Instalment in arrears (X)
31.12.X1 Liability c/d X
1.1.X2–31.12.X2 Interest at x% X
31.12.X2 Instalment in arrears (X)
31.12.X2 Liability > 1 year X
The current liability at 31.12.X1 is calculated as the difference between the liability at 31.12.X1 and
the liability at 31.12.X2.
Alternatively, if payments are made in advance, there will be no lease payment in the first period
and interest is simply applied to the PVFLP on initial recognition of the liability. In subsequent
periods, interest is calculated after deducting the instalment payment as follows:
Payments in advance
$
1.1.X1 Lease liability (PVFLP) X
1.1.X1–31.12.X1 Interest at x% X*
31.12.X1 Liability c/d X
Instalment in advance
1.1.X2 (current liability) (X)
Bento Co enters into a contract to gain the right to use an asset from 1 January 20X1. The
contract meets the definition of a lease under IFRS 16. The terms of the lease require Bento Co to
pay a non-refundable deposit of $575 followed by seven annual instalments of $2,000 payable in
arrears. The present value of the future lease payments on 1 January 20X1 is $10,000.
The interest rate implicit in the lease is 9.2%.
Required
1 What is the interest charge in the statement of profit or loss of Bento Co for the year ended 31
December 20X1?
$
2 What are the current and non-current liability balances included in the statement of financial
position of Bento Co as at 31 December 20X1?
Current liability $1,179; Non-current liability $7,741
Current liability $Nil; Non-current liability $8,920
Current liability $2,000; Non-current liability $6,920
Current liability $Nil; Non-current liability $7,741
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4 Right-of-use asset
Right-of-use asset: An asset that represents a lessee’s right-to-use an underlying asset for the
KEY
TERM lease term.
The key is the right to control the use of the asset. The right to control the use of an identified
asset depends on the lessee having:
(a) The right to obtain substantially all of the economic benefits from use of the identified asset;
and
(b) The right to direct the use of the identified asset. This arises if either:
(i) The customer has the right to direct how and for what purpose the asset is used during
the whole of its period of use; or
(ii) The relevant decisions about use are predetermined and the customer can operate the
asset without the supplier having the right to change those operating instructions, or the
customer designed the asset in a way that predetermines how and for what purpose the
asset will be used throughout the period of use.
$m $m
Initial measurement of lease liability X
Payments made before or at commencement of lease X
Less incentives received (X)
X
Initial direct costs X
PV of costs of dismantling, removing and restoring the site X
Right-of-use asset X
At the commencement date, recognise a right-of-use asset, representing the right to use the
underlying asset and a lease liability representing the company’s obligation to make lease
payments
DEBIT Depreciation X
CREDIT Right-of-use asset (accumulated depreciation) (SOFP) X
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(a) The useful life of the asset, if ownership transfers at the end of the lease term, or if the lessee
has a purchase option and is likely to exercise it; or
(b) If there is no transfer of ownership or purchase option, the shorter of the lease term and the
useful life of the asset.
The depreciation rate should be consistent with other non-current assets in the same class, to
ensure a consistent accounting policy.
Revaluation model
If a lessee applies the IAS 16 Property, Plant and Equipment revaluation model to a certain class of
property, plant and equipment, then the lessee can choose to also apply the revaluation model to
right-of-use assets that relate to that same class of property, plant and equipment (IFRS 16: para.
35).
If the revaluation model has been adopted for the same type of class of non-current asset, and
the entity must therefore apply the same accounting policy to the right-of-use asset. Impairment
reviews will be required in accordance with IAS 36 Impairment of Assets.
Investment property
If the type of asset meets the criteria of an investment property, then the fair value model under
IAS 40 Investment Property must be adopted.
5 Presentation
5.1 Statement of financial position
Right-of-use assets
Right-of-use assets should be disclosed separately from other assets, either as a separate line on
the statement of financial position or separately within the notes.
Right-of-use assets which qualify as investment property are an exception; they should be
presented within investment property in the statement of financial position.
Lease liabilities
Lease liabilities should be disclosed separately from other liabilities, either in the statement of
financial position or in the notes.
The balance remaining at the year-end needs to be split between current liabilities and non-
current liabilities. (IFRS 16 does not require this but this should be in accordance with IAS 1
Presentation of Financial Statements.)
Non-current liabilities
Lease liabilities X
Current liabilities
Lease liabilities X
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5.3 Disclosures
IFRS 16 requires information about a company’s leases to be disclosed in a separate note and
include:
$
Interest expense on lease liabilities X
Activity 3: Alpha Co
Alpha Co makes up its accounts to 31 December each year. It enters an agreement, which meets
the definition of a lease under IFRS 16, for the right to use an item of equipment with the following
terms:
Required
1 What is the carrying amount of the right-of-use asset in the statement of financial position of
Alpha Co as at 31 December 20X1?
$8,000
$6,460
$6,000
$8,075
2 What is the non-current liability balance in the statement of financial position as at 31
December 20X1?
$4,075
$4,804
$6,804
$6,075
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6 Recognition exemptions
6.1 Which leases are exempt?
IFRS 16 provides optional exemptions from applying the full requirements of IFRS 16 on the
following types of lease:
(a) Short-term leases. These are leases with a lease term of 12 months or less. This election is
made by class of underlying asset. A lease that contains a purchase option cannot be a
short-term lease.
(b) Leases of assets with a low underlying value (low value leases). These are leases where the
underlying asset has a low value when new (such as tablet and personal computers or small
items of office furniture and telephones). This election can be made on a lease-by-lease
basis. An underlying asset qualifies as low value only if two conditions apply:
(i) The lessee can benefit from using the underlying asset.
(ii) The underlying asset is not highly dependent on, or highly interrelated with, other assets.
An entity must elect to utilise the exemption. The election for low value leases can be made on a
lease-be-lease basis, but the election for short-term leases is made by class of underlying assets.
Activity 4: Oscar Co
Oscar Co is preparing its financial statements for the year ended 30 June 20X6. On 1 May 20X6,
Oscar made a payment of $32,000 for an eight-month lease of a milling machine. Oscar has
elected to utilise any lease exemptions available.
Required
What amount would be charged to Oscar Co’s statement of profit or loss for the year ended 30
June 20X6 in respect of this transaction?
Solution
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7 Sale and leaseback transactions
7.1 Issue
A sale and leaseback transaction involves the sale of an asset and the leasing back of the same
asset. The key question in determining the accounting treatment is: does the transaction
constitute a sale? This is determined by considering when the performance obligation is satisfied
in accordance with IFRS 15 Revenue from Contracts with Customers.
The discounted future lease payments are calculated as for any other lease.
Recognise only the amount of any gain or loss on the sale that relates to the rights transferred to
the buyer/lessor. The gain or loss that can be recognised is calculated in three stages:
Stage 1: Calculate total gain = fair value ( = proceeds) less carrying amount
The right-of-use asset continues to be depreciated as normal, although a revision of its remaining
useful life may be necessary to restrict it to the lease term.
Note. In the FR exam you will only be tested on situations in which the proceeds on the sale of the
asset are equal to the fair value of the asset at the date of sale.
Activity 5: Wigton Co
On 1 April 20X2, Wigton Co bought an injection moulding machine for $600,000. The carrying
amount of the machine as at 31 March 20X3 was $500,000. On 1 April 20X3, Wigton Co sold it to
Whitehaven Co for $740,000, its fair value. Wigton Co immediately leased the machine back for
five years, the remainder of its useful life, at $160,000 per annum payable in arrears. The present
value of the future lease payments is $700,000 and the transaction satisfies the IFRS 15 criteria to
be recognised as a sale.
Required
What gain should Wigton Co recognise for the year ended 31 March 20X4 as a result of the sale
and leaseback?
$227,027
$240,000
$12,973
$40,000
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Activity 6: Capital Co
Capital Co entered into a sale and leaseback on 1 April 20X7. It sold a lathe with a carrying
amount of $300,000 for $400,000 (equivalent to fair value) and leased it back over a five-year
period, equivalent to its remaining useful life. The transaction constitutes a sale in accordance
with IFRS 15.
The lease required Capital Co to make five annual payments in arrears of $90,000. The rate of
interest implicit in the lease is 5%. The cumulative value of $1 in five years’ time is $4.329.
Required
What are the amounts to be recognised in the financial statements at 31 March 20X8 in respect of
the sale and leaseback transaction?
Solution
Essential reading
In Chapter 12 of the Essential reading there is additional examples relating to sale and leaseback
transactions.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
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Chapter summary
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Sale and leaseback transactions
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Knowledge diagnostic
1. Issue
• Lessee accounting is an example of the application of the substance over form concept.
• The asset is recognised in the books of the entity that controls it, even though that asset may
never be owned by the entity.
2. Leases
• A contract, or part of a contract, that conveys the right to use an asset, the underlying asset,
for a period of time in exchange for consideration.
• Lessees must recognise assets and liabilities for all leases with a term of more than 12 months,
unless the underlying asset is of low value.
3. Recognition exemptions
• For short-term leases or leases of low value assets, the lease payments are simply charged to
profit or loss as an expense.
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Further study guidance
Question practice
Now try the following from the Further question practice bank (available in the digital edition of
the Workbook):
24 Bulwell Aggregates Co
25 Lis Co
Further reading
There are articles in the Exam Resources section of the ACCA website which are relevant to the
topics covered in this chapter and would be useful to read:
IFRS 16 Leases
www.accaglobal.com
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Activity answers
Activity 1: Is it a lease?
This is not a lease. There is no identifiable asset. Fastcoach Co can substitute one coach for
another, and would derive economic benefits from doing so in terms of convenience. Therefore,
Outandabout Co should account for the rental payments as an expense in the statement of profit
or loss.
1 $ 920
$
1.1.X1 Liability b/d 10,000
1.1.X1–31.12.X1 Interest at 9.2% 920
31.12.X1 Instalment 1 (in arrears) (2,000)
31.12.X1 Liability c/d 8,920
2 The correct answer is: Current liability $1,179; Non-current liability $7,741
$
1.1.X1 Liability b/d 10,000
1.1.X1–31.12.X1 Interest at 9.2% 920
31.12.X1 Instalment 1 (in arrears) (2,000)
31.12.X1 Liability c/d 8,920
1.1.X2–31.12.X2 Interest at 9.2% 821
31.12.X2 Instalment 2 (in arrears) (2,000)
Liability c/d (payable > 1
31.12.X2 year) 7,741
Activity 3: Alpha Co
1 The correct answer is: $6,460
RIGHT-OF-USE ASSET
$
Initial measurement of lease liability 6,075
Payments made before or at commencement of lease 2,000
Right-of-use asset 8,075
Depreciation charge = $8,075/5 = $1,615 (depreciate over shorter of useful life or lease term)
Carrying amount = $8,075 – $1,615 = $6,460
2 The correct answer is: $4,804
STATEMENT OF FINANCIAL POSITION (EXTRACT)
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$
Non-current assets
Right-of-use asset (8,075 – 1,615) 6,460
Current liabilities
Lease liability 2,000
Non-current liabilities
Lease liability (W) 4,804
Working
$
1.1.X1 Liability b/d 6,075
1.1.X1-31.12.X1 Interest at 12% 729
31.12.X1 Liability c/d 6,804
1.1.X2 Instalment 2 (in advance) – current liability (2,000)
1.1.X2 Non-current liability 4,804
Activity 4: Oscar Co
The lease is for eight months, which counts as a short-term lease, and so it does not need to be
recognised in the statement of financial position. The amount charged to profit or loss for the year
ended 30 June 20X6 is therefore $32,000 × 2/8 = $8,000.
Activity 5: Wigton Co
The correct answer is: $12,973
Step 1 Gain on sale: $740,000 – $500,000 = $240,000
Step 2 Gain relating to rights retained = $(240,000 × 700,000/740,000) = $227,027
Step 3 Gain relating to rights transferred = $240,000 – $227,027 = $12,973
Activity 6: Capital Co
$
Statement of profit or loss
Gain on transfer (W3) 2,598
Depreciation (W2) (58,442)
Interest (W1) (19,480)
Non-current liabilities
Lease liability (W1) 245,044
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$
Current liabilities
Lease liability (W1) 74,046
Workings
1 Lease liability
$
Lease liability (present value of future lease payments)
1.4.X7 ($90,000 × $4.329 = $389,610) 389,610
1.4.X7 – 31.3.X8 Interest at 5% 19,480
31.3.X8 Instalment paid in arrears (90,000)
31.3.X8 Liability carried down 319,090
1.4.X8 – 31.3.X9 Interest at 5% 15,954
31.3.X9 Instalment paid in arrears (90,000)
31.3.X9 Liability due in more than 1 year 245,044
Current liabilities of $74,046 ($319,090 - 245,044) reflect the amount of the lease liability that
will become due within 12 months.
2 Right of use asset
$
Right of use asset at commencement date
= carrying amount × PVFLP/fair value
= 300,000 × 389,610/400,000 292,208
Depreciation (over 5 years) (58,442)
Carrying amount at 31.3.X8 233,766
= $400,000 – $300,000
= $100,000
= $(100,000 × 389,610/400,000)
= $97,402
Stage 3: Gain relating to the rights = Total gain (Stage 1) – gain on rights
transferred retained (Stage 2)
= $100,000 – $97,402
= $2,598
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Skills checkpoint 4
Application of accounting
standards
Chapter overview
cess skills
Exam suc
Answer planning
c FR skills C
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tio
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Approach to Application
reta
agi
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Spreadsheet Interpretation
Go od
skills skills
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Approach
em
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OTQs
an
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Effi
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a nd p r
esentation
Introduction
FR introduces a number of IFRS Standards and tests further understanding of those already
covered in your earlier studies (for example, IAS 2 Inventories and IAS 16 Property, Plant and
Equipment).
It is important that you understand how the IFRS Standards that are covered in the FR exam
apply to financial statements, not just gaining the knowledge of what they are and how they
work, but also developing your application skills. These application skills will be further developed
in SBR, so it is vitally important that you gain a confident knowledge of the main IFRS Standards
in your FR studies.
Knowledge of the IFRS Standards will be required in all sections of the FR exam. You may be asked
to identify the key requirements of an IFRS Standard in a knowledge based narrative question and
are likely to be asked questions about the application or impact of IFRS Standards in an OTQ.
Knowledge of the requirements of IFRS Standards is essential when preparing financial statements
and may be relevant in the interpretation of an entity’s performance and position in Section C.
The key to success in the FR exam is:
• Understanding the key elements of the IFRS Standards; and
• Applying your knowledge of these IFRS Standards.
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Skill activity
STEP 1 Ensure you have a high-level overview of the key IFRS Standards covered in the FR exam. Use the summary
diagrams at the end of the chapters in the Workbook to act as your summaries. These are a useful way of
remembering the key points.
It is important that you have the knowledge of the mechanics of the standard. One way of doing
this is by using the chapter summaries in the Workbook which summarise the key points about the
standards discussed. IAS 8 is discussed in Chapter 17 of the Workbook, and here is an extract of
the summary diagram.
Disclosure
• Nature of the change
• Quantify the effect of the
change
Ensure that you are familiar with IAS 8, and understand the key points made in the summary. This
will act, initially, as your main reference for applying the accounting treatment. Once you have
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gained additional question practice, you will be familiar with different question styles and
different scenarios.
STEP 2 Practice the numerical questions in the workbook and in the BPP Practice and Revision Kit. These will test
your knowledge of the mechanics of the accounting standards. Often there can be a difference between
understanding what the standard does and how it applies to a specific scenario. Practice OTQs as well as
longer Section C questions to consolidate your knowledge.
Question practice is key to success in your FR exam. Practising the OTQ style questions are a
relatively quick way of testing your knowledge, both of narrative and numerical questions.
However, having knowledge of the theory of the standard and applying that knowledge can often
cause problems for candidates, especially in the more complex standards such as IFRS 16 Leases.
STEP 3 Practice the narrative questions which test your understanding of how the standard can affect the financial
statements. This will help you to revise your understanding of why the IFRS Standard is important in a
scenario, for example, what are the key tests for impairment of assets and why would this be important for
the financial statements?
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Answering this question required you to understand IAS
8, but also the underlying accounting standards
relating to IAS 2, IAS 16 and to a lesser extent IAS 23.
Correct interpretation of Make sure you have answered the question by referring to the
requirements given information. As mentioned above, this question hinged
on you understanding that you should focus on accounting
policies and not the whole of IAS 8.
Efficient numerical analysis There was not any numerical analysis in this narrative
question. Remember that FR is not all about getting the
numbers right. Expect a range of numerical and narrative
questions in the exam.
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Exam success skills Your reflections/observations
Effective writing and In an OTQ, you don’t need to worry about writing and
presentation presentation. However, consider how you might discuss the
impact of the change in accounting policy in an interpretation
question in Section C.
Most important action points to apply to your next question – work through each of the
alternative answers carefully as the differences between the options are often subtle.
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Provisions and events
13 after the reporting
period
13
Learning objectives
On completion of this chapter, you should be able to:
Syllabus reference
no.
State when provisions may and may not be made and demonstrate how B7(c)
they should be accounted for.
Define contingent assets and liabilities and describe their accounting B7(e)
treatment and required disclosures.
Exam context
You will already have covered the basic aspects of IAS 37 Provisions, Contingent Liabilities and
Contingent Assets, in your earlier studies. The FR exam builds on this knowledge by looking at the
need for discounting certain provisions and by considering in detail some specific transactions.
IAS 10 Events After the Reporting Period is also revisited. You need to be able to review financial
statements and correct for errors and omissions which occur after the reporting date. The exam
will test your application of IAS 37 and IAS 10 within both objective test and as part of longer
(Section C) questions. If you require revision from your earlier studies, review the activities and
information in the Essential reading section.
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Chapter overview
Provisions and events after the reporting period
Measurement Restructuring
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1 Provisions (IAS 37 Provisions, Contingent Liabilities and
Contingent Assets)
You were introduced to IAS 37 Provisions, Contingent Liabilities and Contingent Assets in your
earlier studies, so some of this section will be revision. In FR, provisions become more complex and
you need to be aware of the requirements of IAS 37 for specific types of provision. The complexity
of provisions is greater at FR as discounting is also introduced to reflect the time value of money
for amounts to be settled in the future.
Essential reading
Provision: A provision is a liability of uncertain timing or amount. (IAS 37: para. 10)
KEY
TERM
Recognition
(a) A provision shall be recognised when: an entity has a present obligation (legal or constructive)
as a result of a past event, it is probable that an outflow of resources embodying economic
benefits will be required to settle obligation, and a reliable estimate can be made of the
amount of the obligation.
(IAS 37: para. 14)
Unless all of these conditions are met, no provision can be recognised.
(b) Provisions are reviewed each year and adjusted to reflect current best estimate. If it is no
longer probable that an outflow of resources embodying economic benefits will be required,
the provision is reversed.
Present obligations and obligating events
(c) A past event which leads to a present obligation is called an obligating event. For an event to
be an obligating event, it is necessary that the entity has ‘no realistic alternative to settling
that obligation’ created by the event (IAS 37: para. 17).
(d) In rare cases, it is not clear whether there is a present obligation. In these cases, a past event
is deemed to give rise to a present obligation if, taking into account all available evidence, it is
more likely than not that a present obligation exists at the end of the reporting period.
Legal and constructive obligations
(e) An obligation can either be legal or constructive.
(f) A legal obligation is one that derives from a contract, legislation or any other operation of
law.
(g) A constructive obligation is an obligation that derives from the actions of an entity where:
(i) From an established pattern of past practice, published policies or a specific statement,
the entity has indicated to other parties that it will accept certain responsibilities; and
(ii) As a result, the entity has created a valid expectation in other parties that it will
discharge those responsibilities. (IAS 37: para. 10)
Measurement
(h) The amount recognised as a provision is the best estimate of the expenditure required to
settle the obligation at the end of the reporting period.
Provisions are discounted where the effect of discounting (time value of money) is material.
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Activity 1: Discounting the provision
Cambridge Co is preparing its financial statements for the year ended 31 December 20X.
Cambridge Co was informed on 31 December 20X4 that, due to a change in environmental
legislation, it will be required to pay environmental clean-up costs of $5 million on 31 December
20X9.
The relevant discount rate in this case is 10%.
The discounted values of $1 are as follows:
$1 in five years = $0.621
Required
1 Calculate the provision required for the year ended 31 December 20X4.
2 Calculate the provision required for the year ended 31 December 20X6.
Solution
Essential reading
The Essential reading has an example showing the double entry and full explanation of unwinding
of a discount, looking in depth at the impact on the financial statements.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
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Uncertainties
If the provision involves a large population of items:
• Use expected values, taking into account the probability of all expected outcomes.
If a single obligation is being measured:
• The individual most likely outcome may be the best evidence of the liability.
2 Types of provision
FR develops your application of knowledge gained in your earlier studies as well as introducing
more complex ideas. You need to be aware of the specific requirements relating to the following:
2.1 Warranties
Warranties are argued to be genuine provisions based on past experience that it is probable, ie
more likely than not, that some claims will emerge.
Due to the developments in IFRS 15, Revenue from Contracts with Customers, the nature of how
the liability has arisen should be taken into account regarding its accounting treatment. You
should consider whether:
• There is a legal obligation, such as all goods being purchased online may be returned within
14 days for a full refund under the Consumer Contracts Regulations; or
• There is a constructive obligation, such as the store has historically allowed a 12 month, ‘no
quibble’ return guarantee.
Then the entity should make the provision under IAS 37.
Warranties that the customer pays for separately (extended warranties, such as for white goods)
are covered by IFRS 15 Revenue from Contracts with Customers (see Chapter 6). This is due there
being a contract between the customer and the supplier in exchange for a separable component
(a performance obligation).
The nature of the warranty granted will determine whether the warranty should be accounted for
under IAS 37 or IFRS 15.
Activity 2: Warranties
Warren Co gives warranties, at no additional cost, to its customers. There is no legal requirement
to repair or replace these items after 28 days, but Warren Co promises, on its website, to make
good, by repair or replacement, manufacturing defects that become apparent within a period of
one year from the date of the sale. Warren Co has replaced between 4% and 6% of total sales of
the product in the past five years.
Required
Which of the following statements about the above scenario is correct?
Warren Co is not required to make a provision because there is no legal obligation to
undertake the repair work.
Warren Co has an obligation to repair or replace all items of product that show
manufacturing defects, therefore a provision for the cost of this should be made.
Warren Co has an obligation to repair or replace all items that show manufacturing defects,
however, as the amount cannot be reliably estimated, no provision is required.
Warren Co must make a provision under IAS 37 because this is a potential future operating
loss.
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decommissioning costs are legally required. If the provision relates to an asset, then it can be
capitalised as part of the cost of the asset. The decommissioning or other environmental costs
often occur many years in the future, and so the future cost should be discounted to present
value.
For example, when an oil company initially purchases an oilfield it is put under a legal obligation
to decommission the site at the end of its life.
IAS 37 considers that a legal obligation exists on the initial expenditure on the field and therefore
the provision should be recognised immediately. The view is taken that the cost of purchasing the
field in the first place is not only the cost of the field itself but also the costs of putting it right
again. Thus, the costs of decommissioning may be capitalised.
The costs have not yet been expensed in the statement of profit or loss. Instead, the costs are
released to the profit or loss account by depreciating the asset (and the capitalised provision).
Subsequent double entries would be:
This will expense the cost of the provision over the period, such as a refurbishment required in five
years’ time, depreciation expensed over five years.
Once the provision is required in the final year, the accounting entries will be:
DEBIT Provision
CREDIT Cash
Petrolleo Co built an oil rig at a cost of $80 million. The oil rig came into operation on 1 January
20X2. The operating licence is for 20 years from 1 January 20X2, after which time Petrolleo Co is
obliged to dismantle the oil rig and dispose of the parts in an environmentally friendly way. At 1
January 20X2, the cost of dismantling was estimated at $10 million.
An appropriate discount rate is 6%, when the present value of $1 is $0.312 in 20 years’ time.
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Required
1 Which of the following statements are TRUE?
A legal obligation to dismantle the rig exists from 1 January 20X2, therefore a provision
should be recognised at that date and expensed through the profit or loss immediately.
A legal obligation to dismantle the rig exists from 1 January 20X2, therefore a provision
should be recognised at that date and added to the cost of the asset.
A legal obligation accrues over the 20-year operating life of the asset, therefore the
provision should be accrued over the period.
No obligation exists until the rig is dismantled and thus no provision is required.
2 What is the value of the provision in the statement of financial position at 31 December 20X2?
Nil
$500,000
$3,118,000
$3,307,000
3 What is the carrying amount of the oil rig asset at 31 December 20X2?
$76 million
$78.964 million
$83.118 million
$85.5 million
Onerous contracts: An onerous contract is a contract entered into with another party under
KEY
TERM which the unavoidable costs of fulfilling the terms of the contract exceed any revenues
expected to be received from the goods or services supplied or purchased directly or indirectly
under the contract and where the entity would have to compensate the other party if it did not
fulfil the terms of the contract (IAS 37: para. 68). An example might be a three-year contract to
make and supply a service to a third party. The seller can no longer provide the service, so it
becomes ‘onerous’, and the costs to the seller would be the costs of outsourcing the provision
of the service or any penalties for non-provision.
If an entity has a contract that is onerous, the present obligation under the contract should be
recognised as a provision (IAS 37: para. 66). The obligation is measured as:
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An amendment to IAS 37 was issued in 2020 which sought to clarify what constitutes the cost of
fulfilling the contract:
The cost of fulfilling a contract comprises the costs that relate directly to the contract. Costs that
relate directly to a contract consist of both:
(a) the incremental costs of fulfilling that contract—for example, direct labour and materials; and
(b) an allocation of other costs that relate directly to fulfilling contracts—for example, an
allocation of the depreciation charge for an item of property, plant and equipment used in
fulfilling that contract
(IAS 37, para. 68A)
You have a contract to buy 300 metres of silk from China Co each month for $9 per metre. From
each metre of silk, you make one silk shirt. You also incur labour and other direct variable costs of
$8 per shirt.
Usually you can sell each shirt for $22 but in late July 20X8 the market price falls to $14. You are
considering ceasing production since you think that the market may not improve. If you decide to
cancel the silk purchase contract without two months’ notice you must pay a cancellation penalty
of $1,200 for each of the next two months.
Required
What will appear in respect of the contract in your financial statements for the period ending 31
July 20X8?
$1,800
$2,400
$8,400
$10,200
The IAS gives the following examples of events that may fall under the definition of restructuring.
• The sale or termination of a line of business
• The closure of business locations in a country or region or the relocation of business activities
from one country region to another
• Changes in management structure, for example, the elimination of a layer of management
• Fundamental reorganisations that have a material effect on the nature and focus of the
entity’s operations (IAS 37: para. 70)
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Activity 5: Constructive obligation for business closure
On 12 December 20X1, the board of Shutdown Co decided to close down a division. The detailed
plan was agreed by the board on 20 December 20X1, and letters sent to notify customers. By the
year end of 31 December 20X1, the staff had received redundancy notices.
Required
Explain the appropriate accounting treatment for the closure for the year ended 31 December
20X1.
Solution
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Activity 6: Provision or not?
In which TWO of the following circumstances would a provision be recognised in the year ended
31 December 20X8?
On 13 December 20X8, the board of an entity decided to close down a division. The decision
was not communicated to any of those affected and no other steps were taken to implement
the decision until 18 January 20X9.
The board agreed a detailed closure plan on 20 December 20X8 and details were given to
customers and employees.
The entity is obliged to incur clean-up costs for environmental damage caused as a result of
the construction of its factory.
The entity intends to carry out future expenditure to operate in a particular way in the future.
3 Contingent liabilities
3.1 Definition
Contingent liability:
KEY
TERM • A possible obligation that arises from past events and whose existence will be confirmed
only by the occurrence or non-occurrence of one or more uncertain future events not
wholly within the control of the entity; or
• A present obligation that arises from past events but is not recognised because:
- It is not probable that an outflow of resources embodying economic benefits will be
required to settle the obligation; or
- The amount of the obligation cannot be measured with sufficient reliability
(IAS 37: para. 10)
3.2 Recognition
Contingent liabilities should not be recognised in financial statements but they should be
disclosed (unless the possibly of the outflow of resources is remote) (IAS 37, para. 27).
Essential reading
See Chapter 13 Section 1.5 of the Essential reading for a decision tree summarising the recognition
criteria of IAS 37 for provisions and contingent liabilities.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
3.3 Disclosure
For each class of contingent liability, an entity must disclose at the end of the reporting period all
of the following:
(a) The nature of the contingent liability
(b) An estimate of its financial effect
(c) An indication of the uncertainties relating to the amount or timing of any outflow
(d) The possibility of any reimbursement (see illustration ‘Product recall’ later in the chapter for
an example of this).
(IAS 37: para. 86)
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The users of the financial statements need to be made aware of any potential impact on cash
flows of the company and any impacts on future profits, hence the reason for explaining the
nature, possible timing and amount of the financial impact.
4 Contingent assets
4.1 Definition
Contingent asset: A possible asset that arises from past events and whose existence will be
KEY
TERM confirmed by the occurrence or non-occurrence of one or more uncertain future events not
wholly within control of the entity. (IAS 37: para. 10)
• A contingent asset must not be recognised (IAS 37, para. 31).
• A contingent asset should only be disclosed when an inflow of economic benefits is
probable (IAS 37, para. 34).
• Only when the realisation of the related economic benefits is virtually certain should
recognition take place. At that point, the asset is no longer a contingent asset.
Solution
• There is a requirement for a provision at 31 December 20X5 as the obligating event was the
faulty Bimblebats which were manufactured prior to the year-end.
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• The supplier has taken responsibility and agree to reimburse Jackaboo Co. However, there is
doubt as to the exact amount that will be recovered, however probable that recovery may be.
Therefore, it will be recognised as a contingent asset.
During 20X0 Smack Co gives a guarantee of certain borrowings of Pony Co, whose financial
condition at that time is sound. During 20X1, the financial condition of Pony Co deteriorates and
at 30 June 20X1 Pony Co files for protection from its creditors.
Required
Explain the accounting treatment that is required:
1 At 31 December 20X0
2 At 31 December 20X1
Solution
4.4 Disclosure
The following must be disclosed in a note to the accounts:
(a) A brief description of the nature of the contingent asset at the end of the reporting period
(b) Where possible, an estimate of the financial effect
Although the contingent asset will not be included within the figures of the financial statements,
the user should be made aware of any potential impact on cash flows of the company and any
impacts on future profits.
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5 IAS 10 Events after the Reporting Period
This topic was covered in your earlier studies, so if you require a revision on the detail, please refer
to Chapter 13 of the Essential reading. In your FR exam, you are likely to come across IAS 10
questions either as an objective test question, or as part of an explanatory written question in
Section C. Making adjustments to existing draft financial statements or revising notes to the
financial statements should be expected in Section C longer questions, so ensure that you are
familiar with the difference between provisions and contingent liabilities or assets.
5.1 Definition
Events after the reporting period: Those events, both favourable and unfavourable, that occur
KEY
TERM between the end of the reporting period and the date when the financial statements are
authorised for issue.
5.2 Recognition
• Those that provide evidence of conditions that existed at the end of the reporting period –
adjusting
• Those that are indicative of conditions that arose after the reporting period – non-adjusting
(IAS 10: para. 3)
Essential reading
See Chapter 13, Section 4 of the Essential reading for revision on the main elements of IAS 10,
including a table which gives examples of adjusting and non-adjusting events.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
Activity 8: IAS 10
Which ONE of the following events taking place after the year-end but before the financial
statements were authorised for issue would require adjustment in accordance with IAS 10 Events
After the Reporting Period?
Three lines of inventory held at the year-end were destroyed by flooding in the warehouse.
The directors announced a major restructuring.
Two lines of inventory held at the year-end were discovered to have faults rendering them
unsaleable.
The value of the company’s investments fell sharply.
Activity 9: Provisions
Extraction Co prepares its financial statements to 31 December each year. During the years
ended 31 December 20X0 and 31 December 20X1, the following event occurred:
Extraction Co is involved in extracting minerals in a number of different countries. The process
typically involves some contamination of the site from which the minerals are extracted.
Extraction Co makes good this contamination only where legally required to do so by legislation
passed in the relevant country.
The company has been extracting minerals in Copperland since January 20W8 and expects its
site to produce output until 31 December 20X5. On 31 December 20X0, it came to the attention of
the directors of Extraction Co that the government of Copperland was virtually certain to pass
legislation requiring the making good of mineral extraction sites. The legislation was duly passed
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on 15 March 20X1. The directors of Extraction Co estimate that the cost of making good the site in
Copperland will be $2 million. This estimate is of the actual cash expenditure that will be incurred
on 31 December 20X5.
Required
Calculate the effect of the estimated cost of making good the site on the financial statements of
Extraction Co for BOTH of the years ended 31 December 20X0 and 20X1. Give full explanations of
the figures you compute.
Note. The annual discount rate to be used in any relevant calculations is 10%.
The relevant discount factors at 10% are:
Year 4 at 10% – 0.683
Year 5 at 10% – 0.621
Solution
5.3 Disclosure
• An entity discloses the date when the financial statements were authorised for issue and who
gave the authorisation (IAS 10: para. 17).
• If non-adjusting events after the reporting period are material, non-disclosure could influence
the decisions of users taken on the basis of the financial statements. Accordingly, the following
is disclosed for each material category of non-adjusting event after the reporting period:
- The nature of the event; and
- An estimate of its financial effect, or statement that such an estimate cannot be made (IAS
10: para. 21).
PER alert
One of the competences you require to fulfil Performance Objective 7 of the PER is the ability
to review financial statements and correct for errors and make any required disclosures
regarding events after the reporting date. The information in this chapter will give you
knowledge to help you demonstrate this competence.
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Chapter summary
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Contingent Contingent Events after the
liabilities assets reporting period (IAS 10)
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Knowledge diagnostic
1. Provisions
Provisions are recognised when there is a present obligation as a result of a past event, with a
probable outflow of economics resources that can be measured reliably.
3. Contingent liabilities
• Contingent liabilities are not recognised because they are possible rather than present
obligations, the outflow is not probable or the liability cannot be reliably measured.
• Contingent liabilities are disclosed.
4. Contingent assets
Contingent assets are disclosed, but only where an inflow of economic benefits is probable.
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Further study guidance
Question practice
Now try the following from the Further question practice bank (available in the digital edition of
the Workbook):
17 Provisions
Further reading
The FR examining team has provided a useful technical article on IAS 37 Provisions, Contingent
Liabilities and Contingent Assets. This should help you in understanding the key criteria of the
standard.
IAS 37, Provisions, contingent liabilities and contingent assets
www.accaglobal.com
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Activity answers
$
$5m × 0.621* 3,105,000
$
Carrying amount of provision at 1 January 20X6 3,105,000
Unwinding of the carrying amount at 10% 310,500
Carrying amount of the provision at 31 December 20X6 ($5m × 0.683**) 3,415,000
Activity 2: Warranties
The correct answer is: Warren Co has an obligation to repair or replace all items of product that
show manufacturing defects, therefore a provision for the cost of this should be made.
Warren Co has an obligation to repair or replace all items of product that manifest
manufacturing defects in respect of which warranties are given before the end of the reporting
period, and a provision for the cost of this should therefore be made. The cost cannot be avoided.
Warren Co is obliged to repair or replace items that fail within the entire warranty period.
Therefore, in respect of this year’s sales, the obligation provided for at the end of the reporting
period should be the cost of making good items for which defects have been notified but not yet
processed, plus an estimate of costs in respect of the other items sold for which there is sufficient
evidence that manufacturing defects will manifest themselves during their remaining periods of
warranty cover.
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3 The correct answer is: $78.964 million
The provision has been capitalised, by crediting the provision and debiting the non-current
asset. This is applying the accruals method as it is matching the costs of the provision and the
asset with the revenue generated by the provision.
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(3) A provision should be recognised for such present value of the environmental costs .
(4) No present obligation exists and under IAS 37 no provision would be required. This is because
the entity could avoid the future expenditure by its future actions.
Activity 8: IAS 10
The correct answer is: Two lines of inventory held at the year-end were discovered to have faults
rendering them unsaleable.
We can assume that the faults that rendered the inventory unsaleable also existed at the year-
end, so this is the only option which would require adjustment. The others give information about
conditions that arose after the end of the reporting period and therefore do not require to be
adjusted.
Activity 9: Provisions
For the year ended 31 December 20X0:
• A provision of $1,242,000 (2,000,000 × 0.621) is reported as a liability.
• A non-current asset of $1,242,000 is also recognised. The provision results in a corresponding
asset because the expenditure gives the company access to an inflow of resources embodying
future economic benefits; there is no effect on profit or loss for the year.
For the year ended 31 December 20X1:
• Depreciation of $248,400 (1,242,000 × 20%) is charged to profit or loss. The non-current asset
is depreciated over its remaining useful life of five years from 31 December 20X0 (the site will
cease to produce output on 31 December 20X5).
• Therefore, at 31 December 20X1 the carrying amount of the non-current asset will be $993,600
(1,242,000 – 248,400).
• At 31 December 20X1, the provision will be $1,366,000 (2,000,000 × 0.683).
• The increase in the provision of $124,000 (1,366,000 – 1,242,000) is recognised in profit or loss
as a finance cost. This arises due to the unwinding of the discount.
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Inventories and
14 biological assets
14
Learning objectives
On completion of this chapter, you should be able to:
Exam context
You should be familiar with the key requirements of IAS 2 Inventories from your previous studies.
Inventory is an important balance as it is often a key figure in the statement of financial position
and impacts on cost of sales in the statement of profit or loss. IAS 41 Agriculture provides the
requirements relating to biological assets and produce before the point of harvest and is therefore
relevant only in the farming industry. Questions on inventory or biological assets could appear as
OTQs in Section A or B. Inventories may also feature in an accounts preparation question and will
be relevant when analysing the gross profit margin or the inventory holding period in an
interpretation question in Section C.
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Disclosure Measurement
Presentation
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1 IAS 2 Inventories
1.1 Introduction
IAS 2 Inventories lays out the required accounting treatment for inventories. Inventories are
recorded as an asset of the entity until they are sold, at which point the asset (inventories) is
derecognised and an expense (cost of sales) is recognised.
1.3 Measurement
Inventories shall be measured at the lower of cost and net realisable value (NRV) (IAS 2: para. 9).
*Fixed production overheads relate to indirect costs such as the cost of factory management and
administration which remain relatively constant regardless of the volume of production. These
should be allocated to units of production based on a normal level of activity.
Variable production overheads include indirect materials and labour and vary with the volume of
production.
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Examples include:
An entity must use the same cost formula for all inventories having a similar nature and use to
the entity.
You should be aware of these methods from your previous studies and also know that the last in,
first out (LIFO) formula is not permitted by IAS 2 on the basis that it does not bear a good
approximation to actual costs.
Essential reading
Chapter 14, Section 1 of the Essential reading provides more detail on the consistency of cost
formula used.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
Net realisable value: The estimated selling price in the ordinary course of business, less:
KEY
TERM • The estimated cost of completion; and
• The estimated costs necessary to make the sale, eg marketing, selling and distribution costs
(IAS 2: para. 6).
As noted above, where the net realisable value of inventories is less than cost the inventories in the
financial statements should be measured at the lower of cost and net realisable value.
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1.8 NRV less than cost
The net realisable value of inventories may be less than cost due to:
Essential reading
Chapter 14, Section 1 of the Essential reading provides more detail on the NRV of inventory.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
A B C
$ $ $
Cost 20 9 12
Selling price 30 12 22
Modification cost to enable sale – 2 8
Marketing costs 7 2 2
Required
Calculate the value of inventory held at the year-end in accordance with IAS 2 Inventories.
Solution
The value of inventory is $8,800.
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Activity 1: Write down of inventory
Teddy Co has 500 items of product HGJ in inventory at 31 October 20X8. These items are no
longer saleable in their current condition. However, they can be adjusted for a cost of $2.50 per
item. Once adjusted, the items can be sold at their normal price of $5.30 each.
The original cost of the items was $2.25 each. The replacement cost of item HGJ at 31 October
20X8 is $2.45 each.
Required
At what amount should Teddy Co measure its inventory at 31 October 20X8?
$nil
$275
$1,125
$1,400
1.9 Disclosure
The financial statements should disclose the following:
• The accounting policies adopted in measuring inventories, including the cost formula used;
• The total carrying amount of inventories and the carrying amount in classifications
appropriate to the entity;
• The carrying amount of inventories carried at fair value less costs to sell;
• The amount of inventories recognised as an expense during the period;
• The amount of any write‑down of inventories recognised as an expense in the period;
• The amount of any reversal of any write‑down that is recognised as a reduction in the amount
of inventories recognised as expense in the period;
• The circumstances or events that led to the reversal of a write‑down of inventories; and
• The carrying amount of inventories pledged as security for liabilities.
2 IAS 41 Agriculture
2.1 Introduction
IAS 41 Agriculture covers the accounting treatment of biological assets (except bearer plants) and
agricultural produce at the point of harvest. After harvest, IAS 2 Inventories applies to the
agricultural produce, as illustrated in the timeline below.
IAS 41 IAS 2
Time
Biological transformation
Planting/ Harvest/ Sale
birth slaughter
Bearer plants, which are plants that are used to grow crops but are not themselves consumed (eg
grapevines), are excluded from the scope of IAS 41. Instead they are accounted for under IAS 16
using either the cost or revaluation model.
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2.2 Definitions
Essential reading
Chapter 14, Section 3 of the Essential reading provides further explanation as to what a biological
asset is.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
2.3 Recognition
As with other non-financial assets under the Conceptual Framework, a biological asset or
agricultural produce is recognised when:
(a) The entity controls the asset as a result of past events;
(b) It is probable that future economic benefits associated with the asset will flow to the entity;
and
(c) The fair value or cost of the asset can be measured reliably.
(IAS 41: para. 10)
2.4 Measurement
Biological assets are measured both on initial recognition and at the end of each reporting period
at fair value less costs to sell.
Agricultural produce at the point of harvest is also measured at fair value less costs to sell.
The fair value less costs to sell of agricultural produce harvested becomes its cost under IAS 2.
After harvest, the agricultural produce is measured at the lower of cost and net realisable value in
accordance with IAS 2.
Fair value is the price that would be received to sell the asset (IFRS 13 Fair Value Measurement).
Costs to sell are incremental costs directly attributable to disposal of the asset, eg commissions to
brokers and transfer taxes.
Changes in fair value less costs to sell are recognised in profit or loss.
Where fair value of biological assets cannot be measured reliably, they are measured at cost
less accumulated depreciation and impairment losses.
2.5 Presentation
Biological assets are presented as non-current assets.
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Activity 2: Biological assets
PER alert
Performance objective 7 of the PER requires you to demonstrate that you can contribute to the
drafting or reviewing of primary financial statements according to accounting standards and
legislation. The Standards covered in this chapter will help you to do this for a business’s
inventory and biological assets.
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Chapter summary
Recognition
Measurement • Entity controls the asset as a result of past
• At the lower of cost and net realisable value events
• Cost: • Probable that future economic benefits will
– Costs of purchase flow to the entity
– Costs of conversion • Fair value or cost of the asset can be
– Other costs measured reliably
• Estimation techniques to determine cost:
– Standard cost
– Retail method Measurement
– FIFO • Biological assets
– Weighted average – Initial measurement at fair value less costs
• NRV: to sell
– Estimated selling price less estimated costs – Subsequent measurement also at fair value
of completion and estimated costs less costs to sell
necessary to make the sale (marketing, • Agricultural produce
selling, distribution) – Initial measurement (at harvest) at fair value
less costs to sell
– Subsequent measurement per IAS 2
Disclosure
• Accounting policies including cost formula
• Total carrying amount of inventories Presentation
(RM, WIP, FG) Biological assets are non-current assets
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Knowledge diagnostic
1. IAS 2 Inventories
Inventories are held at the lower of cost and net realisable value. The cost of interchangeable
inventories is measured using the FIFO or weighted average methods only.
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Further study guidance
Question practice
Now try the following from the Further question practice bank (available in the digital edition of
the Workbook):
15 Villandry Co
16 Biological assets
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Activity answers
$
Selling price 5.30
Adjustment costs (2.50)
Net realisable value 2.80
Use lower of cost and net realisable value. This is the cost amount: $2.25 × 500 units = $1,125.
The replacement value is irrelevant.
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Taxation
15
15
Learning objectives
On completion of this chapter, you should be able to:
Exam context
Current tax refers to tax on a company’s taxable profits in the current period. It is a relatively
simple concept to understand and account for. Deferred tax is more complex and is an
application of accrual accounting. Current and deferred tax could both be tested in Section A or
Section B of the exam as an objective test (OT) question. Deferred tax may feature as an
adjustment in a financial statements preparation question.
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Temporary differences
Measurement
Presentation
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1 IAS 12 Income Taxes
1.1 Introduction
IAS 12 Income Taxes covers both current and deferred tax. Current tax is relatively straightforward.
Complexities arise when we consider the future tax consequences of items which are currently
recorded in the accounts. This can result in deferred tax, which we will look at later in this chapter.
Having calculated the amount of tax due to be paid on the company’s taxable profits using the
current rates set by legislation, the accounting entry is as follows:
1.2 Definitions
IAS 12 provides the following definitions:
Accounting profit: Net profit or loss for a period before deducting tax expense is referred to as
KEY
TERM the accounting profit.
Taxable profit (tax loss): The profit (loss) for a period, determined in accordance with the rules
established by the taxation authorities, upon which income taxes are payable (recoverable).
Tax expense (tax income): The aggregate amount included in the determination of net profit
or loss for the period in respect of current tax and deferred tax.
Current tax: The amount of income taxes payable (recoverable) in respect of the taxable profit
(tax loss) for a period.
Deferred tax liabilities: The amounts of income taxes payable in future periods in respect of
taxable temporary differences.
Deferred tax assets: The amounts of income taxes recoverable in future periods in respect of:
• Deductible temporary differences
• The carry forward of unused tax losses
• The carry forward of unused tax credits
Temporary differences: Differences between the carrying amount of an asset or liability in the
statement of financial position and its tax base. Temporary differences may be either:
• Taxable temporary differences, which are temporary differences that will result in taxable
amounts in determining taxable profit (tax loss) of future periods when the carrying amount
of the asset or liability is recovered or settled
• Deductible temporary differences, which are temporary differences that will result in
amounts that are deductible in determining taxable profit (tax loss) of future periods when
the carrying amount of the asset or liability is recovered or settled
Tax base: The tax base of an asset or liability is the amount attributed to that asset or liability
for tax purposes.
(IAS 12: para. 5)
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2 Current tax
2.1 Recognition of current tax liabilities and assets
IAS 12 requires any unpaid tax in respect of the current or prior periods to be recognised as a
liability.
Any excess tax paid in respect of current or prior periods over what is due should be recognised as
an asset. (IAS 12: para. 12)
Tax arising from business combination Tax arising from transaction which
Treat as part of goodwill (IAS 12: para. 19) affects equity only
• Include within equity (IAS 12: Obj)
• Eg IAS 8 adjustment made to the opening
balances due to change in accounting policy
or fundamental error
Illustration 1: Darton Co
In 20X8, Darton Co had taxable profits of $120,000. In the previous year, (20X7) income tax on
profits had been estimated as $30,000. The income tax rate is 30%.
Required
Calculate tax payable and the charge for 20X8 if the tax due on 20X7 profits was subsequently
agreed with the tax authorities as:
1 $35,000; or
2 $25,000
Note. Any under- or over-payments are not settled until the following year’s tax payment is due.
Solution
1
$
Tax due on 20X8 profits ($120,000 × 30%) 36,000
Underpayment for 20X7 5,000
Tax charge and liability 41,000
$
Tax due on 20X8 profits (as above) 36,000
Overpayment for 20X7 (5,000)
Tax charge and liability 31,000
Alternatively, the rebate due could be shown separately as income in the statement of
comprehensive income and as an asset in the statement of financial position. An offset
approach like this is, however, most likely.
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Activity 1: Current tax
Tax of $60,000 is payable in respect of the profits for the year ended 31 December 20X8. The
balance of current tax in the trial balance is an under/over provision for tax in the previous year
and is shown below.
Debit Credit
$ $
Current tax 850
Required
What is the tax expense to be shown in the statement of profit or loss and the tax liability to be
included in the statement of financial position for the year ended 31 December 20X8?
Expense $60,000; Liability $60,850
Expense $60,850; Liability $60,850
Expense $60,850; Liability $60,000
Expense $59,150; Liability $60,000
3 Deferred tax
Deferred tax is an accounting measure used to match the tax effects of transactions with their
accounting impact.
If the future tax consequences of transactions are not recognised, profit can be overstated,
leading to overpayment of dividends and distortion of share price and earnings per share (EPS).
Where a difference arises, IAS 12 requires companies to recognise a deferred tax liability (or
deferred tax asset).
Deferred tax is the tax attributable to temporary differences.
Temporary differences
Differences between
There are
two types
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3.2 Specific examples of temporary differences
Deferred tax
• Not a tax payable to the authorities
• Accounting adjustment only
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Exam focus point
It is important for you to understand how to calculate and account for deferred tax. The
March 2018 examination required students to compare the carrying amount of property, plant
and equipment to the tax base provided and calculate a temporary difference to include in
the deferred tax calculation. In the June 2018 examination, deferred tax was tested as part of
Section A questions.
3.4 Measurement
Deferred tax assets and liabilities are measured at the tax rates expected to apply to the period
when the asset is realised or liability settled, based on tax rates (and tax laws) that have been
enacted (or substantively enacted) by the end of the reporting period (IAS 12: para. 47).
Changes in tax rates after the year-end are therefore non-adjusting events after the reporting
period.
Custard Co purchased machinery costing $1,500. At the end of 20X8 the carrying amount is
$1,000. The cumulative depreciation for tax purposes is $900 and the current tax rate is 25%.
Required
Calculate the deferred tax liability for the asset.
Solution
Custard Co must therefore recognise a deferred tax liability of $100, recognising the difference
between the carrying amount of $1,000 and the tax base of $600 as a taxable temporary
difference.
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Activity 2: Tax base
Calculate the tax base and temporary difference for each of the following assets, stating whether
the temporary difference is taxable or deductible.
1 A machine costs $10,000 and has a carrying amount of $8,000. For tax purposes,
depreciation of $3,000 has already been deducted in the current and prior periods and the
remaining cost will be deductible in future periods, either as depreciation or through a
deduction on disposal. Revenue generated by using the machine is taxable, any gain on
disposal of the machine will be taxable and any loss on disposal will be deductible for tax
purposes.
Required
Calculate the tax base and the temporary difference, stating whether it is taxable or
deductible.
2 Interest receivable has a carrying amount of $1,000. The related interest revenue will be taxed
on a cash basis.
Required
Calculate the tax base and the temporary difference, stating whether it is taxable or
deductible.
3 Trade receivables have a carrying amount of $10,000. The related revenue has already been
included in taxable profit (tax loss).
Required
Calculate the tax base and the temporary difference, stating whether it is taxable or
deductible.
4 A loan receivable has a carrying amount of $1 million. The repayment of the loan will have no
tax consequences.
Required
Calculate the tax base and the temporary difference, stating whether it is taxable or
deductible
Solution
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4.3 Development costs
Development costs which have been capitalised, are treated in a similar way. Under IAS 38
Intangible Assets, development costs are capitalised when the criteria are met and are then
amortised over their useful life. Under tax rules, these costs are tax deductible once they are paid
(in the period incurred).
Therefore, a temporary tax difference occurs.
Activity 3: Epsilon Co
During the year ended 31 March 20X4, Epsilon Co correctly capitalised development costs of $1.6
million in accordance with IAS 38 Intangible Assets. The development project began to generate
economic benefits for Epsilon from 1 January 20X4. The directors of Epsilon Co estimated that the
project would generate economic benefits for five years from that date. Amortisation is charged
on a monthly pro-rata basis. The development expenditure was fully deductible against taxable
profits for the year ended 31 March 20X4 and the rate of tax applicable is 25%.
Required
Discuss the deferred tax implications of the above in the financial statements of Epsilon for the
year ended 31 March 20X4.
Solution
Activity 4: Lecehus Co
Lecehus Co purchased some land on 1 January 20X7 for $400,000. On 31 December 20X8, the
land was revalued to $500,000. In the tax regime in which the company operates, revaluations do
not affect either the tax base of the asset or taxable profits.
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The income tax rate is 30%. Profit for the year was $850,000.
Required
1 How much should be included with other comprehensive income and as a liability at 31
December 20X8?
Other comprehensive income $100,000; Liability $30,000
Other comprehensive income $70,000; Liability $30,000
Other comprehensive income $30,000; Liability $30,000
Other comprehensive income $100,000; Liability $100,000
2 What is the balance on the revaluation surplus at 31 December 20X8?
$’000
Activity 5: Pargatha Co
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Solution
Essential reading
In Chapter 15 of the Essential reading, there is an additional activity (Activity 2: Ginger Co) which
looks at the effect of changing tax rates on deferred tax. Do attempt further question practice on
this topic as it is a tricky area.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
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Activity 6: Deorf Co
Deorf Co incurs $80,000 of tax losses in the year ended 31 December 20X1 which it can carry
forward for two accounting periods before they expire. Deorf Co expects to make a loss in 20X2
and to return to profitability in 20X3, expecting to make a profit of $50,000 in that year. The
company pays tax at 20%. What is the deferred tax balance in the statement of financial position
at 31 December 20X1?
Required
What is the deferred tax balance in the statement of financial position at 31 December 20X1?
Deferred tax asset $10,000
Deferred tax liability $10,000
Deferred tax asset $50,000
Deferred tax liability $50,000
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(d) There may also be a liability on the deferred taxation account. Deferred taxation is shown
under ‘non-current liabilities’ in the statement of financial position.
Taxation in the statement of profit or loss
The tax on profit on ordinary activities is calculated by aggregating:
(a) Income tax on taxable profits
(b) Transfers to or from deferred taxation
(c) Any under provision or overprovision of income tax on profits of previous years
Activity 7: Awkward Co
Awkward Co buys an item of equipment on 1 January 20X1 for $1,000,000. It has a useful life of
10 years and an estimated residual value of $100,000. The equipment is depreciated on a
straight-line basis. For tax purposes, a tax expense can be claimed on a 20% reducing balance
basis.
The rate of income tax can be taken as 30%.
Required
In respect of the above item of equipment, calculate the deferred tax charge/credit in the profit or
loss of Awkward Co for the year to 31 December 20X2 and the deferred tax balance in the
statement of financial position at that date.
Solution
1
MOVEMENT IN THE DEFERRED TAX LIABILITY FOR THE YEAR ENDED 31 DECEMBER 20X2
$’000
Workings
1 Deferred tax liability
Accounting Deferred
carrying Temporary tax liability
amount Tax base differences @ 30%
20X1
Cost
Depreciation
(W2) and (W3)
c/d
20X2
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Accounting Deferred
carrying Temporary tax liability
amount Tax base differences @ 30%
b/d
Depreciation
(W2) and (W3)
c/d
2 Depreciation
20X1:
20X2:
Essential reading
In Chapter 15 of the Essential reading, there is an additional activity (Activity 3: Norman Kronkest
Co) which looks at the effect of deferred tax on a number of different adjustments to the financial
statements. Do attempt further question practice on this topic as it is generally an area that
students struggle with in the exam.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
In the accounting year to 31 December 20X3, Neil Down Co generated a profit before tax of
$110,000.
Income tax on the profit before tax has been estimated as $45,000. In the previous year (20X2),
income tax on profits had been estimated as $38,000 but it was subsequently agreed at $40,500.
A transfer to the credit of the deferred taxation account of $16,000 will be made in 20X3.
Required
1 Calculate the tax on profits for 20X3 for disclosure in the accounts.
2 Calculate the amount of tax payable
Solution
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Chapter summary
Taxation
IAS 12 covers current and deferred tax • Tax actually payable to the tax authorities
• Tax charged by tax authority
• Unpaid tax due is recognised as a liability
• Excess tax paid over what is due is recognised as
an asset
• Having calculated the tax due:
– DEBIT Tax charge (SOPL)
– CREDIT Tax liability (SOFP)
Deferred tax is calculated as follows: Losses can be carried forward to reduce the future
$ tax liability – future tax saving – deferred tax asset
Carrying amount of asset/(liability) [in recognised
accounting statement of financial position] X/(X)
Less tax base [value for tax purposes] (X)/X Presentation
X/(X) • Deferred tax assets/liabilities should be shown
Deferred tax (liability)/asset [always opposite separately from other assets/liabilities.
• Current tax – can be offset ONLY WHEN
(X)/X – Legally enforceable right to do so
– Amounts will be settled on a net basis, or the
asset and liability settled at the same time
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Knowledge diagnostic
2. Current tax
Current tax is the amount actually payable to the tax authorities in relation to the trading
activities of the entity during the period.
IAS 12 requires any unpaid tax in respect of the current or prior periods to be recognised as a
liability.
Conversely, any excess tax paid in respect of current or prior periods over what is due should be
recognised as an asset.
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Further study guidance
Question practice
Now try the following from the Further question practice bank (available in the digital edition of
the Workbook):
23 Telenorth Co
26 Carpati Co
Further reading
ACCA has prepared a useful technical article on deferred tax, which is available on its website
under Exam Support Resources.
Deferred Tax
www.accaglobal.com
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Activity answers
Carrying Temporary
amount Tax base difference Taxable or
$ $ $ deductible
7,000
Machine 8,000 (10,000- 3,000) 1,000 Taxable
Carrying
amount Tax base Temporary Taxable or
$ $ difference $ deductible
Interest
receivable 1,000 Nil 1,000 Taxable
The interest has not yet been received in cash and is therefore not yet recognised for tax
purposes. The tax base of the interest receivable is therefore nil.
3
Carrying
amount Temporary Taxable or
$ Tax base $ difference deductible
Trade
receivables 10,000 10,000 Nil N/A
As the revenue is included in profit or loss and is therefore taxable in the period it is earned, the
tax base of the trade receivables is equal to the carrying amount. There is no temporary
difference as the carrying amount and tax base are equal.
4
Carrying Temporary
amount Tax base difference Taxable or
$ $ $ deductible
Loan receivable 1,000,000 1,000,000* Nil N/A
*The loan is not taxable and so the tax base is deemed to be the carrying amount of the loan
which is $1 million. There is no temporary difference.
Activity 3: Epsilon Co
Amortisation of the development costs over their useful life of five years should commence on 1
January 20X4. Therefore, at 31 March 20X4, the development costs have a carrying amount of
$1.52 million ($1.6m – ($1.6m × 1/5 × 3/12)) in the financial statements.
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The tax base of the development costs is nil since the relevant tax deduction has already been
claimed.
The deferred tax liability will be $380,000 ($1.52m × 25%).
Activity 4: Lecehus Co
1 The correct answer is: Other comprehensive income $70,000; Liability $30,000
Inclusions:
$’000
Other comprehensive income:
Gain on property revaluation 100
Deferred tax relating to other comprehensive income (Working) (30)
Other comprehensive income for the year, net of tax 70
Working
$’000
Accounting carrying amount 500
Tax base (400)
Temporary difference 100
2 The revaluation surplus is carried net of deferred tax. The balance is therefore $70,000
($100,000 surplus less $30,000 deferred tax).
Activity 5: Pargatha Co
The carrying amount of the warranty provision for accounting purposes is the $10,000
recognised.
The tax base of the provision is nil (as the amount in respect of warranty claims will not be
deductible for tax purposes until future periods when the claims are paid).
When the liability is settled for its carrying amount, the entity’s future taxable profit will be
reduced by $10,000 and so its future tax payments by $10,000 × 25% = $2,500.
The difference of $10,000 between the carrying amount ($10,000) and the tax base (nil) is a
deductible temporary difference. Pargatha Co should therefore recognise a deferred tax asset of
$10,000 × 25% = $2,500 provided that it is probable that the entity will earn sufficient taxable
profits in future periods to benefit from a reduction in tax payments.
Activity 6: Deorf Co
The correct answer is: Deferred tax asset $10,000
A deferred tax asset is recognised in 20X1 for $50,000 × 20% = $10,000:
In 20X3 the deferred tax asset is charged to profit or loss when profits are earned that the tax
losses are used against.
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Activity 7: Awkward Co
MOVEMENT IN THE DEFERRED TAX LIABILITY FOR THE YEAR ENDED 31 DECEMBER 20X2
$’000
Workings
1 Deferred tax liability
Accounting Deferred
carrying Temporary tax liability
amount Tax base differences @ 30%
20X1
20X2
2 Depreciation
$1,000,000 cost – $100,000 residual value/10 years = $90,000 per annum.
3 Tax depreciation/capital allowances
20X1: $1,000,000 × 20% = $200,000
20X2: $800,000 carrying amount b/d × 20% = $160,000
The deferred tax liability in the statement of financial position at 31 December 20X2 will be the
potential tax on the difference between the accounting carrying amount of $820,000 and the tax
base of $640,000. The temporary difference is $180,000 and the deferred tax on the difference is
a $54,000 charge/liability.
The charge (or credit) for deferred tax in profit or loss for the year is the increase (or decrease) in
the deferred tax liability during the year. The closing deferred tax liability of $54,000 is greater
than the opening deferred tax liability of $33,000, so there is a deferred tax charge of $21,000 to
profit or loss in respect of this year.
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Activity 8: Neil Down Co
1
$
Income tax on profit before tax (liability in the statement of financial position) 45,000
Deferred taxation 16,000
Underprovision of tax in previous year ($40,500 – $38,000) 2,500
Tax on profits for 20X3 (profit or loss charge) 63,500
$
Tax payable on 20X3 profits (liability) 45,000
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Presentation of
16 published financial
statements
16
Learning objectives
On completion of this chapter, you should be able to
Prepare and explain the contents and purpose of the statement D1(b)
of changes in equity.
Exam context
The presentation of published financial statements is a key area of the Financial Reporting
syllabus and will be tested in a constructed response question in Section C of the exam. In Section
C, you will be required to prepare the statement of financial position, statement of profit or loss
and other comprehensive income and/or the statement of cash flows.
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Presentation of published financial statements
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1 IFRS financial statements
1.1 IAS 1 Presentation of Financial Statements
1.1.1 Scope
IAS 1 Presentation of Financial Statements applies to the preparation and presentation of general-
purpose financial statements in accordance with IFRS Standards.
Essential reading
Chapter 16, Section 1 Presentation of Financial Statements of the Essential reading provides useful
information on how information is reported in the financial statements. This includes detail on
reporting profit or loss for the year, disclosure, identification of financial statements, the reporting
period and timeliness. Review this section carefully.
Further, you must understand the type of information that is included in the notes to the financial
statements. Read Chapter 16, Section 3 Notes to the financial statements in the Essential reading
and make sure you can explain the type of information shown by way of a note.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
20X7 20X6
$’000 $’000
Assets
Non-current assets
Property, plant and equipment XXX XXX
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Right of use assets XXX XXX
Goodwill XXX XXX
Other intangible assets XXX XXX
Investments in associates XXX XXX
Investments in equity instruments XXX XXX
XXX XXX
Current assets
Inventories XXX XXX
Trade receivables XXX XXX
Other current assets XXX XXX
Cash and cash equivalents XXX XXX
XXX XXX
Total assets XXX XXX
Equity and liabilities
Equity attributable to owners of the parent
Share capital XXX XXX
Retained earnings XXX XXX
Other components of equity XXX XXX
XXX XXX
Non-controlling interest XXX XXX
Total equity XXX XXX
Non-current liabilities
Long-term borrowings XXX XXX
Deferred tax XXX XXX
Long-term provisions XXX XXX
Total non-current liabilities XXX XXX
Current liabilities
Trade and other payables XXX XXX
Short-term borrowings XXX XXX
Current portion of long-term borrowings XXX XXX
Current tax payable XXX XXX
Short-term provisions XXX XXX
Total current liabilities XXX XXX
Total liabilities XXX XXX
Total equity and liabilities XXX XXX
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2.2 The current/non-current distinction
An entity must present current and non-current assets as separate classifications on the face of
the statement of financial position. A presentation based on liquidity should only be used where it
provides more relevant and reliable information, in which case all assets and liabilities must be
presented broadly in order of liquidity. (IAS 1: para. 60)
In either case, the entity should disclose any portion of an asset or liability that is expected to be
recovered or settled after more than 12 months. For example, for an amount receivable that is due
in instalments over 18 months, the portion due after more than 12 months must be disclosed. (IAS
1: para. 61)
The IAS emphasises how helpful information on the operating cycle is to users of financial
statements. Where there is a clearly defined operating cycle within which the entity supplies
goods or services, then information disclosing those net assets that are continuously circulating
as working capital is useful. (IAS 1: para. 62)
This distinguishes them from those net assets used in the long-term operations of the entity.
Assets that are expected to be realised and liabilities that are due for settlement within the
operating cycle are therefore highlighted. (IAS 1: para. 62)
The liquidity and solvency of an entity is also indicated by information about the maturity dates
of assets and liabilities. As we will see later, IFRS 7 Financial Instruments: Disclosures requires
disclosure of maturity dates of both financial assets and financial liabilities. (Financial assets
include trade and other receivables; financial liabilities include trade and other payables.) (IAS 1:
para. 63)
Non-current assets include tangible, intangible, operating and financial assets of a long-term
nature. Other terms with the same meaning can be used (eg ‘fixed’, ‘long-term’). (IAS 1: para. 67)
The term ‘operating cycle’ has been used several times above. The standard defines it as follows.
Operating cycle: The time between the acquisition of assets for processing and their
KEY
TERM realisation in cash or cash equivalents. (IAS 1: para. 68)
Current assets therefore include inventories and trade receivables that are sold, consumed and
realised as part of the normal operating cycle. This is the case even where they are not expected
to be realised within 12 months. (IAS 1: para. 68)
Current assets will also include marketable securities if they are expected to be realised within 12
months after the reporting period. If expected to be realised later, they should be included in non-
current assets. (IAS 1: para. 68)
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• Is held primarily for the purpose of trading; or
• Is due to be settled within 12 months after the end of the reporting period; or when
• The entity does not have the right at the end of the reporting period to defer settlement of
the liability for at least 12 months after the end of the reporting period.
All other liabilities should be classified as non-current liabilities.
(IAS 1: para. 69)
The categorisation of current liabilities is very similar to that of current assets. Thus, some current
liabilities are part of the working capital used in the normal operating cycle of the business (ie
trade payables and accruals for employee and other operating costs). Such items will be classed
as current liabilities, even where they are due to be settled more than 12 months after the end of
the reporting period. (IAS 1: para. 70)
There are also current liabilities that are not settled as part of the normal operating cycle, but
which are due to be settled within 12 months of the end of the reporting period. These include
bank overdrafts, income taxes, other non-trade payables and the current portion of interest-
bearing liabilities. Any interest-bearing liabilities that are used to finance working capital on a
long-term basis, and that are not due for settlement within 12 months, should be classed as non-
current liabilities. (IAS 1: para. 71)
A non-current financial liability due to be settled within 12 months of the end of the reporting
period should be classified as a current liability, even if (a) the original term was for a period
longer than 12 months and (b) an agreement to refinance, or to reschedule payments, on a long
term basis is completed after the end of the reporting period and before the financial statements
are authorised for issue. (IAS1, para. 72) An entity’s right to defer settlement must have substance
and must exist at the end of the reporting period. (IAS 1, para. 72A)
A non-current financial liability that is payable on demand because the entity breached a
condition of its loan agreement should be classified as current at the end of the reporting period,
even if the lender has agreed after the end of the reporting period, and before the financial
statements are authorised for issue, not to demand payment as a consequence of the breach.
However, if the lender has agreed by the end of the reporting period to provide a period of grace
ending at least 12 months after the end of the reporting period within which the entity can rectify
the breach, and during that time the lender cannot demand immediate repayment, the liability is
classified as non-current.
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3 Statement of profit or loss and other comprehensive
income
3.1 Format
IAS 1 allows income and expense items to be presented either:
(a) In a single statement of profit or loss and other comprehensive income; or
(b) In two statements: a separate statement of profit or loss and statement of other
comprehensive income.
(para. 81)
The format for a single statement of profit or loss and other comprehensive income is shown as
follows in the standard. The section down to ‘profit for the year’ can be shown as a separate
‘statement of profit or loss’ with an additional ‘statement of other comprehensive income’. Note
that not all of the items that would appear under ‘other comprehensive income’ are included in
your syllabus.
20X7 20X6
$’000 $’000
Revenue XXX XXX
Cost of sales XXX XXX
Gross profit XXX XXX
Other income XXX XXX
Distribution costs XXX XXX
Administrative expenses XXX XXX
Finance costs XXX XXX
Share of profit of associates XXX XXX
Profit before tax XXX XXX
Income tax expense XXX XXX
Profit for the year from continuing operations XXX XXX
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Loss for the year from discontinued operations XXX XXX
Profit for the year XXX XXX
Other comprehensive income:
Gains on property revaluation XXX XXX
Investments in equity instruments XXX XXX
Other comprehensive income for the year XXX XXX
Total comprehensive income for the year XXX XXX
PER alert
One of the competences required to fulfil performance objective 7 of the PER is the ability to
prepare and review financial statements in accordance with legal and regulatory
requirements. You can apply the knowledge you obtain from this section of the Workbook to
help you demonstrate this competence.
Essential reading
Chapter 16, Section 2 Proforma Financial Statements shows the structure of the financial
statements. Make sure you are familiar with these proformas and can produce them quickly in the
exam.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
4.1 Format
This is the format of the statement of changes in equity as per IAS 1. For clarity, columns relating
to items not in the Financial Reporting syllabus, as highlighted in Section 3 are omitted, and the
totals are amended accordingly. (IAS 1: IG)
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GENERIC GROUP – STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER
20X7
Share
capital
Retained
earnings
Investments
In equity
instruments
Revaluation
surplus
Total
Non-controlling
interest
Total equity
$’000
$’000 $’000 $’000 $’000 $’000 $’000
Balance at 1
January 20X6 XXX XXX XXX – XXX XXX XXX
Dividends – (XXX) – – (XXX) – (XXX)
Total
comprehensive
income for the
year – XXX XXX XXX XXX XXX XXX
Balance at 31
December 20X6 XXX XXX XXX XXX XXX XXX XXX
Changes in equity
for 20X7
Issue of share
capital XXX – – – XXX – XXX
Dividends – (XXX) – – (XXX) – (XXX)
Total
comprehensive
income for the
year – XXX (XXX) XXX XXX XXX XXX
Transfer to retained
earnings – XXX – (XXX) – – –
Balance at 31
December 20X7 XXX XXX XXX XXX XXX XXX XXX
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4.2 Illustration
Having explored the proformas for the statement of financial position, the statement of profit and
loss and the statement of changes in equity, this next Illustration will demonstrate how a set of
IFRS financial statements are prepared.
Illustration 1: Wislon Co
The accountant of Wislon Co has prepared the following list of account balances as at 31
December 20X7.
$’000
50c ordinary shares (fully paid) 450
10% loan notes (secured) 200
Retained earnings 1.1.X7 242
Other components of equity 1.1.X7 171
Land and buildings 1.1.X7 (cost) 430
Plant and machinery 1.1.X7 (cost) 830
Accumulated depreciation
Buildings 1.1.X7 20
Plant and machinery 1.1.X7 222
Inventory 1.1.X7 190
Sales 2,695
Purchases 2,152
Ordinary dividend 15
Loan note interest 10
Wages and salaries 254
Light and heat 31
Sundry expenses 113
Suspense account 135
Trade accounts receivable 179
Trade accounts payable 195
Cash 126
Additional information
(1) Sundry expenses include $9,000 paid in respect of insurance for the year ending 1 September
20X8. Light and heat does not include an invoice of $3,000 for electricity for the three
months ending 2 January 20X8, which was paid in February 20X8. Light and heat also
includes $20,000 relating to sales commission.
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(2) The suspense account is in respect of the following items.
$’000
Proceeds from the issue of 100,000 ordinary shares 120
Proceeds from the sale of plant 300
420
Less consideration for the acquisition of Mary & Co 285
135
(3) The net assets of Mary & Co were purchased on 3 March 20X7. Assets were valued as follows.
$’000
Equity investments 231
Inventory 34
265
All the inventory acquired was sold during 20X7. The equity investments were still held by Wislon
at 31.12.X7. Goodwill has not been impaired in value.
(4) The property was acquired some years ago. The buildings element of the cost was estimated
at $100,000 and the estimated useful life of the assets was 50 years at the time of purchase.
As at 31 December 20X7, the property is to be revalued at $800,000.
(5) The plant, which was sold, had cost $350,000 and had a carrying amount of $274,000 as on
1.1.X7. $36,000 depreciation is to be charged on plant and machinery for 20X7.
(6) The management wish to provide for:
(i) Loan note interest due
(ii) A transfer from other components of equity to retained earnings of $16,000 in respect of
a previous revaluation surplus
(iii) Audit fees of $4,000
(7) Inventory as at 31 December 20X7 was valued at $220,000 (cost).
(8) Taxation is to be ignored.
Required
Prepare the financial statements of Wislon Co as at 31 December 20X7. You do not need to
produce notes to the statements.
Solution
For ease of reference, we will first address the adjustments and then prepare the financial
statements proformas. Both the adjustments and figures per the trial balance that do not require
adjustment are posted to the proformas.
(1) Normal adjustments are needed for accruals and prepayments (insurance, light and heat,
loan note interest and audit fees). The loan note interest accrued is calculated as follows.
$’000
Charge needed in profit or loss (10% × $200,000) 20
Amount paid so far, as shown in list of account balances 10
Accrual: presumably six months’ interest now payable 10
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The accrued expenses shown in the statement of financial position comprise:
$’000
Loan note interest 10
Light and heat 3
Audit fee 4
17
(2) The misposting of $20,000 to light and heat is also adjusted, by reducing the light and heat
expense, but charging $20,000 to sales commission.
(3) Depreciation on the building is calculated as $100,000/50 = $2,000.
The carrying amount of the building is then $430,000 – $20,000 – $2,000 = $408,000 at the end
of the year. When the property is revalued, a revaluation surplus of $800,000 – $408,000 =
$392,000 is then recognised within other components of equity.
(4) The profit on disposal of plant is calculated as proceeds $300,000 (per suspense account)
less carrying amount $274,000, ie $26,000. The cost of the remaining plant is calculated at
$830,000 – $350,000 = $480,000. The depreciation provision at the year end is:
$’000
Balance 1.1.X7 222
Charge for 20X7 36
Less depreciation on disposals (350 – 274) (76)
182
$’000
Consideration (per suspense account) 285
Assets at valuation 265
Goodwill 20
This is shown as an asset in the statement of financial position. The equity investments, being
owned by Wislon Co at the year end, are also shown on the statement of financial position,
whereas Mary & Co’s inventory, acquired and then sold, is added to the purchases figure for the
year.
(6) The other item in the suspense account is dealt with as follows:
$’000
Proceeds of issue of 100,000 ordinary shares 120
Less nominal value 100,000 × 50c 50
Excess of consideration over par value (= share premium) 70
(7) The transfer from other components of equity results in a other components of equity
balance of $171,000 (b/f) + $392,000 (note 3) - $16,000 = $547,000.
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We can now prepare the financial statements.
WISLON CO
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE YEAR ENDED
31 DECEMBER 20X7
$’000
Revenue 2,695
Cost of sales (W1) (2,156)
Gross profit 539
Other income (profit on disposal of plant) 26
Administrative expenses (W2) (437)
Finance costs (20)
Profit for the year 108
Other comprehensive income:
Gain on property revaluation 392
Total comprehensive income for the year 500
Note. The only item of ‘other comprehensive income’ for the year was the revaluation surplus. If
there had been no revaluation surplus, only a statement of profit or loss would have been
required.
Workings
1 Cost of sales
$’000
Opening inventory 190
Purchases (2,152 + 34) 2,186
Closing inventory (220)
2,156
2 Administrative expenses
$’000
Wages, salaries and commission (254 + 20) 274
Sundry expenses (113 – 6) 107
Light and heat (31 – 20 + 3) 14
Depreciation: buildings 2
plant 36
Audit fees 4
437
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WISLON CO
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20X7
$’000 $’000
Assets
Non-current assets
Property, plant and equipment
Property at valuation 800
Plant: cost 480
accumulated depreciation (182)
298
Goodwill 20
Equity investments 231
Current assets
Inventories 220
Trade accounts receivable 179
Prepayments 6
Cash and cash equivalents 126
531
Total assets 1,880
Equity and liabilities
Equity
50c ordinary shares 500
Share premium 70
Other components of equity 547
Retained earnings 351
1,468
Non-current liabilities
10% loan stock (secured) 200
Current liabilities
Trade and other payables 195
Accrued expenses 17
212
Total equity and liabilities 1,880
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WISLON CO
STATEMENT OF CHANGES IN EQUITY
FOR THE YEAR ENDED 31 DECEMBER 20X7
Other
Share Share Retained components
capital premium earnings of equity Total
$’000 $’000 $’000 $’000 $’000
Balance at 1.1.X7 450 – 242 171 863
Issue of share capital 50 70 120
Dividends (15) (15)
Total comprehensive
income for the year 108 392 500
Transfer to other
components of equity – – 16 (16) –
Approach to questions
Step 3 Transfer the figures from the trial balance to your proforma.
Step 4 Work through the adjustments in the additional notes. Deal with both sides
of the double entry, balance off workings and transfer the figures to your
proforma.
Activity 1: Mandolin Co
Mandolin Co is a quoted manufacturing company. Its finished products are stored in a nearby
warehouse until ordered by customers. Mandolin Co has performed very well in the past, but has
been in financial difficulties in recent months and has been organising the business to improve
performance.
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The trial balance for Mandolin Co at 31 March 20X3 was as follows:
$’000 $’000
Sales 124,900
Cost of goods manufactured in the year to
31 March 20X3 (excluding depreciation) 94,000
Distribution costs 9,060
Administrative expenses 16,020
Restructuring costs 121
Interest received 1,200
Loan note interest paid 639
Land and buildings (including land $20,000,000) 50,300
Plant and equipment 3,720
Accumulated depreciation at 31 March 20X2:
Buildings 6,060
Plant and equipment 1,670
Investment properties (at market value) 24,000
Inventories at 31 March 20X2 4,852
Trade receivables 9,330
Bank and cash 1,190
Ordinary shares of $1 each, fully paid 20,000
Share premium 430
Revaluation surplus 3,125
Retained earnings at 31 March 20X2 28,077
Ordinary dividends paid 1,000
7% loan notes 20X7 18,250
Trade payables 8,120
Proceeds of share issue – 2,400
214,232 214,232
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could then be sold for $55,000. The wrongly packaged goods were included in closing
inventories at their cost of $50,000.
(5) The 7% loan notes are ten-year loans due for repayment by 31 March 20X7. Interest on these
loan notes needs to be accrued for the six months to 31 March 20X3.
(6) The restructuring costs in the trial balance represent the cost of a major restructuring of the
company to improve competitiveness and future profitability.
(7) No fair value adjustments were necessary to the investment properties during the period.
(8) During the year, the company issued 2 million new ordinary shares for cash at $1.20 per
share. The proceeds have been recorded as ‘Proceeds of share issue’.
Required
Prepare the statement of profit or loss and other comprehensive income and statement of
changes in equity for Mandolin Co for the year to 31 March 20X3 and a statement of financial
position at that date.
Solution
1
Notes to the financial statements are not required, but all workings must be clearly shown.
Mandolin Co
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME
FOR THE YEAR ENDED 31 MARCH 20X3
$’000
Revenue
Cost of sales
Gross profit
Distribution costs
Administrative expenses
Other expenses
Finance income
Finance costs
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Other expenses represent the cost of a major restructuring undertaken during the period.
MANDOLIN CO
STATEMENT OF FINANCIAL POSITION AS AT 31 MARCH 20X3
$’000
Non-current assets
Investment properties
Current assets
Inventories
Trade receivables
Equity
Share capital
Share premium
Retained earnings
Revaluation surplus
Non-current liabilities
Current liabilities
Trade payables
Interest payable
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Mandolin Co
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 MARCH 20X3
Balance at 1 April
20X2
Issue of share
capital
Dividends
Total
comprehensive
income for the
year
Balance at 31
March 20X3
Workings
1 Expenses
Cost b/d
Accumulated depreciation
b/d
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Land Buildings P&E Total
Revaluation (balancing
figure)
3 Inventories
$’000
Defective batch:
Selling price 55
Cost to complete: repackaging required (20)
NRV 35
Cost (50)
Write-off required (15)
4 Share issue
The proceeds have been recorded separately in the trial balance. This requires a transfer to the
appropriate accounts:
$’000 $’000
DEBIT Proceeds of share issue 2,400
CREDIT Share capital (2,000 × $1) 2,000
CREDIT Share premium (2,000 × $0.20) 400
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Chapter summary
IAS 1 Presentation of Financial Key sections of the statement of Key sections of the statement of
Statements applies to the financial position profit or loss
preparation and presentation of • Non-current assets • Revenue
general purpose financial • Current assets • Cost of sales
statements in accordance with • Equity • Gross profit
IFRS • Non-current liabilities • Other income
• Current liabilities • Distribution costs
• Administrative expenses
• Other expenses
• Finance costs
• Income tax expense
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Knowledge diagnostic
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Further study guidance
Question practice
Now try the following from the Further question practice bank (available in the digital edition of
the Workbook):
4 Polymer Co
23(a) Telenorth Co
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Activity answers
Activity 1: Mandolin Co
Notes to the financial statements are not required, but all workings must be clearly shown.
Mandolin Co
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME
FOR THE YEAR ENDED 31 MARCH 20X3
$’000
Revenue 124,900
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Other expenses represent the cost of a major restructuring undertaken during the period.
MANDOLIN CO
STATEMENT OF FINANCIAL POSITION AS AT 31 MARCH 20X3
$’000
Non-current assets
72,262
Current assets
15,685
87,947
Equity
59,962
Non-current liabilities
Current liabilities
9,735
87,947
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Mandolin Co
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 MARCH 20X3
Workings
1 Expenses
Opening 4,852
inventories
Depreciation on 1,515
buildings (W2)
Depreciation on 513
P&E (W2)
Closing (5,165) – – –
inventories (5,180
– (W3) 15)
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Land Buildings P&E Total
3 Inventories
$’000
Defective batch:
Selling price 55
Cost to complete: repackaging required (20)
NRV 35
Cost (50)
Write-off required (15)
4 Share issue
The proceeds have been recorded separately in the trial balance. This requires a transfer to the
appropriate accounts:
$’000 $’000
DEBIT Proceeds of share issue 2,400
CREDIT Share capital (2,000 × $1) 2,000
CREDIT Share premium (2,000 × $0.20) 400
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Reporting financial
17 performance
17
Learning objectives
On completion of this chapter, you should be able to:
Define and account for non-current assets held for sale and B9(b)
discontinued operations.
Exam context
This chapter considers the IFRS Standards which deal with presentation issues, such as a change
in an accounting policy or the correction of a fundamental error which are both covered by IAS 8
Accounting Policies, Changes in Accounting Estimates and Errors. Questions covering IAS 8 are
more likely to feature in Section A or B questions, but could be an adjustment in an accounts
preparation question in Section C.
IFRS 5 Non-current Assets Held for Sale and Discontinued Operations looks at how to deal with
business operations which have ceased in the year. You have already seen how to account for
non-current assets that the entity plans to continue to use. IFRS 5 considers the situation where
assets will be sold in the near future.
Some transactions take place in foreign currencies. IAS 21 The Effects of Changes in Foreign
Exchange Rates explains which exchange rates to use and how to translate transactions for
inclusion in the financial statements. You are likely to be asked about IAS 21 in Sections A or B,
although you may be asked to translate some foreign currency transactions as part of a longer
Section C question.
Ensure you are familiar with the key points and practice your OTQs in order to consolidate your
knowledge and application skills in this chapter.
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Chapter overview
Reporting financial performance
Disclosure Disclosure
Disclosure
Disclosure
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1 IAS 8 Accounting Policies, Changes in Accounting
Estimates and Errors
This standard deals with:
• Selection and application of accounting policies
• Changes in accounting policies
• Changes in accounting estimates
• Accounting for errors
Accounting policies: The specific principles, bases, conventions, rules and practices applied by
KEY
TERM an entity in preparing and presenting the financial statements (IAS 8: para. 5).
An entity determines its accounting policies by applying the appropriate IFRS Standards.
In the absence of an IFRS Standard applying to a transaction, management uses its judgement to
develop and apply a policy that results in information that is relevant and that faithfully
represents what it purports to represent as outlined in the Conceptual Framework.
In making the judgement management also considers (in order of importance):
(a) IFRS Standards dealing with similar and related issues;
(b) The definitions, recognition criteria and measurement concepts outlined in the Conceptual
Framework; and
(c) The most recent pronouncements of other standard-setting bodies that use a similar
conceptual framework or accepted industry practices.
Accounting policies must be consistently applied for similar transactions, categories, other events
and conditions. The exception being if a standard requires or permits categorisation of items for
which different policies may be appropriate.
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(b) Adjusting the opening balance of each affected component of equity for the earliest prior
period presented; and
(c) Including the adjustment to opening equity as the second line of the statement of changes in
equity.
Where it is impracticable to determine the period-specific effects, the entity applies the new
accounting policy from the earliest period for which retrospective application is practicable (and
discloses that fact).
Changes in accounting estimates result from new information or new developments and,
accordingly, are not correction of errors.
Examples of estimates that may change include:
• Allowances for doubtful debts
• Inventory obsolescence
• Useful lives/expected pattern of consumption of depreciable assets
• Warranty obligations
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1.2.3 Key disclosures
The nature and amount of changes in accounting estimates that affect current and/or future
periods must be disclosed.
The materiality of the change is also relevant. The nature and the amount have a material effect,
and this should be disclosed.
Prior period errors: Omissions from, and misstatements in, the entity’s financial statements for
KEY
TERM one or more prior periods arising from a failure to use, or misuse of, reliable information that:
(a) Was available when the financial statements for those periods were authorised for issue;
and
(b) Could reasonably be expected to have been obtained and taken into account in the
preparation and presentation of those financial statements.
(IAS 8: para. 5)
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Activity 1: IAS 8
IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors provides guidance as to
how to account for prior period errors.
Required
Which of the following options describe a prior period error?
A material decrease in the valuation of the closing inventory resulting from a change in
legislation affecting the saleability of the company’s products.
The discovery of a significant fraud in a foreign subsidiary resulting in a write-down in the
valuation of its assets. The perpetrators have confessed to the fraud which goes back at least
five years.
The company has a material under provision for income tax arising from the use of incorrect
data by the tax advisers acting for the company.
A deterioration in sales performance has led to the directors restating their methods for the
calculation of the allowance for irrecoverable debts.
Essential reading
Chapter 17 Section 1 Reporting Financial Performance of the Essential reading covers additional
examples and activities on changes in accounting policies, estimates and errors. Do familiarise
yourself with them and practice the activities.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
2.1 Definition
Disposal group: A group of assets to be disposed of, by sale or otherwise, together as a group
KEY
TERM in a single transaction, and liabilities directly associated with those assets that will be
transferred in the transaction. (In practice a disposal group could be a subsidiary, a cash-
generating unit or a single operation within an entity.)
Cash-generating unit: The smallest identifiable group of assets for which independent cash
flows can be identified and measured (IFRS 5: App A).
Fair value: The price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date.
Costs of disposal: The incremental costs directly attributable to the disposal of an asset (or
disposal group), excluding finance costs and income tax expense.
Recoverable amount: The higher of an asset’s fair value less costs of disposal and its value in
use.
Value in use: The present value of estimated future cash flows expected to arise from the
continuing use of an asset and from its disposal at the end of its useful life (IFRS 5: App A).
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2.2 Classification as held for sale
Non-current assets are classified as held for sale if their carrying amount will be recovered
principally through a sales transaction rather than through continuing use.
To be classified as ‘held for sale’, the following criteria must be met:
(a) The asset must be available for immediate sale in its present condition, subject only to usual
and customary sales terms; and
(b) The sale must be highly probable.
For the sale to be highly probable, the following must apply:
(a) Management must be committed to a plan to sell the asset.
(b) There must be an active programme to locate a buyer.
(c) The asset must be marketed for sale at a price that is reasonable in relation to its current fair
value.
(d) The sale should be expected to take place within one year from the date of classification.
(e) It is unlikely that significant changes to the plan will be made or that the plan will be
withdrawn.
(IFRS 5: para. 8).
If the fair value of an asset less costs of disposal is lower than the carrying amount, an
impairment loss is recorded.
• Immediately before initial classification as held for sale, the asset is measured in accordance
with the applicable IFRS Standard (eg property, plant and equipment held under the IAS 16
revaluation model is revalued).
• On classification of the non-current asset as held for sale, it is written down to fair value less
costs to sell (if less than carrying amount). Any impairment loss arising under IFRS 5 is
charged to profit or loss.
• Non-current assets classified as held for sale are not depreciated/amortised.
• Disclosure:
- As a single amount separately from other assets;
- On the face of the statement of financial position; and
- Normally as current assets
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Activity 2: Starlight Co
Starlight Co has an asset with a carrying amount of $150,000 at 1 January 20X3 held under the
cost model (cost $200,000) and being depreciated straight line over an eight-year life to a nil
residual value. At 1 July 20X3, Starlight Co classifies the asset as held for sale (and all necessary
criteria is met). At that date, it is estimated that the asset could be sold for $135,000 and that it
would cost $1,000 to secure the sale.
Required
What is the amount charged to the profit or loss on 1 July 20X3 on classification of the asset as
held for sale?
$2,500
$3,500
$7,000
$9,000
2.4.1 Definition
IFRS 5 requires specific disclosures for components meeting the definition during the accounting
period. This allows users to distinguish between operations which will continue in the future and
those which will not, and makes it more possible to predict future results.
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Essential reading
Chapter 17 Section 3 of the Essential reading has examples of proforma disclosure for
discontinued operations.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
Activity 3: Milligan Co
MILLIGAN CO STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
YEAR ENDED 31 DECEMBER 20X1
20X1
$’000
Revenue 3,000
Cost of sales (1,000)
Gross profit 2,000
Distribution costs (400)
Administrative expenses (900)
Profit before tax 700
Income tax expense (210)
PROFIT FOR THE YEAR 490
Other comprehensive income for the year, net of tax 40
TOTAL COMPREHENSIVE INCOME FOR THE YEAR 530
During the year, Milligan Co ran down a material business operation with all activities ceasing on
26 December 20X1. The results of the operation for 20X1 were as follows:
20X1
$’000
Revenue 320
Cost of sales (150)
Gross profit 170
Distribution costs (120)
Administrative expenses (100)
Loss before tax (50)
Income tax expense 15
LOSS FOR THE YEAR (35)
Other comprehensive income for the year, net of tax 5
TOTAL COMPREHENSIVE INCOME FOR THE YEAR (30)
Milligan Co recognised a loss of $30,000 on initial classification of the assets of the discontinued
operation as held for sale, followed by a subsequent gain of $120,000 on their disposal in 20X1.
These have been netted against administrative expenses. The income tax rate applicable to profits
on continuing operations and tax savings on the discontinued operation’s losses is 30%.
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Required
Prepare the statement of profit or loss and other comprehensive income for the year ended 31
December 20X1 for Milligan Co complying with the provisions of IFRS 5.
Solution
1
MILLIGAN CO STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
YEAR ENDED 31 DECEMBER 20X1
20X1
$’000
Revenue
Cost of sales
Gross profit
Distribution costs
Administrative expenses
20X1
$’000
Revenue
Cost of sales
Gross profit
Distribution costs
Administrative expenses
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20X1
$’000
3 Foreign currency
An entity may trade with customers and suppliers overseas (foreign transactions). This may result
in invoices being denominated in a foreign currency. Therefore, the entity will need to translate
these invoices into its own currency in order to record the double entry in its accounting records.
Foreign currency: Foreign currency is a currency other than the functional currency of the
KEY
TERM entity (IAS 21, para. 8).
Functional currency: Functional currency is the currency of the primary economic
environment in which the entity operates (IAS 21, para. 8).
Presentational currency: Presentation currency is the currency in which the financial
statements are presented (IAS 21, para. 8).
An entity can present its financial statements in any currency (or currencies) it chooses.
Its presentation currency will normally be the same as its functional currency (the currency of
the country in which it operates).
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(b) The currency that mainly influences labour, material and other costs of providing goods or
services (will often be the currency in which such costs are denominated and settled).
The following factors may also provide evidence of an entity’s functional currency:
(a) The currency in which funds from financing activities are generated
(b) The currency in which receipts from operating activities are usually retained
Non-monetary assets measured at fair value Retranslate at exchange rate when the fair
value was determined
San Francisco Co, a company whose functional currency is the dollar, entered into the following
foreign currency transaction:
31.10.X8 Purchased goods from Mexico SA for 129,000 Mexican pesos
31.12.X8 Payables have not yet been paid
31.1.X9 San Francisco Co paid its payables
The exchange rates are as follows:
Pesos to $1
31.10.X8 9.5
31.12.X8 10.0
31.1.X9 9.7
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Required
How would this transaction be recorded in the books of San Francisco Co as at 31 December
20X8?
Solution
1
Essential reading
An additional Activity - Seattle is include in Chapter 17 of the Essential reading to give you and
extra chance to practice calculating exchange gains and losses.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
Tinker Co operates in A-Land and its functional currency is the A$. On 1 January 20X3, Tinker Co
purchases some land in a foreign currency for B$5,600,000. Tinker Co chooses to hold its land
under the revaluation model. On 31 December 20X3, the land is revalued to B$7,000,000.
The following exchange rates are relevant:
Required
On 31 December 20X3, what is the accounting entry required to record the revaluation of the land
in Tinker Co’s records?
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Solution
PER alert
One of the competences you require to fulfil Performance Objective 8 of the PER is the ability
to evaluate the effect of chosen accounting policies on the reported performance and position
of the company. Also, to demonstrate the ability to evaluate any underlying estimates on the
position of the entity.
It can also be used to support your competency in Performance Objective 7 which requires the
ability to correct errors and to disclose them. This chapter deals with important disclosures
and you can apply the knowledge you obtain from this chapter to help to demonstrate this
competence.
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Chapter summary
Disclosure
• Nature of the change
• Quantify the effect of the
change
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IFRS 5 Non-current Assets Held for Sale IAS 21
and Discontinued Operations Foreign
currency
Aids the users of the statements Discontinued operations • Functional currency: currency
to under the future of the • A major line of of the primary economic
company's operations business/geographical region environment in which the entity
of business; or operates
• Part of a single co-ordinated • Translated at spot rate at date
Non-current assets held for sale plan to dispose of a major of transaction.
To be classified as 'held for sale': line/geographical region of • Restatement at year end
business; or (closing rate) if: Monetary
(a) The asset must be available
• Subsidiary acquired for resale assets and liabilities
for immediate sale in its
• Exchange differences
present condition, subject
recognised in SOPL
only to usual and customary
Disclosure • Differences arising on items in
sales terms; and
OCI are also charged to OCI
(b) The sale must be highly • On the face of the SOPL: single
(eg revaluations)
probable amount of post-tax profit or
loss of discontinued operations
and post-tax gain/loss on any
Accounting treatment FV adjustments
• Write down NCA to FV less • On the face of the statement of
costs to sell (if less than CA) profit or loss and other
• Impairment loss charged to comprehensive income or in
SOPL the notes:
• NCA classified as 'Held for sale' – Revenue
and not depreciated/amortised – Expenses
– Profit before tax
– Income tax expense
Disclosure – Post-tax gain or loss on
• As a single amount separately disposal of assets or on
from other assets remeasurement to fair value
• On the face of the SOFP less costs to sell
• Normally as current assets
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Knowledge diagnostic
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Further study guidance
Question practice
Now try the following from the Further question practice bank (available in the digital edition of
the Workbook):
8 Hewlett Co
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Activity answers
Activity 1: IAS 8
The correct answer is: The discovery of a significant fraud in a foreign subsidiary resulting in a
write-down in the valuation of its assets. The perpetrators have confessed to the fraud which goes
back at least five years.
1. This is not a prior period error. It will be accounted for in the current period.
2. A fraud dating back five years is a prior period error and will require to be accounted for
retrospectively.
3. This is an error in the estimated amount of income tax. It does not require to be adjusted
retrospectively. Under and over provisions of income tax are accounted for in the period in which
they are first discovered.
4. The allowance for irrecoverable debts is an accounting estimate. Any changes in the estimate
are accounted for in the current period.
Activity 2: Starlight Co
The correct answer is: $3,500
At 1 July 20X3, the carrying amount of the asset is $137,500 ($150,000 – $200,000/8 × 6/12). Its
fair value less costs to sell is $134,000.
Therefore, a loss of $3,500 is recognised in profit or loss.
Activity 3: Milligan Co
MILLIGAN CO STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
YEAR ENDED 31 DECEMBER 20X1
20X1
$’000
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During the year, Milligan Co ran down a material business operation with all activities ceasing on
26 December 20X1. The results of the operation were as follows:
20X1
$’000
Revenue 320
$ $
31.10.X8 Purchases (129,000 × 9.50) 13,579
Payables 13,579
Working
Payables
$
Payables as at 31.12.X8 (129,000 × 10) 12,900
Payables as previously recorded 13,579
Exchange gain 679
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Activity 5: Foreign currency and revaluation
On initial recognition, the land is recorded at its spot rate at the date of the transaction (A$1:B$8)
= B$5,600,000/8 = A$700,000
The land is a non-monetary asset so would not normally be retranslated. It is only retranslated at
31 December 20X3 because it is remeasured to fair value under the revaluation model.
At the date of revaluation
A$
Revalued amount (B$7,000,000 / 7) 1,000,000
Less: Carrying amount of land (700,000)
Revaluation surplus 300,000
$ $
DEBIT Land 300,000
CREDIT Revaluation surplus 300,000
Note that there is no need to separate out the exchange gain or loss when revaluing a foreign
currency asset.
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Skills checkpoint 5
Interpretation skills
Chapter overview
cess skills
Exam suc
r planning
Answe
c FR skills C
n Specifi o
tio
rr req
a
ec ui
of
m
t i rem
or
nt
inf
erp ents
ng
Approach to Application
reta
agi
tion l y si s
Spreadsheet Interpretation
Go od
skills skills
ana
ti m
c al
Approach
em
to Case
e ri
OTQs
an
um
ag
tn
em
en
en
t ci
Effi
Effe cti
ve writing
a nd p r
esentation
Introduction
One of the Section C questions in the FR exam will require you to interpret a set of single entity or
group financial statements, or extracts from a set of financial statements. The interpretation will
require the calculation of ratios, but your focus should be on the interpretation of those ratios to
explain the change in performance and position of the single entity or group you are presented
with.
Given that the interpretation of financial statements will feature in Section C of every exam, it is
essential that you master the appropriate technique for analysing and interpreting information
and drawing relevant conclusions in order to maximise your chance of passing the FR exam.
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STEP 1: Read and analyse the requirement.
Read the requirement carefully to see what calculations are required and how many
marks are set for the calculation and how many for the commentary.
Work out how many minutes you have to answer each sub-requirement.
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be awarded 1 mark per relevant, well explained point so you should aim to generate sufficient
points to score a comfortable pass.
• Efficient numerical analysis. The most effective way to approach this part of the question is to
calculate your ratios and put them in a separate appendix, so all your numbers are in one
place. Make sure you show your workings, so that if you make a mistake, the Examining team
can award marks for method or following the number through in your explanation. If a
preformatted response is provided in the exam, ensure you use it when answering the relevant
requirement.
• Effective writing and presentation. Use headings and sub-headings in your answer and write
in full sentences, ensuring your style is professional. Ensuring that all sub-requirements are
answered and that all issues in the scenario are addressed will help you obtain maximum
marks.
Skill Activity
STEP 1 Read the requirement carefully to see what calculations are required and how many marks are set for the
calculation and how many for the commentary.
Work out how many minutes you have available to answer each sub requirement.
Required
(a) Comment on the performance (including addressing the shareholder’s observation) and
financial position of Bengal Co for the year ended 31 March 20X1. Up to five marks are
available for the calculation of appropriate ratios. (15 marks)
(b) Explain the limitations of ratio analysis. (5 marks)
(Total = 20 marks)
There are two parts to this question. The first part is asking for you to analyse the performance of
Bengal Co, together with the calculation of appropriate ratios.
When you read the scenario, consider which ratios would be appropriate. As only five marks are
available for the calculation of the ratios, you should not spend any longer than nine minutes on
this element of the question.
This will leave the remaining ten marks from Part (a) requiring interpretation of the ratios which
you have calculated and any remaining conclusions that you reached from reading the scenario.
This is demonstrating your application and interpretation skills.
Part B of the question is worth five marks and should be based upon your knowledge of ratio
analysis, tying your answer, where possible, to the scenario. Again, be strict on your timekeeping
here as you should only spend nine minutes on this part.
The question is worth 20 marks, so you should spend no longer than 36 minutes on this question.
STEP 2 Read and analyse the scenario.
Identify the type of company you are dealing with and how the financial topics in the requirement relate to
that type of company. As you go through the scenario you should be highlighting key information which
you think will play a key role in answering the specific requirements.
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(e) Analysis of consolidated financial statements
(disposal of a subsidiary)
Notes
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4. Income tax increased by 125% in 20X1. Profit before
tax increased by 50%. What could be the cause?
Notes
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3. Increase in shares, has this been from a bonus issue
(no cash flow) or rights issue (cash flow)? Increase in
shares used to fund capital growth.
Additional information:
Required
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Performance = SOPL
• Revenue increase/profit for
year increase Calculation of
• Finance cost increase suitable ratios
• Income tax charge increase 5 marks = 9 minutes
Required
(a) The requirement for Part (a) has been looked at in great detail, and following the review of the
scenario, already some ideas about potential issues have been noted (liquidity, gearing,
increase in non-production and selling costs, such as finance and income tax).
(b) The requirement for Part (b) is simpler but again, already some notes have been made to get
at least four out of five marks here:
Explain the limitations of ratio analysis. (5 marks)
Difference in calculation
Seasonality of trading
Besides the plan which generates ideas, you will need to ensure that you have a brief introduction
(because it is the shareholder who needs the question answering) and a conclusion to summarise
your findings.
STEP 4 Write your answer
As you write your answer, try wherever possible to apply your analysis to the scenario, instead of simply
writing about the financial topic in generic, technical terms. As you write your answer, explain what you
mean – in one (or two) sentence(s) – and then explain why this matters in the given scenario. This should
result in a series of short paragraphs that address the specific context of the scenario.
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One recurring complaint which the Examining team
make during their exam reports is that the students do
not refer their interpretation answers back to the
scenario. As a result of this, the answers are often
generic and can lack focus on the main points to be
answered in the question.
Required
(a) Overview
Performance
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The shareholders will also be interested in the ROCE.
There has been a significant increase in capital
employed during the year ended 31.3. 20X1.
Position/Gearing
Liquidity
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As we can see from the statement of financial position,
cash and cash equivalents have fallen by $4.2 million
and the company is now running an overdraft.
Conclusion
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Ratios are based upon financial statements which may
not be comparable due to the adoption of different
accounting policies and different estimation techniques.
For instance, whether non-current assets are carried at
original cost or current value will affect ROCE, as will
the use of different depreciation rates. In addition,
financial statements are often prepared with the key
ratios in mind, so may have been subject to creative
accounting. The year-end values also may not be
representative of values during the year, due to
seasonal trading.
Appendix: Ratios26 26
Ratios are kept in a separate appendix.
20X1 20X0
Net profit % (note) (3,000/25,500) / (2,500/17,250) 11.8% 14.5%
Net profit % (pre-tax) (5,250/25,500) / (3,500/17,250) 20.6% 20.3%
Gross profit % (10,700/25,500) / (6,900/17,250) 42% 40%
ROCE (5,900/18,500) / (3,600/9,250) 31.9% 38.9%
ROE (3,000/9,500) / (2,500/7,250) 31.6% 34.5%
Gearing (9,000/9,500) / (2,000/7,250) 94.7% 27.6%
Interest cover (5,900/650) / (3,600/100) 9 times 36 times
Current ratio (8,000/5,200) / (7,200/3,350) 1.5:1 2.1:1
Quick ratio (2,400/5,200) / (5,400/3,350) 0.5:1 1.6:1
Note. There are 9 ratios calculated here. You would only need 5 of these at most, as only 5 marks
are available. Do not waste your time providing ratios that are not asked for or are not relevant to
the scenario and the requirement as you will not score credit.
Managing information Ensure you highlight or underline useful information and make
notes in the margins where appropriate.
Think about the impact of each issue or ratio on the
performance or position of the company.
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Exam success skills Your reflections/observations
Ensure you answer the query posed by the shareholder.
Answer planning Check that your plan covered all parts of the question.
Make sure you generate enough points to score a pass.
Correct interpretation of the Ensure you analyse the requirements and address all aspects
requirements in your answer.
Efficient numerical analysis Use separate workings for your ratios and used an appendix or
separate area to show the ratio and the workings.
Most important action points to apply to your next question – Remember that you are asked
to interpret the ratios using the information in the scenario, not to explain what the ratio
means in generic terms.
Summary
For a question requiring you to explain the impact on a specified ratio, the key to success is to
think of the formula of the ratio. Then you need to think about the double entry and the impact it
has on the numerator and/or denominator and therefore the overall ratio.
However, this is a very broad syllabus area that could generate many different types of questions
so the approach in this Skills Checkpoint will have to be adapted to suit the specific requirements
and scenario in the exam. The basic five steps for answering any FR question will always be a
good starting point:
(1) Time (1.8 minutes per mark)
(2) Read and analyse the requirement(s)
(3) Read and analyse the scenario
(4) Prepare an answer plan
(5) Write up your answer
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Earnings per share
18
18
Learning objectives
On completion of this chapter, you should be able to:
Exam context
Earnings per share (eps) is a commonly reported performance measure. It is widely used by
investors as a measure of a company’s performance and is of particular importance for
comparing the results of an entity over time and for comparing the performance of one entity
against another. It also allows investors to compare against the returns obtainable from loan stock
and other forms of investment. It is important in the FR exam that you can calculate basic and
diluted eps, and that you can interpret why changes or differences in eps may have occurred.
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Chapter overview
Earnings per share
Basic eps
Objective Calculation
Presentation
Convertible debt
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1 Basic earnings per share (eps)
1.1 Objective
The objective of IAS 33 Earnings per Share is to provide a basis for the comparison of the
performance of different entities in the same period and of the same entity in different accounting
periods. The standard prescribes methods for determining the number of shares to be included in
the calculation of earnings per share and other amounts per share and specifies their
presentation. Disclosure of eps is only required for entities with shares which are publicly traded.
Ordinary shares: ‘An equity instrument that is subordinate to all other classes of equity
KEY
TERM instruments’. (IAS 33: para. 5)
Potential ordinary share: ‘A financial instrument or other contract that may entitle its holder to
ordinary shares’. (IAS 33: para. 5)
Options, warrants and their equivalents: ‘Financial instruments that give the holder the right
to purchase ordinary shares’. (IAS 33: para. 5)
Financial instrument: ‘Any contract that gives rise to both a financial asset of one entity and a
financial liability or equity instrument of another entity’. (IAS 32: para. 11)
Equity instrument: ‘Any contract that evidences a residual interest in the assets of an entity
after deducting all of its liabilities’. (IAS 32: para. 11)
Dilution: ‘A reduction in earnings per share or an increase in loss per share resulting from the
assumption that convertible instruments are converted, that options or warrants are exercised,
or that ordinary shares are issued upon the satisfaction of specified conditions’. (IAS 33: para.
5)
1.2 Presentation
Both basic and diluted eps are shown on the face of the statement of profit or loss and other
comprehensive income with equal prominence whether the result is positive or negative for each
class of ordinary shares and period presented.
1.3 Calculation
The basic eps calculation is:
Earnings
eps = Weighted average no. of equity shares outstanding during the period cents
1.3.1 Earnings
Earnings is profit or loss for the period attributable to ordinary equity holders of the parent,
which is the consolidated profit after deducting:
• Income taxes
• Non-controlling interests
• Preference dividends (on preference shares classified as equity)*
*As you may recall from Chapter 11, redeemable preference shares are treated as financial
liabilities and their dividends as a finance cost, which will already have been deducted in arriving
at the consolidated profit. (IAS 33: paras. 12–14)
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Activity 1: Calculation of earnings
An extract from Apricot’s consolidated statement of profit or loss for the year ended 31 December
20X9 is as follows:
$’000
Profit for the year attributable to:
Owners of the parent 7,000
Non-controlling interests 1,000
8,000
Share issues
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Illustration 1: Time apportionment
Murray Co has a year end of 31 December 20X2. On 1 October 20X2, it issued 300,000 shares at
full market price. The share capital before the share issue was 600,000 shares.
Required
Calculate the weighted average number of shares that should be used in the basic earnings per
share calculation for the year ended 31 December 20X2.
Solution
Weighted number of shares:
20X2 20X1
Assets (eg cash) $100,000 $100,000
Earnings $20,000 $20,000
Shares 200,000 100,000
eps 10c 20c
To make eps comparable, we need to restate the 20X1 figure as if it had the same share capital as
20X2, ie $20,000 / 100,000 × 2/1.
This is algebraically the same as restating the previous eps by the reciprocal of the bonus
fraction, ie 20c × 1/2 = 10c.
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Activity 2: Bonus issue
Greymatter Co has a year end of 31 December 20X2. It had 400,000 shares in issue until 30
September 20X2 when it made a bonus issue of 100,000 shares. Its earnings for 20X2 were
$80,000 and its eps 20X1 was $0.1875.
Required
Calculate the eps for 20X2 and the restated figure for 20X1.
Solution
A bonus fraction which must be applied in respect of the bonus shares is calculated as:
Fair value per share immediately before exercise of rights
Theoretical ex rights price (TERP)
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Theoretical ex-rights price (TERP) is calculated as:
Fair value of all outstanding shares + total received from exercise of rights
No. shares outstanding prior to exercise + no. shares issued in exercise
Monty Co makes a rights issue on a 1 for 4 basis. Monty Co’s share price immediately before
exercise of rights is $10 and the rights price is $6.50.
Required
Calculate the bonus fraction.
Solution
$
4 @ 10 = 40.00
1 @ 6.50 6.50
5 46.50
Essential reading
Chapter 18, Section 2 of the Essential reading provides the procedure that you should apply when
a rights issue has been made in the year. It also includes an activity which gives another
opportunity to practise the rights issue calculations.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
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2 What is the earnings per share for the year ended 31 December 20X1?
17.6c
17.0c
16.5c
16.3c
3 What is the restated earnings per share for the year ended 31 December 20X0?
20.2c
18.3c
17.1c
18.9c
2 Diluted eps
2.1 The issue
Basic eps is calculated by comparing earnings with the number of shares currently in issue. If an
entity has a commitment to issue shares in the future, for example on the exercise of options or
the conversion of loan stock, this may result in a change to the basic eps. IAS 33 refers to such
commitments as ‘potential ordinary shares’, defined as ‘a financial instrument or other contract
that may entitle its holder to ordinary shares’ (IAS 33: para. 5).
Diluted eps shows how basic eps would change if potential ordinary shares (such as convertible
debt) become ordinary shares. It is therefore a ‘warning’ measure of what may happen in the
future for current ordinary shareholders.
When the potential shares are actually issued, the impact on basic eps will be twofold:
2.3.1 Earnings
Earnings is adjusted for the interest or preference dividends which would be ‘saved‘ if conversion
into ordinary shares took place. Interest on convertible debt attracts tax relief. This tax relief will
be lost on conversion of the debt into ordinary shares, therefore, the net increase in earnings
(which is an after-tax figure) is the interest less the tax relief.
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Earnings $
Basic earnings X
Add back saving on interest on debt, net of income tax ‘saved’ X
X
Diluted number X
Acorn Co had the same 10 million ordinary shares in issue on both 1 April 20X1 and 31 March
20X2. On 1 April 20X1, the company issued 1.2 million $1 units of 5% convertible loan stock. Each
unit of loan stock is convertible into four ordinary shares on 1 April 20X9 at the option of the
holder. The following is an extract from Acorn Co’s statement of profit or loss and other
comprehensive income for the year ended 31 March 20X2:
$’000
Profit before interest and tax 980
Finance cost on 5% convertible loan stock (60)
Profit before tax 920
Income tax at 30% (276)
Profit for the year 644
Required
What is the diluted earnings per share for the year ended 31 March 20X2?
4.76c
4.64c
4.35c
6.86c
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Potential ordinary shares
(options or warrants)
Shares that would have been issued Shares that are treated as having
+
if the cash received on exercise of been issued for no consideration
the option / warrant had been used to
buy shares at average market price
for the period
2.4.1 Calculation
It is only the shares deemed to have been issued for no consideration which are added to the
number of shares in issue when calculating diluted eps (shares issued at full market price have no
dilutive effect). There is no impact on earnings.
Galaxy Co has a profit for the year of $3 million for the year. 1.4 million ordinary shares were in
issue during the year.
Galaxy Co also had 250,000 options outstanding for the whole year with an exercise price of $15.
The AMP of one ordinary share during the period was $20.
Required
What is the diluted eps?
$2.05
$1.89
$2.14
$1.88
Essential reading
Chapter 18, Section 3 of the Essential reading contains a further activity which will allow you to
practise calculating diluted eps.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
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3 eps as a performance indicator
3.1 Importance of the eps measure
• eps may be a better indication than profit of the financial performance of an entity as it
considers changes in capital during the period, ie new capital can only generate a return from
the date it is paid into the company.
• eps is considered a key stock market indicator and is quoted in the financial press.
• ps is important because of its role in the price/earnings (p/e) ratio. This is probably the most
important ratio for analysis work due to the ability to compare different companies and its use
as a ‘value for money’ measure.
Essential reading
Chapter 18, Section 4 of the Essential reading provides further information relating to the
disclosure of eps and Section 5 on alternative ways of presenting the eps figure.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
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Chapter summary
Basic eps
Objective Calculation
• Improve comparison between entities and over Earnings
• Basic EPS =
periods Weighted average no. of equity shares
• Applies to listed companies only outstanding during the period
• Earnings is profit attributable to ordinary
shareholders of the parent ie consolidated profit
Definitions after:
• Ordinary shares – equity instrument subordinate to – Income taxes
all other classes of equity instruments – Non-controlling interests
• Potential ordinary shares – financial instrument – Preference dividends on preference shares
that may entitle its holder to ordinary shares. classified as equity
• Financial instrument – contract that gives a
financial asset of one entity and a financial liability
or equity instrument of another entity. Weighted average number of shares outstanding
• Equity instrument – any contract that evidences a • Full market price:
residual interest in the assets of an entity after – Time apportion share issues in the year
deducting all of its liabilities. • Bonus issue:
• Dilution – A reduction in earnings per share or an Number of shares after bonus issue
increase in loss per share – Bonus fraction =
Number of shares before bonus issue
– Use bonus fraction retrospectively in current year
– Fraction = no shares after/no shares before
Presentation
– Use reciprocal to restate comparative
Basic and diluted EPS shown on face of SPLOCI with
• Rights issue:
equal prominence Fair value per share immediately
– Bonus fraction = before exercise of rights
for rights issue Theoretical ex-rights price (TERP)
– Use bonus fraction retrospectively in current year
– Fraction = FV before rights/TERP
– Use reciprocal to restate comparative
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Diluted eps Eps as a performance measure
No. of shares
Basic weighted average number of shares X
Add additional (max) shares on conversion X
Diluted number of shares X
Working 1
No. shares under option X
Less no. that would have been issued at average
market price X
No. of shares deemed issued for nil consideration X
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Knowledge diagnostic
1. Basic eps
Basic eps is calculated as earnings/weighted average number of equity shares outstanding during
the period.
Earnings is consolidated profit after tax, non-controlling interest and preference dividends (on
redeemable preference shares).
The weighted average number of shares is adjusted for issues in the period. Share issues may be:
• Issued at full market value – include pro-rata
• Bonus issues – calculate bonus fraction and apply it retrospectively
• Rights issue – separate into shares paid for at full value and bonus issue; calculate the bonus
fraction and apply it retrospectively
2. Diluted eps
Diluted eps represents a ‘warning’ measure of how eps would change if ‘potential ordinary shares’
were converted into shares. Both earnings and the number of shares are adjusted for the effects
of the conversion of debt into shares. The number of shares is adjusted for the effects of share
options/warrants into shares.
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Further study guidance
Question practice
Now try the following from the Further question practice bank (available in the digital edition of
the Workbook):
23(b) Telenorth Co
27 Pilum Co
Further reading
ACCA provides a useful article relating to performance appraisal in the FR exam:
Performance appraisal
www.accaglobal.com
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Activity answers
$’000
Profit for the year attributable to the owners of the parent 7,000
Less: Preference dividends on preference shares classified as equity (500,000 × 6%) (30)
6,970
The irredeemable preference shares are classified as equity as there is no obligation to pay the
dividends or repay the principal. Therefore, the dividends on the preference shares need to be
deducted from the profit for the year attributable to the owners to the parent to arrive at earnings
relating to ordinary shareholders.
However, the redeemable preference shares are classified as a financial liability as there is an
obligation to pay the dividends and to repay the principal. Therefore, the dividends on these
shares are treated as a finance cost so have already been deducted in arriving at the profit for
the year figure. As such, there is no need to deduct them when calculating earnings.
20X2
Earnings $80,000
The number of shares for 20X1 must also be adjusted if the figures for eps are to remain
comparable.
The eps for 20X1 is therefore restated as:
$0.1875 × 400,000/500,000 = $0.15
Workings
1 Weighted average number of shares
Bonus Weighted
Date Narrative Shares Time fraction average
× (3.10/3.00
(W2)) ×
1.1.20X1 2,000,000 × (4/12) (21/20) 723,333
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Bonus Weighted
Date Narrative Shares Time fraction average
× (3.10/3.00
Full market 270,000/2,2 (W2)) ×
30.4.20X1 price 70,000 × (3/12) (21/20) 615,738
Rights issue 227,000/2,4
31.7.20X1 (1/10) 97,000 × (2/12) × (21/20) 436,975
Bonus issue 124,850/2,6
30.9.20X1 (1/20) 21,850 × (3/12) 655,462
2 TERP
$
10 @ $3.10 31.00
1 @ $2.00 2.00
11 33.00
33/11 = $3.00
2 The correct answer is: 16.5c
Eps for year ended 31.12.X1 = $400,000 / 2,431,508 (W) = 16.5c
3 The correct answer is: 17.1c
Restated eps for year ended 31.12.20X0
18.6c × 3.00/3.10 × 20/21 = 17.1c
$
Basic 644,000
Interest saving, net of tax 1,200,000 @ 5% × 70% 42,000
686,000
Number of shares
Basic 10,000,000
On conversion (1,200,000 × 4) 4,800,000
14,800,000
No that would have been issued at average market price [(250,000 × (187,500)
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Number of shares under option 250,000
$15)/$20]
No of shares treated as issued for nil consideration 62,500
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Interpretation of
19 financial statements
19
Learning objectives
On completion of this chapter, you should be able to:
Exam context
Interpretation questions can be examined in either Section A, B or C of the FR exam. One of the
20-mark questions in Section C of the FR exam will require you to interpret the financial
statements of either a single entity or a group. The FR Examining team has stated that ‘although
candidates will be expected to calculate various accounting ratios, FR places emphasis on the
interpretation of what particular ratios are intended to measure and the impact that
consolidation adjustments may have on any comparisons of group financial statements. The
financial statements that require interpretation will include the Statement of Profit or Loss, the
Statement of Financial Position and the Statement of Cash Flows’. Therefore, the focus of this
chapter and your study should be on interpretation rather than the calculation of ratios.
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Chapter overview
Interpretation of financial statements
Profitability ratios
Interpretation questions
in the exam
Short term liquidity
and efficiency
Stakeholder perspectives
Long-term liquidity/gearing
Investors' ratios
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1 Analysis and interpretation
1.1 Ratio analysis v interpretation
1.1.1 Ratio analysis
Calculating ratios may highlight unusual results or clarify trends, but they are simply a starting
point to understand how an entity has changed over time or how it compares to another entity or
to industry averages.
It is important that you can:
• Identify which ratios should be calculated in different circumstances, depending on what area
of the business you want to understand more about; and
• Accurately calculate ratios using the primary financial statements
However, the identification and calculation of ratios is unlikely to be worth many marks in the FR
exam, the focus must be on interpretation.
1.1.2 Interpretation
Interpretation involves using the ratios calculated, the financial statements provided and
information within a scenario to explain your understanding of the performance and position of
an entity in the period.
For ratios to be useful, comparisons must be made – on a year-to-year basis, or between
companies. On their own, they are useless for any sensible decision-making. It is important that
you use information you are provided with about an entity to draw conclusions as to why a ratio
has changed or is different to another entity.
It is important that you understand what the ratio is intended to show in order to explain it
correctly.
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2 Financial ratios
2.1 Categories of ratios
Formula to learn
PBIT
ROCE = Capital Employed × 100
PBIT = profit before interest and tax. It is often referred to internationally as IBIT (income before
interest and tax) and may also be called operating profit.
Capital employed = debt + equity = TALCL (total assets less current liabilities). It represents the
debt and equity capital that is used by the company to generate profit.
Return on capital employed (ROCE) measures how efficiently a company uses its capital to
generate profits. A potential investor or lender should compare the return to a target return or a
return on other investments/loans. It is impossible to assess profits or profit growth properly
without relating them to the amount of funds (capital) that were employed in making the profits.
Therefore, ROCE is a very important profitability ratio as it allows the profitability of different
companies or time periods to be compared.
When considering changes in ROCE year to year or differences between entities, consider looking
PBIT and capital employed separately to understand if transactions or events that you are made
aware of in the scenario impact on both the numerator and denominator in the same way. If a
transaction only impacts profit, or only impacts capital employed, that would affect the ROCE for
that company/period.
The following are reasons why ROCE might differ between years or companies.
(a) Type of industry (a manufacturing company will typically have higher assets and therefore
lower ROCE than a services or knowledge-based company)
(b) Age of assets (old assets have a lower carrying amount resulting in low capital employed and
high ROCE)
(c) Leased assets versus asset purchased outright for cash (a leased asset results in recognition
of a lease liability, a proportion of which will appear as a non-current liability, increasing
capital employed and reducing ROCE; whereas an asset purchased with surplus cash will
have no impact on capital employed)
(d) Timing of the purchase of assets (eg if assets are purchased at the year-end, capital
employed will increase but there will have been no time to increase profits yet, so ROCE is
likely to fall).
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(e) Assets held under the revaluation model versus assets held under the cost model (an upwards
revaluation results in recognition of a revaluation surplus which increases capital employed
whilst higher depreciation will result in a lower PBIT; a decrease in the numerator and an
increase in the denominator will cause ROCE to fall)
Illustration 1: ROCE
Maroon Co has PBIT of $1.64 million and capital employed of $32.85 million at 31 December 20X5.
Its ROCE for 20X5 has, therefore, been calculated as 5.0%, a significant decrease on the ROCE
for 20X4 of 6.8%.
Further information has revealed that Maroon Co purchased $10 million of non-current assets on
20 December 20X5. Maroon Co fully financed the purchase using a bank loan taken out on the
same date.
Required
Discuss the reasons for the decrease in ROCE.
Solution
The timing of the purchase of the asset, just before the year-end means that the machine will not
have been able to impact profit/returns. We have the situation where the denominator (capital
employed) has increased by $10 million without any corresponding increase in the numerator
(return). Without the $10 million loan, the ROCE would have been 7.2% ($1.64m / ($32.65m –
$10m)), which is actually a slight improvement on the 20X4 ROCE.
It is important that you read the information given on the question carefully and consider the
interactions between increases and decreases to profit/return and capital employed in the light of
the business’s performance for the year. Taking ROCE as a standalone figure does not give the
user of the financial statements the whole picture.
We often sub‑analyse ROCE, to find out more about why the ROCE is high or low, or better or
worse than last year. There are two factors that contribute towards a return on capital employed:
Formula to learn
PBIT
Net profit margin = Revenue × 100
Net (operating) profit margin considers how much of an entity’s sales are converted to profit.
There is no right or wrong net profit margin that an entity should achieve and what is ‘normal’ will
vary by industry and by company based on the target market of that company. It is important
that you consider volume of sales as well as the net profit margin. For example, a company that
makes a profit of 25c per $1 of sales is making a bigger return on its revenue than another
company making a profit of only 10c per $1 of sale. However, if the high margin is because sales
prices are high, there is a strong possibility that the volume of sales will be low and, therefore,
revenue may be depressed, and so the asset turnover will be lower.
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2.2.3 Asset turnover
Formula to learn
Revenue
Asset turnover = Capital employed
Asset turnover is a measure of how well the assets (total assets less current liabilities) of a business
are being used to generate sales. For example, if two companies each have capital employed of
$100,000 and Company A makes sales of $400,000 per annum whereas Company B makes sales
of only $200,000 per annum, Company A is making a higher revenue from the same amount of
assets (twice as much asset turnover as Company B) and this will help A to make a higher return
on capital employed than B. Asset turnover is expressed as ‘x times’ so that assets generate x
times their value in annual sales. Here, Company A’s asset turnover is four times and B’s is two
times.
Extracts from the financial statements of Burke for the year ended 31 December 20X1 are shown
below:
EXTRACT FROM THE STATEMENT OF PROFIT OR LOSS
$’000
Gross profit 300
Finance cost (10)
Profit before tax 230
Tax (70)
Profit for the year 160
$’000
Non-current assets 550
Equity
Share capital 200
Share premium 40
Retained earnings 500
Revaluation surplus 60
Required
Calculate Burke’s return on capital employed for the year ended 31 December 20X1. Give your
answer as a percentage to one decimal place.
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Solution
Formula to learn
Profit after tax and preference dividends
Return on equity = Ordinary share capital + reserves
Whilst the return on capital employed looks at the overall return on the long-term sources of
finance, return on equity focuses on the return for the ordinary shareholders.
Return on equity gives a more restricted view of capital than ROCE, but it is based on the same
principles. ROE is not a widely used ratio, however, because there are more useful ratios that give
an indication of the return to shareholders, such as earnings per share, dividend per share,
dividend yield and earnings yield, which are described later.
Formula to learn
Gross profit
Gross profit margin = Revenue × 100
The gross profit margin measures how well a company is running its core operations.
Depending on the format of the statement of profit or loss, you may be able to calculate the gross
profit margin as well as the net profit margin. Gross profit margin is a measure of the profit
generated from an entity’s sales. Looking at the two profit margins together can be quite
informative. If two entities have a similar net profit margin but a different gross profit margin, it
may be that they classify expenses differently which causes the inconsistency. For example, one
company might present the depreciation on its machinery in cost of sales, which will reduce the
gross profit margin. Another company might present the depreciation on its machinery as an
administrative expense and therefore report a higher gross profit margin. When it comes to
calculating the net profit margin, where the depreciation is presented does not make a difference.
There may be various reasons for a change in gross profit margin, but it is important to note that
a change in sales volume alone will not necessarily affect gross margin as the same proportionate
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change would be expected in cost of sales. However, if an increase in sales volume is achieved by
offering customers a bulk buy discount, this will cause the gross margin to fall.
The following factors could explain the movement in gross margin between years or companies:
(a) Change in sales price
(b) Change in sales mix
(c) Change in purchase price and/or production costs (eg due to discounts/efficiencies)
(d) Inventory obsolescence (written off through cost of sales)
The following information is available for two potential acquisition targets. The entities have
similar capital structures and both operate in the manufacturing sector.
Fulton Hutton
Revenue $460m $420m
Gross profit margin 25% 14%
Net profit margin 10% 9%
Required
Which TWO of the following statements give realistic conclusions that could be drawn from the
above information? Tick the correct answers.
Hutton has sourced cheaper raw materials than Fulton.
Fulton operates its production process more efficiently than Hutton with less wastage and
more goods produced per machine hour.
Hutton operates in the low price end of the market but incurs similar manufacturing costs to
Fulton.
Fulton’s management exercises better cost control of the entity’s non-production overheads
than Hutton’s management.
Hutton has access to cheaper interest rates on its borrowings than Fulton.
Formula to learn
Current assets
Current ratio = Current liabilities
Current ratio is a measure of a company’s ability to meet its short-term obligations using its
current assets. The idea behind this is that a company should have enough current assets that
give a promise of ‘cash to come’ to meet its future commitments to pay off its current liabilities.
Obviously, a ratio in excess of one should be expected. Otherwise, there would be the prospect
that the company might be unable to pay its debts on time. In practice, a ratio comfortably in
excess of one should be expected, but what is ‘comfortable’ varies between different types of
businesses.
Companies are not able to convert all their current assets into cash very quickly. In particular,
some manufacturing companies might hold large quantities of raw material inventories, which
must be used in production to create finished goods inventory. These might be warehoused for a
long time or sold on lengthy credit terms. Some companies produce or manufacture products that
necessarily have to be stored for a long period of time, such as certain chemical and
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pharmaceutical products. In such businesses, where inventory turnover is slow, most inventories
are not very ‘liquid’ assets, because the cash cycle is so long. For these reasons, we calculate an
additional liquidity ratio, known as the quick ratio or acid test ratio.
Formula to learn
Current assets - inventories
Quick ratio (acid test) = Current liabilities
This ratio should ideally be at least one for companies with a slow inventory turnover. For
companies with a fast inventory turnover, a quick ratio can be comfortably less than one without
suggesting that the company could be in cash flow trouble.
Both the current ratio and the quick ratio offer an indication of the company’s liquidity position,
but the absolute figures should not be interpreted too literally. It is often theorised that an
acceptable current ratio is 1.5 and an acceptable quick ratio is 0.8, but these should only be used
as a guide. Different businesses operate in very different ways. A supermarket group for example
might have a current ratio of 0.52 and a quick ratio of 0.17. Supermarkets have low receivables
(people do not buy groceries on credit), low cash (good cash management), medium inventories
(high levels of inventories but quick turnover, particularly in view of perishability) and very high
payables. Contrast this with, for example, a luxury sofa manufacturer is likely to have a higher
current ratio (to cover the time to make the sofas as well as holding sufficient materials on hand).
What is important is the trend of these ratios. From this, one can easily ascertain whether liquidity
is improving or deteriorating. If a supermarket has traded for the last ten years (very successfully)
with current ratios of 0.52 and quick ratios of 0.17, then it should be supposed that the company
can continue in business with those levels of liquidity. If, in the following year, the current ratio
were to fall to 0.38 and the quick ratio to 0.09, then further investigation into the liquidity situation
would be appropriate. It is the relative position that is far more important than the absolute
figures.
Do not forget the other side of the coin either: A current ratio and a quick ratio can get bigger
than they need to be. A company that has large volumes of inventories and receivables might be
over‑investing in working capital, and so tying up more funds in the business than it needs to. This
would suggest poor management of receivables (credit) or inventories by the company.
Activity 3: Liquidity
Which of the following independent options is the most likely cause of the movement in Robbo’s
current ratio?
20X3 20X2
Current ratio 2.1 2.4
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Essential reading
Chapter 19 Section 1 of the Essential reading provides more information on liquidity and the cash
cycle.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
Formula to learn
Inventories
Inventory holding period = Cost of sales × 365 days
This indicates the average number of days that items of inventory are held for. This is a measure
of how vigorously a business is trading. A lengthening inventory holding period from one year to
the next indicates:
(a) A slowdown in demand/trading; or
(b) A build-up in inventory levels, perhaps suggesting that the investment in inventories is
becoming excessive
Generally, the lower the inventory holding period (ie the fewer days that an entity holds its
inventory) the better, assuming the inventory is being sold at a profit, however several aspects of
inventory holding policy have to be balanced. An entity must hold enough inventory to satisfy
demand, and therefore must consider:
(a) Lead times
(b) Seasonal fluctuations in orders
(c) Alternative uses of warehouse space
(d) Bulk buying discounts
(e) Likelihood of inventory perishing or becoming obsolete
Formula to learn
Trade receivables
Receivables collection period = Credit revenue × 365 days
The receivables collection period tells us how long, on average, it takes a company to collect
payment from credit customers. Note that any cash sales should be excluded from the revenue
denominator. This ratio only uses credit sales as they generate trade receivables. The trade
receivables are not the total figure for receivables in the statement of financial position, which
includes prepayments and non‑trade receivables. The trade receivables figure will be itemised in
an analysis of the receivable total, in a note to the accounts.
The estimate of the accounts receivable collection period is only approximate.
(a) The value of receivables in the statement of financial position might be abnormally high or
low compared with the ‘normal’ level the company usually has.
(b) Sales revenue in the statement of profit or loss is exclusive of sales taxes, but receivables in
the statement of financial position are inclusive of sales tax. We are not strictly comparing like
with like.
Sales made to other companies are usually made on ‘normal credit terms’ of payment within, say,
30 days. A collection period significantly in excess of this might be representative of poor
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management of funds of a business. However, some companies must allow generous credit terms
to win customers.
The type of company is also important: A retail company will have the majority of its sales made
with immediate payment (such as shops, online sales where the customer pays prior the goods
being despatched). A wholesaler or distribution company is more likely to offer credit terms; for
example, a wholesaler will sell its range of toys to a retail store offering 30–60 day credit terms.
Exporting companies in particular may have to carry large amounts of receivables, and so their
average collection period might be well in excess of 30 days.
It is important to give reasons specific to the example in the exam, as noting a company with few
trade receivables may be implicit of the type of company rather than them being particularly
good at credit collection.
The trend of the collection period over time is probably the best guide. If the collection period is
increasing year on year, this is indicative of a poorly managed credit control function (and
potentially, therefore, a poorly managed company). Also, this may affect credit being offered to it
in the longer-term, which would mean paying for its supplies up front (or ‘proforma’) which would
put an increased pressure on the cash flow.
Formula to learn
Trade payables
Payables payment period = Credit purchases × 365 days
The payables payment period tells us how long, on average, it takes a company to pay its credit
suppliers. The payables payment period It is rare to find purchases disclosed in published
accounts and so cost of sales serves as an approximation. The payment period often helps to
assess a company’s liquidity; an increase is often a sign of lack of long‑term finance or poor
management of current assets, resulting in the use of extended credit from suppliers, increased
bank overdraft and so on.
Payables Working
payment period capital cycle
Pay payables
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Activity 4: Working capital ratios
20X9 20X8
Current ratio 1.2 1.5
Receivables collection period 75 days 50 days
Payables payment period 30 days 45 days
Inventory holding period 42 days 35 days
Required
Which TWO of the following statements are correct?
Tungsten Co’s liquidity and working capital has improved in 20X9.
Tungsten Co is receiving cash more quickly from customers in 20X9 than in 20X8.
Tungsten Co is suffering from a worsening liquidity situation in 20X9.
Tungsten Co is paying its suppliers more quickly in 20X9 than in 20X8.
Formulas to learn
Debt
Gearing = Debt + Equity × 100
Gearing or leverage is concerned with a company’s long‑term capital structure. We can think of
a company as consisting of non-current assets and net current assets (ie working capital, which is
current assets minus current liabilities). These assets must be financed by long‑term capital of the
company, which is one of two things:
(a) Issued share capital which can be divided into:
(i) Ordinary shares plus other equity (eg reserves)
(ii) Non-redeemable preference shares (unusual)
(b) Long-term debt including redeemable preference shares
Preference share capital is normally classified as a non-current liability in accordance with IAS 32
(AG35), and preference dividends (paid or accrued) are included in finance costs in profit or loss.
There is no absolute limit to what a gearing ratio ought to be. A company with a gearing ratio of
more than 50% is said to be high‑geared (whereas low gearing means a gearing ratio of less than
50%). Many companies are high geared, but if a high geared company is becoming increasingly
high geared, it is likely to have difficulty in the future when it wants to borrow even more, unless it
can also boost its shareholders’ capital, either with retained profits or by a new share issue.
Gearing is, amongst other things, an attempt to quantify the degree of risk involved in holding
equity shares in a company, risk both in terms of the company’s ability to remain in business and
in terms of expected ordinary dividends from the company. The problem with a highly geared
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company is that by definition there is a lot of debt. Debt generally carries a fixed rate of interest
(or fixed rate of dividend if in the form of preference shares), hence there is a given (and large)
amount to be paid out from profits to holders of debt before arriving at a residue available for
distribution to the holders of equity. The more highly geared the company, the greater the risk
that little (if anything) will be available to distribute by way of dividend to the ordinary
shareholders.
Activity 5: Gearing
The following is an extract from the statement of financial position of Fleck Co:
$’000
Equity
Share capital 200
Share premium 50
Retained earnings 400
Revaluation surplus 70
Total equity 720
Non-current liabilities
Long-term borrowings 300
Redeemable preference shares 100
Deferred tax 20
Warranty provision (not discounted) 60
Total non-current liabilities 480
Required
What is the gearing ratio for Fleck (calculated as debt/(debt + equity))? Give your answer as a
percentage to one decimal place.
Essential reading
Chapter 19 Section 2 of the Essential reading provides discussion of the impact of a high or low
gearing ratio.
The debt ratio is another ratio that considers capital structure, though is less commonly used than
gearing. The debt ratio is discussed in Chapter 19 Section 3 of the Essential reading.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
Formula to learn
PBIT
Interest cover = Finance cost
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The interest cover ratio shows whether a company is earning enough profits before interest and
tax to pay its interest costs comfortably, or whether its interest costs are high in relation to the size
of its profits, so that a fall in PBIT would then have a significant effect on profits available for
ordinary shareholders.
An interest cover of two times or less would be low, and should really exceed three times before the
company’s interest costs are to be considered within acceptable limits.
Formula to learn
Dividend per share
Dividend yield = Share price × 100
Dividend yield is the return a shareholder is currently expecting on the shares of a company.
(a) The dividend per share is taken as the dividend for the previous year.
(b) If the share price is quoted ‘ex-div’, that means that the share price does not include the right
to the most recent dividend.
Shareholders look for both dividend yield and capital growth.
Formula to learn
Earnings per share (eps)
Dividend cover = Dividend per share
Dividend cover shows the proportion of profit for the year that is available for distribution to
shareholders that has been paid (or proposed) and what proportion will be retained in the
business to finance future growth. A dividend cover of two times would indicate that the
company had paid 50% of its distributable profits as dividends, and retained 50% in the business
to help to finance future operations. Retained profits are an important source of funds for most
companies, and so the dividend cover can in some cases be quite high.
A significant change in the dividend cover from one year to the next would be worth looking at
closely. For example, if a company’s dividend cover were to fall sharply between one year and the
next, it could be that its profits had fallen, but the directors wished to pay at least the same
amount of dividends as in the previous year, so as to keep shareholder expectations satisfied.
Formula to learn
Share price
Price/Earnings (P/E) ratio = Earnings per share
A high P/E ratio indicates strong shareholder confidence in the company and its future, eg in
profit growth, and a lower P/E ratio indicates lower confidence.
The P/E ratio of one company can be compared with the P/E ratios of:
• Other companies in the same business sector
• Other companies generally
It is often used in stock exchange reporting where prices are readily available.
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3 Interpretation
3.1 Approach to interpretation
• Identify user and format required for solution
• Read question and analyse data
- Look for obvious changes/differences in the figures (no ratio calculations yet, but can
consider % movements year on year)
• Calculate key ratios as required by the question
• Write up your answer summarising performance and position:
- Structured using your categories
- Comment on main features first
- Then bring in relevant ratios to support your arguments
- Suggest reasons for key changes
- Use any information given in the question!
• Reach a conclusion
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consider whether there are any differences in accounting policies which might skew the
comparison (accounting for non-current assets at cost vs fair value is often a key reason for
return on assets or return on equity differences). There may also be useful information about
which areas of the market the company targets (for example, a company that sells luxury goods
is likely to have a higher gross profit margin than a discount retailer within the same industry) or
information about significant customers.
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Date of acquisition
Consolidated statement of CSPLOCI will include results CSPLOCI will not include the
profit or loss will include of subsidiary post acquisition results of subsidiary whereas
results of subsidiary for the whereas the CSFP will include the CSFP will include all
whole year and the all assets and liabilities of the assets and liabilities of the
consolidated statement of subsidiary. This means that subsidiary. As such, students
financial position will ratios that use elements of must reflect that the increase
include all assets and both performance (CSPLOCI) in assets and liabilities of the
liabilities of the subsidiary. and position (CSFP) will be group will not have
There is therefore complex to interpret. generated additional results
consistency between the Students should reflect on in the period, which will skew
CSPLOCI and CSFP and this within their interpretation. the ratios.
discussion can focus on For example, if a subsidiary is
the impact of the acquired six months into the
acquisition as above. year, then only six months
revenue will be included, but
the entire receivables balance
will be included within the
statement of financial
position. This would give a
false impression of the
receivables collection period.
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mean that the cash generated from investing activities increases in the period, but is clearly not a
sign that the entity has performed well.
Cash generated / used in financing activities
Similar to investing activities, cash flows are likely to be one-off in nature. Where there has been,
for example, a new loan which increases cash generated from financing activities, this may be
positive for the company if the proceeds from the loan are used to invest in new assets (which you
should be able to link to cash used in investing activities), but negative for the company if the
proceeds are needed to allow the company to continue trading.
(Amended from ‘Tell me a story’, from www.accaglobal.com)
Activity 6: Stakeholder
1 This question has been adapted from the June 2015 exam.
Yogi Co is a public company and extracts from its most recent financial statements are
provided below:
STATEMENTS OF PROFIT OR LOSS FOR THE YEAR ENDED 31 MARCH
20X5 20X4
$’000 $’000
Revenue 36,000 50,000
Cost of sales (24,000) (30,000)
Gross profit 12,000 20,000
Profit from sale of division (Note (a)) 1,000 -
Distribution costs (3,500) (5,300)
Administrative expenses (4,800) (2,900)
Finance costs (400) (800)
Profit before tax 4,300 11,000
Income tax expense (1,300) (3,300)
Profit for the year 3,000 7,700
20X5 20X4
$’000
$’000 $’000 $’000
ASSETS
Non-current assets
Property, plant and equipment 16,300 19,000
- 2,000
16,300 21,000
Current assets
Inventories 3,400 5,800
Trade receivables 1,300 2,400
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20X5 20X4
$’000
$’000 $’000 $’000
Cash and cash equivalents 1,500 -
6,200 8,200
Total assets 22,500 29,200
Notes.
(1) On 1 April 20X4, Yogi Co sold the net assets (including goodwill) of a separately operated
division of its business for $8 million cash on which it made a profit of $1 million. This
transaction required shareholder approval and, in order to secure this, the management
of Yogi Co offered shareholders a dividend of 40 cents for each share in issue out of the
proceeds of the sale. The trading results of the division which are included in the
statement of profit or loss for the year ending 31 March 20X4 above are:
$’000
Revenue 18,000
Cost of sales (10,000)
Gross profit 8,000
Distribution costs (1,000)
Administrative expenses (1,200)
Profit before interest and tax 5,800
(2) Key ratios for Yogi Co for 20X4 (as originally reported) are as follows:
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Asset turnover 2.27 times
Solution
(c) Banks and capital providers • Ability to pay existing interest and loan capital
• Decision whether to grant further loans
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Stakeholder Potential interest
(f) Suppliers • Creditworthiness as a customer
Below are the summarised financial statements for the year to 31 March 20X5 and 20X6 of
Heywood Bottles Co, a company which manufactures bottles for many different drinks
companies.
Note. The statements for the year to 31 March 20X6 have not been audited.
HEYWOOD BOTTLES CO – STATEMENTS OF PROFIT OR LOSS OR THE YEARS ENDED 31 MARCH
20X6 20X5
$m $m $m $m
Revenue 300 120
Manufacturing costs 261 83
Depreciation 9 7
Costs of sales (270) (90)
Gross profit 30 30
Other expenses (28) (10)
Profit before interest and tax 2 20
Finance costs (10) (2)
Profit/(loss) before tax (8) 18
Income tax expense (4) (6)
PROFIT/(LOSS) FOR THE
YEAR (12) 12
Dividends paid 8 8
20X6 20X5
$m $m
Non-current assets
Land and buildings 5 5
Plant and equipment 18 10
Right-of-use asset 40 28
63 43
Current assets
Inventories 18 12
Receivables 94 25
Other receivables 6 –
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20X6 20X5
$m $m
Bank – 8
118 45
181 88
Equity
$1 ordinary shares 25 25
Other reserves 10 11
Retained earnings (12) 8
23 44
Non-current liabilities
Lease liabilities 32 19
Current liabilities
Trade payables 80 15
Other payables 12 10
Bank overdraft 34 –
126 25
181 88
The directors were disappointed in the profit for the year to 31 March 20X5 and held a board
meeting in April 20X5 to discuss future strategy. The Managing Director was insistent that the way
to improve the company’s results was to increase sales and market share. As a result, the
following actions were implemented.
(1) An aggressive marketing campaign costing $12 million was undertaken during the year. All
advertisements had been placed in the year to 31 March 20X5. Due to expected long-term
benefits $6 million of this has been included as a current asset in the statement of financial
position at 31 March 20X6.
(2) A ‘price promise’ to undercut any other supplier’s price was announced in the advertising
campaign.
(3) A major contract with Koola Drinks Co was signed that accounted for a substantial
proportion of the company’s output. This contract was obtained through very competitive
tendering.
(4) The credit period for receivables was extended from two to three months.
A preliminary review by the board of the accounts to 31 March 20X6 concluded that the
company’s performance had deteriorated rather than improved. There was particular concern
over the prospect of renewing the bank facility because the maximum agreed level of $30 million
had been exceeded. The board decided that it was time to seek independent professional advice
on the company’s situation.
Required
In the capacity of a business consultant, prepare a report for the board of Heywood Bottles Co
based on a review of the company’s performance for the year to 31 March 20X6 in comparison
with the previous year. Particular emphasis should be given to the effects of the implementation
of the actions referred to in points (a) to (d) above.
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Solution
Tutorial note. The previous Activity is not representative of the style of question you may face
in the FR exam. It contains more calculations that you would be expected to produce. It is
however a useful learning tool and covers a good range of ratios that you should be
comfortable with calculating and analysing.
1 Below are extracts from the consolidated statement of profit or loss for the Advent Group for
the year ended 31 December 20X4 and individual statement of profit or loss for Advent Co for
the year ended 31 December 20X3. Advent Co operates as an online-only book retailer, which
is a highly competitive market in which customers expect books to be sold at a discount to
their recommended retail price. During 20X4, it ceased advertising on TV and instead relies on
social media and word of mouth.
20X4 20X3
(Advent Group) (Advent Co individual)
$’000 $’000
Revenue 24,280 19,924
Cost of sales (13,740) (11,814)
Gross profit 10,540 8,110
Operating expenses (3,100) (6,010)
Profit from operations 7,440 2,100
Finance costs (890) (810)
Profit before tax 6,550 1,290
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In order to compare Advent Co’s results for the years ended 20X3 and 20X4, the results of Elf
Co need to be eliminated from the above consolidated statement of profit or loss for 20X4.
Although Elf Co was correctly accounted for in the group financial statements for the year
ended 31 December 20X4, a gain on disposal of Elf Co of $1.26 million is currently included in
operating expenses. This reflects the gain which should have been shown in Advent Co’s
individual financial statements.
In the year ended 31 December 20X4, Elf Co had the following results:
$m
Revenue 8.25
Cost of sales 3.75
Operating expenses 3.00
Finance costs 0.66
During the period from 1 January 20X4 to 1 September 20X4, Advent Co sold $0.64 million of
books to Elf Co after applying a reduced mark-up of 25% on cost. Elf Co had sold all of these
goods on to third parties by 1 September 20X4. The sales continued in the period after
disposal with Advent Co applying its normal arms’ length mark-up of 40%.
Elf Co previously used space in Advent Co’s warehouse, which Advent Co did not charge Elf
Co for. Since the disposal of Elf Co, Advent Co has begun to charge Elf Co the market rate to
rent the space, recording the rental income in operating expenses.
The following ratios have been correctly calculated based on the above financial statements:
20X4 20X3
(Advent Group) (Advent Co individual)
Gross profit margin 43.4% 40.7%
Operating margin 30.6% 10.5%
Interest cover 8.4 times 2.6 times
Required
Remove the results of Elf Co and the gain on disposal of the subsidiary to prepare a revised
statement of profit or loss for the year ended 31 December 20X4 for Advent Co only.
2 Calculate the equivalent ratios to those given for Advent Co for 20X4 based on the revised
statement of profit or loss.
3 Using the ratios calculated in part (c) and those provided in the question, comment on the
performance of Advent Co for the years ended 31 December 20X3 and 20X4.
Solution
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PER alert
Technical performance objective P08 requires you to Analyse and Interpret Financial Reports.
Completion of this chapter will allow you to achieve the following four elements from this
objective:
(a) Assess the financial performance and position of an entity based on financial statements
and disclosure notes.
(b) Evaluate the effect of chosen accounting policies on the reported performance and
position of an entity.
(c) Evaluate the effects of fair value measurements and any underlying estimates on the
reported performance and position of an entity.
(d) Conclude on the performance and position of an entity identifying relevant factors and
make recommendations to management.
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Chapter summary
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Financial ratios continued Interpretation
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Knowledge diagnostic
2. Financial ratios
It is important that you learn the categories of ratio (profitability, short-term liquidity and
efficiency, long-term liquidity/gearing, investors’ ratios), understand the ratio definitions and what
the ratio is trying to tell you, learn the formulae and know how to apply them in questions.
3. Interpretation
You must use the information in the scenario to suggest possible reasons why a ratio has moved in
the period or is different to another entity. You should not simply describe the ratio, nor simply
state that a ratio is good or bad. Try to find relevant points that help you explain the performance
and position.
Interpretation of group financial statements requires you to consider the impact of an acquisition
or disposal on the ratios. Consider that there may be inconsistency between the information in
the consolidated statement of profit or loss and the consolidated statement of financial position
depending on the timing of the acquisition or sale.
Each section of the statement of cash flows should be interpreted separately. You should avoid
saying a cash inflow is good and a cash outflow is bad without understanding the reason for the
cash flow.
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Further study guidance
Question practice
Now try the following from the Further question practice bank (available in the digital edition of
the Workbook):
13 Hever Co
Further reading
There are articles in the Exam Resources section of the ACCA website which are relevant to the
topics covered in his chapter and would be useful to read:
Tell me a story
Performance appraisal
www.accaglobal.com
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Activity answers
Activity 3: Liquidity
The correct answer is: A significant write down of obsolete inventory
This would cause inventory and, therefore, current assets to decrease, which would cause the
current ratio to decrease. The other answers result in the current ratio being unchanged or
increasing.
Replacement of an overdraft with a long-term loan would increase current assets (more cash) and
decrease current liabilities (no overdraft) which would increase the current ratio.
A decrease in the length of credit offered would result in a decrease in trade payables and a
corresponding decrease in cash, so no overall impact on the current ratio.
Issuing bonds would result in a cash inflow (increase of current assets) which would also increase
the current ratio.
Activity 5: Gearing
35.7 %
Gearing ratio:
Working
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Activity 6: Stakeholder
1 Calculation of equivalent ratios (figures in $’000):
Note. The capital employed in the division sold at 31 March 20X4 was $7 million ($8 million sale
proceeds less $1 million profit on sale).
The figures for the calculations of 20X4’s adjusted ratios (ie excluding the effects of the sale of
the division) are given in brackets; the figures for 20X5 are derived from the equivalent figures
in the question, however, the operating profit margin and ROCE calculations exclude the profit
from the sale of the division (as stated in the requirement) as it is a ‘one off’ item.
2 The most relevant comparison is the 20X5 results (excluding the profit on disposal of the
division) with the results of 20X4 (excluding the results of the division), otherwise like is not
being compared with like.
Profitability
Although comparative sales have increased (excluding the effect of the sale of the division) by
$4 million (36,000 – 32,000), equivalent to 12.5%, the gross profit margin has fallen
considerably (from 37.5% in 20X4 down to 33.3% in 20X5) and this deterioration has been
compounded by the sale of the division, which was the most profitable part of the business
(which earned a gross profit margin of 44.4% (8/18)). The deterioration of the operating profit
margin (from 18.8% in 20X4 down to 13.1% in 20X5) is largely due to poor gross profit margins,
but operating expenses are proportionately higher (as a percentage of sales) in 20X5 (23.0%
compared to 18.8%) which has further reduced profitability. This is due to higher
administrative expenses (as distribution costs have fallen), perhaps relating to the sale of the
division.
Yogi Co’s performance as measured by ROCE has deteriorated dramatically from 40.0% in
20X4 (as adjusted) to only 27.6% in 20X5. As the net asset turnover has remained broadly the
same at 2.1 times (rounded), it is the fall in the operating profit which is responsible for the
overall deterioration in performance. Whilst it is true that Yogi Co has sold the most profitable
part of its business, this does not explain why the 20X5 results have deteriorated so much (by
definition the adjusted 20X4 figures exclude the favourable results of the division).
Consequently, Yogi Co’s management need to investigate why profit margins have fallen in
20X5; it may be that customers of the sold division also bought (more profitable) goods from
Yogi Co’s remaining business and they have taken their custom to the new owners of the
division; or it may be related to external issues which are also being experienced by other
companies such as an economic recession. A study of industry sector average ratios could
reveal this.
Other issues
It is very questionable to have offered shareholders such a high dividend (half of the disposal
proceeds) to persuade them to vote for the disposal. At $4 million ($4,000 + $3,000 – $3,000,
ie the movement on retained earnings or 10 million shares at 40 cents) the dividend represents
double the profit for the year of $2 million ($3,000 – $1,000) if the gain on the disposal is
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excluded. Another effect of the disposal is that Yogi Co appears to have used the other $4
million (after paying the dividend) from the disposal proceeds to pay down half of the 10%
loan notes. This has reduced finance costs and interest cover; interestingly, however, as the
finance cost at 10% is much lower than the 20X5 ROCE of 21.8%, it will have had a detrimental
effect on overall profit available to shareholders.
Summary
In retrospect, it may have been unwise for Yogi Co to sell the most profitable part of its
business at what appears to be a very low price. It has coincided with a remarkable
deterioration in profitability (not solely due to the sale) and the proceeds of the disposal have
not been used to replace capacity or improve long-term prospects. By returning a substantial
proportion of the sale proceeds to shareholders, it represents a downsizing of the business.
Introduction
This report was commissioned in order to assess the financial performance of Heywood Bottles Co
for the year to 31 March 20X6 in the light of the strategic actions taken in April 20X5.
Specific areas addressed include profitability, liquidity and solvency. An appendix sets out the
calculations of selected ratios used.
Financial performance
Growth
Heywood Bottles Co revenue has grown by approximately 150% in the year. This appears to be
due to increased sales volume as a result of:
• The marketing campaign undertaken during the year successfully attracting new customers
• The ‘price promise’ to undercut other suppliers winning customers from competitors
• The new contract won with Koola Drinks
• Extending the credit period from two to three months, so attracting new customers
Profitability
Return on capital employed has deteriorated from 31.7% to 3.6% implying a decline in efficiency in
the use of assets to generate profit. This is as a result of the decline in margins (explained below)
and also because Heywood Bottles has purchased and leased new assets during the current year.
Depending on the date on which the new assets were acquired, Heywood Bottles Co may not
have been able to take advantage of these assets to generate additional profit this year.
The improvement in asset turnover implies that Heywood Bottles is successfully using its assets to
generate revenue but has been unable to convert that into improved profitability.
The gross margin has deteriorated from 25% in 20X5 to 10% in 20X6. This is because increased
sales volume has been achieved at the cost of profit margins. The two main causes of this appear
to be:
• Lowering the sales price as a result of the ‘price promise’
• Competitive tendering for the new large contract with Koola Drinks, which implies a lower than
usual sales price
The net profit margin has also deteriorated (from 16.7% to 0.7%). This is partly due to the fall in
gross margin (as explained above) but also due to the one-off marketing expenses of $12 million,
half of which ($6m) have been recognised in operating expenses. Half of the marketing expenses
($6m) were recorded as a current asset but this accounting treatment is not correct as marketing
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expenses do not meet the definition of an asset. Therefore the $6 million asset should be written
off as additional operating expenses. Once this has been adjusted for, the decline in operating
margins is even more severe, resulting in an operating loss of $4 million.
Profitability has been further eroded by a fivefold increase in interest payable, due to Heywood
Bottles’ large overdraft and the new leases entered into during the year.
Financial position
Liquidity
Both the current and quick (acid test) ratios have deteriorated (from 1.8/1.3 to 0.9/0.8). The
expansion during the year has come at a cost of declining profitability and liquidity problems. The
liquidity problems are due to:
• Poor working capital management
• Reliance on the overdraft as a source of long-term finance
An overdraft is not a good source of long-term finance as it is both expensive and risky ie it could
be withdrawn by the bank at any time. Heywood Bottles Co is particularly at risk of having its
overdraft facility withdrawn because the current balance of $34 million is in excess of the $30
million agreed limit.
Working capital management
Working capital management has worsened in the year:
• The receivables collection period has increased from 76 days to 114 days. This is largely
because Heywood Bottles increased its credit terms from two to three months.
• The new contract with Koola Drinks Co was obtained through competitive tendering, which
may imply longer than usual credit terms for this new customer.
• As a result of customers taking longer to pay, a need for extra finance arose. This resulted in
Heywood Bottles Co taking longer to pay its suppliers (61 days in 20X5 and 108 days in 20X6)
and heavy reliance on the overdraft facility. If this continues, there is a risk that Heywood
Bottles Co’s suppliers might stop their credit or even stop supply.
• Even though Heywood Bottles Co appears to be struggling to pay suppliers, the suppliers are
being paid more quickly than debts are being collected from customers. This has exacerbated
the liquidity problems.
• The inventory holding period has gone down from 49 days to 24 days – this is probably due to
increased sales demand as a result of the marketing, price promise, new customer and
increased credit terms. It could also be due to suppliers restricting supplies due to slow
payment.
Solvency
Gearing has increased from 30% to 58%. This increase would have been even higher if the
overdraft were to be included as long-term debt in the 20X6 calculation.
This is due to the fact that new assets were leased during the year (increasing long-term debt)
and because the loss for the year has created negative retained earnings (decreasing equity).
This means that Heywood Bottles is unable to pay a dividend in the current year which will make
investors unhappy. This, combined with the risk associated with increased non-discretionary
interest payments each year, means that it might well be difficult to raise further finance from
investors in the future.
The decline in interest cover from 10 times to 0.2 times shows that whilst Heywood Bottles Co
could easily afford to pay its interest in 20X5, it is now struggling to do so. This could cause
serious problems in the future as interest is non-discretionary so non-payment could result in
withdrawal of the overdraft facility and/or seizure of non-current assets by the lessor.
Conclusion
The company is overtrading and will fail without an immediate injection of new capital and a
change in strategy.
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The board actions in April 20X5 were, with hindsight, disastrous as, although they resulted in
expansion, it was at the cost of both profitability and liquidity. Increased turnover and market
share are only worthwhile while the company is trading profitably.
It will be very difficult to retain the loyalty of customers if prices are increased and relationships
with suppliers and other payables are severely strained.
APPENDIX
Selected ratios
$’000
Revenue (24,280 – 5,500 (8,250 x 8/12) + 640 (intra-group)) 19,420
Cost of sales (13,740 – 2,500 (3,750 x 8/12)) [see Note] (11,240)
Gross profit 8,180
Operating expenses (3,300 – 2,000 (3,000 x 8/12) + 1,260 profit on disposal) (2,560)
Profit from operations 5,620
Finance costs (890 – 440 (660 x 8/12)) (450)
Profit before tax 5,170
Tutorial note. Originally, the intra-group sale resulted in $0.64 million sales and $0.512
million costs of sales. These amounts were recorded in the individual financial statements of
Advent Co. On consolidation, the $0.64 million turnover was eliminated – this needs to be
added back. The corresponding $0.512 million COS consolidation adjustment is technically
made to Elf Co’s financial statements and so can be ignored here.
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2 Ratios of Advent Co, eliminating impact of Elf Co and the disposal during the year
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Limitations of financial
20 statements and
interpretation techniques
20
Learning objectives
On completion of this chapter, you should be able to:
Discuss the limitations in the use of ratio analysis for assessing C3(a)
corporate performance.
Discuss the effect that changes in accounting policies or the use C3(b)
of different accounting polices between entities can have on the
ability to interpret performance.
Exam context
In Chapter 19, we looked at how the calculation of ratios and the interpretation of financial
statements is useful for understanding the position and performance of an entity. In this chapter,
we will consider the reasons why relying on the financial statements can be problematic.
Financial statements are intended to give a fair presentation of the financial performance of an
entity over a period and its financial position at the end of that period. The Conceptual
Framework and the IFRS Standards are there to ensure, as far as possible, that they do. However,
there are a number of reasons why the information in financial statements should not just be
taken at face value. The content of this chapter is important when attempting a Section C
question that requires the interpretation of a single entity or a group.
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Limitations of financial statements and interpretation techniques
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1 Limitations of financial statements
1.1 Problems of historical financial information
The information within the financial statements is historical, as it reflects the performance and
position of the entity for a prior period. Using historical financial information can be problematic
for decision making:
• Financial data quickly becomes out of date and does not necessarily reflect the current
operating conditions of an entity.
• There is no guarantee that trends in historical data will continue and they cannot be reliably
used to predict future performance.
• A change in company strategy may have occurred since the financial data was published.
Similarly, a change in management since the results were published can lead to different
market expectations about the future.
Lanark Co holds its property, which was purchased 20 years ago, at a cost of £100,000. The
property has been depreciated on the straight line basis and has a remaining useful life of 5
years. Lanark Co’s competitor is Alloa Co which acquired new property in the current year at a
cost of £1,000,000. The property has an estimated useful life of 40 years. Alloa Co used a loan to
finance the purchase of the property.
Required
Discuss the impact of measuring property at historical cost on the financial statements of Lanark
Co and Alloa Co.
Solution
The impact on the statement of financial position is likely to be relatively easy to arrive at. Lanark
Co will have a much lower asset value of $20,000 ($100,000 × 5/25 years remaining) due to
having an aged asset that is carried at historical cost. When considering a ratio such as return on
assets, Lanark Co would report a better return than that of Alloa Co due to the low carrying
amount of the property. Alloa Co had to acquire appropriate funding to make the purchase, and
the large loan increases capital employed and therefore decreases Alloa Co’s ROCE.
The impact on the statement of profit or loss and other comprehensive income can be more
difficult to determine. Lanark Co will have depreciation of just $4,000 per annum ($100,000/25
years) whereas Alloa Co will have depreciation of $25,000 per annum ($1,000,000 / 40 years).
This will impact on operating profit and therefore decrease Alloa Co’s margins and ROCE. Alloa
Co will also have a finance cost in respect of the loan which will impact on interest cover. The
information provided about the property held by each company is therefore essential to
understanding a number of ratios that could be calculated for each company.
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1.2.1 Pressure from investors
Listed companies produce their financial statements with one eye on the stock market and, where
possible, they like to produce financial statements which show analysts what they are expecting
to see, for example:
• Steady growth in profits
• Stable dividends
• No key ratio changes for improvement in ratios
This is often supported by the directors who may have bonus targets based on achieving certain
sales or profit targets that are aligned to investor expectations.
Essential reading
In Chapter 19, we discussed the importance of taking account of issues such as intragroup
trading, seasonal trading and the timing of asset acquisitions when interpreting changes or
differences in ratios. Chapter 20, Section 1 of the Essential reading covers these issues in more
detail.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
2.1 Definitions
Related party (IAS 24): A person or entity that is related to the entity that is preparing its
KEY
TERM financial statements (the ’reporting entity’).
(a) A person or a close member of that person’s family is related to a reporting entity if that
person:
(i) Has control or joint control over the reporting entity;
(ii) Has significant influence over the reporting entity; or
(iii) Is a member of the key management personnel of the reporting entity or of a parent
of the reporting entity
(b) An entity is related to a reporting entity if any of the following conditions apply:
(i) The entity and the reporting entity are members of the same group (which means
that each parent, subsidiary and fellow subsidiary is related to the others).
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(ii) One entity is an associate* or joint venture* of the other entity (or an associate or
joint venture of a member of a group of which the other entity is a member).
(iii) Both entities are joint ventures* of the same third party.
(iv) One entity is a joint venture* of a third entity and the other entity is an associate of
the third entity.
(v) The entity is a post-employment benefit plan for the benefit of employees of either
the reporting entity or an entity related to the reporting entity.
(vi) The entity is controlled or jointly controlled by a person identified in (a).
(vii) A person identified in (a)(i) has significant influence over the entity or is a member of
the key management personnel of the entity (or of a parent of the entity).
(viii) The entity, or any member of a group of which it is a part, provides key
management personnel services to the reporting entity or the parent of the reporting
entity.
*including subsidiaries of the associate or joint venture
(IAS 24: para. 9)
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No disclosure is required of intragroup related party transactions in the consolidated financial
statements.
Items of a similar nature may be disclosed in aggregate, except where separate disclosure is
necessary for understanding purposes.
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3.2 Non-financial factors
When analysing the performance and position of an entity, it is usually beneficial to look beyond
the financial statements and consider other relevant factors about the business:
• How technologically advanced is it? If an entity is not using the latest equipment and
processes, it risks being pushed out of the market at some point or having to undertake a high
level of capital expenditure.
• What are its environmental and sustainability policies? Is it in danger of having to pay for
clean up if the law is tightened? Does it appeal to those seeking ‘ethical investment’? Does it
incur additional costs and therefore earn reduced margins because it uses sustainable
products?
• What is the reputation of its management? If it has attracted good people and kept them, that
is a positive indicator.
• What is its mission statement? To what degree does it appear to be fulfilling it?
• What is its reputation as an employer? Do people want to work for this company? What are its
labour relations like? Does it pay its staff more than the average market rate?
• What is the size of its market? Does it trade in just one or two countries or worldwide?
• How strong is its competition? Is it in danger of takeover?
Which THREE are valid limitations of ratio analysis of published financial statements?
Published financial statements are frequently unreliable as a result either of fraud or of error
on the part of management.
Published financial statements contain estimates such as depreciation.
There are no prior year figures to compare to current year figures.
Accounting policies may vary between companies, making comparisons difficult.
The nature and character of a business may change over time, making strictly numerical
comparisons misleading.
The nature of the industry may be volatile, making intercompany comparison within the
industry misleading.
An analyst is comparing the non-current asset turnover ratios of two listed businesses engaged in
similar activities. The non-current asset turnover ratio of one entity is almost 50% higher than that
of the other entity, and she concludes that the entity with the higher non-current asset turnover
ratio is utilising its assets far more effectively.
Required
Which THREE of the following suggest this conclusion might not be valid?
One entity revalues its properties and the other entity holds its assets under the historical cost
model.
One entity buys its assets for cash and the other entity leases its assets under long-term
leases for all, or substantially all, the asset’s useful life.
One entity has assets nearing the end of their useful life, whilst the other entity has recently
acquired new assets.
One entity depreciates its assets over a much shorter useful life than the other entity.
One entity pays a higher rate of interest on its borrowings than the other.
One entity has significantly higher gearing than the other.
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PER alert
One of the competences you require to fulfil Performance Objective 8 of the PER is the ability
to identify inconsistencies between information in the financial statements of an entity and
accompanying narrative reports. You can apply the knowledge you obtain from this chapter
to help to demonstrate this competence.
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Chapter summary
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Knowledge diagnostic
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Further study guidance
Question practice
Now try the following from the Further question practice bank (available in the digital edition of
the Workbook):
29 Webster Co
Further reading
Performance appraisal
www.accaglobal.com
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Activity answers
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Neither interest nor borrowings feature in the asset turnover ratio, so the rate of interest an entity
pays is not relevant this year.
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Statement of cash flows
21
21
Learning objectives
On completion of this chapter, you should be able to:
Prepare a statement of cash flows for a single entity (not a group) D1(c)
in accordance with relevant IFRS Standards using the indirect
method.
Exam context
The preparation of statement of cash flows was first introduced in Financial Accounting. FR builds
on your previous knowledge by looking at the key calculations and introducing the interpretation
of the statement of cash flows. In the FR exam, you may be asked to prepare extracts from the
statement of cash flows in a Section C question or the preparation may be tested in the Objective
Test Questions in Section A or B of the exam.
In addition, in a Section C question, you may well be asked to interpret a statement of cash flows.
Therefore, detailed knowledge of how to perform this type of analysis is required.
21
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1 IAS 7 Statement of Cash Flows
Statement of cash flows: A useful component of the financial statements because it
KEY
TERM recognises that accounting profit is not the only indicator of a company’s performance.
2 Introduction
The purpose of the statement of cash flows is to show the effect of a company’s commercial
transactions on its cash balance.
It is thought that users of accounts can readily understand cash flows, as opposed to statements
of profit or loss and other comprehensive income and statements of financial position which are
subject to the effects of accounting policy choices and accounting estimates.
It has been argued that ‘profit’ does not always give a useful or meaningful picture of a
company’s operations. Readers of a company’s financial statements might even be misled by a
reported profit figure.
Shareholders might believe that if a company makes a profit after tax, of say, $100,000 then this
is the amount which it could afford to pay as a dividend. Unless the company has sufficient cash
in the business which is available to make a dividend payment, the shareholders’ expectations
would be wrong.
Cash flows are used in investment appraisal methods such as net present value and hence a
statement of cash flows gives potential investors the chance to evaluate a business.
2.2 Scope
A statement of cash flows should be presented as an integral part of an entity’s financial
statements. All types of entity can provide useful information about cash flows as the need for
cash is universal, whatever the nature of their revenue-producing activities. Therefore, all entities
are required by the standard to produce a statement of cash flows.
2.4 Definitions
The standard provides the following definitions.
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Cash flows: Inflows and outflows of cash and cash equivalents.
Operating activities: The principal revenue-producing activities of the entity and other
activities that are not investing or financing activities.
Investing activities: The acquisition and disposal of long-term assets and other investments
not included in cash equivalents.
Financing activities: Activities that result in changes in the size and composition of the
contributed equity and borrowings of the entity.
(IAS 7: para. 6).
3 Formats
IAS 7 Statement of Cash Flows allows two possible layouts for the statement of cash flows in
respect of operating activities:
(a) The indirect method, where profit before tax is reconciled to operating cash flow
(b) The direct method, where the cash flows themselves are shown
You will only be examined on the indirect method in your Financial Reporting exam.
Essential reading
Chapter 21 Sections 1 and 2 of the Essential reading recap your knowledge of the preparing a
statement of cash flows with an Activity on this topic using the indirect method.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
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The amount of cash flows arising from operating activities is a key indicator of the extent to which
the operations of the entity have generated sufficient cash flows to repay loans, maintain the
operating capability of the entity, pay dividends and make new investments without recourse to
external sources of finance.
$m $m
Cash flows from operating activities
Profit before taxation 3,390
Adjustments for:
Depreciation 380
Amortisation 75
Profit on sale of property, plant and equipment (5)
Investment income (500)
Interest expense 400
3,740
Decrease in inventories 1,050
Increase in trade and other receivables (500)
Decrease in trade payables (1,740)
Cash generated from operations 2,550
Interest paid (270)
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$m $m
Income taxes paid (900)
Net cash from operating activities 1,380
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4 Interpretation of statement of cash flows
4.1 Introduction
IAS 7 was introduced to enable users to evaluate an entity’s ability to generate cash and cash
equivalents and of its needs to utilise those cash flows.
While the statement of cash flows clearly shows the overall cash inflow or outflow for the period,
and the closing position of cash and cash equivalents, the individuals lines of the statement of
cash flow can be analysed to give users detailed information on how the entity has performed
during the period, and the areas which have generated significant cash inflows and outflows.
As has been seen, the statement of cash flows consists of three main areas. It is important to
understand what the cash flows from operating activities, investing activities and financing
activities tell us about the business’ activities.
Operating In order to continue long-term, the cash from operations figure should be
activities positive. If it is positive then the business will be generating funds from its core
activities, which suggests that it is a viable entity.
A healthy business would also expect to pay the interest and tax charge from
the cash generated from operations.
When you are analysing the cash flows relating to operating activities, consider
the movement in working capital. Does this suggest strong credit control (over
trade receivables), an inventories management system which is appropriate for
the level of sales the business is generating, and that trade payables are being
paid in a reasonable time frame? If not, then there may be issues with the
business’s day-to-day operations.
Investing If the business is seeking growth, there may well be a cash outflow in respect of
activities non-current assets. If the business is struggling then large items of property,
plant and equipment may be sold in order to generate short-term cash inflows.
Investment income will also be recorded in this section and therefore, interest
received or dividend income may feature here.
Financing In respect of financing, essentially the business will receive finance from two
activities main sources – share issues or loans.
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Profit is not as important as the extent to which a company can convert its profits into cash on a
continuing basis. This process should be judged over a period longer than one year. The cash
flows should be compared with profits over the same periods to decide how successfully the
reporting entity has converted earnings into cash.
Illustration 1: Tabba Co
Here is an example of how the position and performance of a company can be analysed using the
statement of financial position, profit or loss extracts and the statement of cash flows.
The following draft financial statements relate to Tabba Co, a private company:
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STATEMENTS OF FINANCIAL POSITION AS AT: 30 September 20X5 30 September 20X4
$’000 $’000 $’000 $’000
Current tax payable 100 5,650 1,200 5,900
Total equity and liabilities 18,600 21,450
STATEMENT OF PROFIT OR LOSS EXTRACT FOR THE YEAR ENDED 30 SEPTEMBER 20X5
$’000
Operating profit before interest and tax 270
Interest expense (260)
Interest receivable 40
Profit before tax 50
Income tax credit 50
Profit for the year 100
Note. The interest expense includes interest payable in respect of lease liabilities.
STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 30 SEPTEMBER 20X5
$’000 $’000
Cash flows from operating activities
Profit before taxation 50
Adjustments for:
Depreciation 2,200
Profit on disposal of PPE (Note (a)) (4,600)
Release of grant (250)
Increase in insurance claim receivable (300)
Interest expense 260
Investment income (40)
(2,680)
(Increase) decrease in inventories (700)
(Increase) decrease in trade & other receivables (500)
Increase (decrease) in trade payables 1,100
Cash used in operations (2,780)
Interest paid (260)
Income taxes paid (1,350)
Net cash outflow from operating activities (4,390)
Cash flows from investing activities
Interest received 40
Proceeds of grants 950
Proceeds of disposal of property 12,000
Purchase of property, plant and equipment (2,900)
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$’000 $’000
Net cash from investing activities 10,090
Cash flows from financing activities
Proceeds of loan (6% loan received) 800
Repayment of loan (10% loan repaid) (4,000)
Payments under leases (1,100)
Net cash used in financing activities (4,300)
Net increase in cash and cash equivalents 1,400
Opening cash and cash equivalents (550)
Closing cash and cash equivalents 850
Additional information
(1) During the year Tabba Co sold its factory for its fair value $12 million.
(2) Property plant and equipment includes plant acquired under lease contacts entered into
during the year which gave rise to right-of-use assets of $1.5 million. The initial measurement
of the right-of-use asset was equal to the present value of the future lease payments on
commencement of the lease.
Required
Using the information above, comment on the change in the financial position of Tabba Co during
the year ended 30 September 20X5.
Note. Note that you are not required to calculate any ratios.
Solution
Changes in Tabba Co’s financial position
The last section of the statement of cash flows reveals a healthy increase in cash of $1.4 million.
However, Tabba Co is losing cash on its operating activities and therefore its going concern status
must be in doubt.
To survive and thrive businesses must generate cash from their operations but Tabba Co has
absorbed a net cash outflow from operating activities of $2.68 million. Whereas most companies
report higher operating cash inflows than profits, Tabba Co has reported the reverse. The main
reason Tabba Co was able to report a profit was because of the one-off $4.6 million surplus on
disposal of property, plant and equipment. There were two other items that inflated profits
without generating cash; a $300,000 increase in the insurance claim receivable and a $250,000
release of a government grant. Without these three items Tabba Co would have reported a $5.1
million loss before tax.
Furthermore, were it not for the disposal proceeds of $12 million from the sale of its factory, Tabba
Co would be reporting a $10.6 million net decrease in cash. Tabba Co will not be able to sell the
factory for cash in the coming year, therefore, it seems likely that the forthcoming period will see
a large outflow of cash unless Tabba Co’s trading position improves.
Despite this downturn in trade Tabba Co’s working capital balances (inventories, trade receivables
and trade payables) have all increased in the year. (In respect of current assets inventories have
increased from $1.85 million and $2.55 million and trade receivables have increased from $2.6
million to $3.1 million.) This suggests poor financial management which in turn damages cash flow.
This is indicated by the increase in the level of payables (which have increased from $2.95 million
to $4.05 million). The increase in trade payables is an indication that the directors are managing
a lack of short-term cash inflows by delaying their payments to suppliers. This policy is not
sustainable.
The income tax paid of $1.35 million in relation to the previous period is high. This suggests that
Tabba Co’s fall from profitability has been swift and steep.
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There are some good signs though. Investment in non-current assets has continued, although $1.5
million of this was on right-of-use assets which are often a sign of cash shortages.
Some of the disposal proceeds have been used to redeem the expensive $4 million 10% loan and
replace it with a smaller and cheaper $800,000 6% loan. This will save $352,000 per annum.
Tabba Co’s recovery may depend on whether the circumstances causing the slump in profits can
be addressed and the company is able to generate an operating cash inflow in the near future.
The statement of cash flows has, however, highlighted some serious issues for the shareholders to
discuss with the directors at the annual general meeting.
$’000
Revenue 2,553
Cost of sales (1,814)
Gross profit 739
Other income: interest received 25
Distribution costs (125)
Administrative expenses (264)
Finance costs (75)
Profit before tax 300
Income tax expense (140)
Profit for the year 160
20X2 20X1
$’000 $’000
Assets
Non-current assets
Property, plant and equipment 380 305
Intangible assets 250 200
Investments – 25
Current assets
Inventories 150 102
Trade receivables 390 315
Short-term investments 50 –
Cash and cash equivalents 2 1
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20X2 20X1
$’000 $’000
Total assets 1,222 948
20X2 20X1
Equity and liabilities $’000 $’000
Equity
Share capital ($1 ordinary shares) 200 150
Share premium account 160 150
Revaluation surplus 100 91
Retained earnings 260 180
Non-current liabilities
Long-term loan 130 50
Environmental provision 40 -
Current liabilities
Trade and other payables 127 119
Bank overdraft 85 98
Taxation 120 110
Total equity and liabilities 1,222 948
$’000
$’000
Cash flows from operating activities
Profit before tax 300
Depreciation charge 90
Loss on sale of property, plant and equipment 13
Profit on sale of non-current asset investments (5)
Interest expense (net) 50
(Increase)/decrease in inventories (48)
(Increase)/decrease in trade receivables (75)
Increase/(decrease) in trade payables 8
333
Interest paid (75)
Dividends paid (80)
Tax paid (130)
Net cash from operating activities 48
Cash flows from investing activities
Payments to acquire property, plant and equipment (161)
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$’000
$’000
Payments to acquire intangible non-current assets (50)
Receipts from sales of property, plant and equipment 32
Receipts from sale of non-current asset investments 30
Interest received 25
Net cash flows from investing activities (124)
Cash flows from financing activities
Issue of share capital 60
Long-term loan 80
Net cash flows from financing 140
Increase in cash and cash equivalents 64
Cash and cash equivalents at 1.1.X2 (97)
Cash and cash equivalents at 31.12.X2 (33)
Required
Refer to the financial statements and additional information relating to Emma Co.
Using the information referenced above, comment on the change in the financial position of
Emma Co during the year ended 30 September 20X5.
Solution
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Activity 2: Financial adaptability
The following is an extract from the statement of cash flows of Quebec Co for the year ended 31
December 20X1:
$m
Cash flows from operating activities 600
Cash flows from investing activities (800)
Cash flows from financing activities (200)
Net decrease in cash and cash equivalents (400)
Cash and cash equivalents at the beginning of the period 100
Cash and cash equivalents at the end of the period (300)
Required
Based on the information provided, which of the following independent statements would be a
realistic conclusion about the financial adaptability of Quebec Co for the year ended 31
December 20X1?
The failure of Quebec Co to raise long-term finance to fund its investing activities has resulted
in a deterioration of Quebec Co’s financial adaptability and liquidity.
Quebec Co must be in decline as there is a negative cash flow relating to investing activities.
The management of Quebec Co has shown competent stewardship of the entity’s resources
by relying on an overdraft to fund the excess outflow on investing activities not covered by the
inflow from operating activities.
The working capital management of Quebec Co has deteriorated year on year.
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Illustration 2: Cash flow ratio
For the year ended 31 December 20X2, Emma Co’s net cash inflow is $48,000 and its total debt is
$502,000.
Required
Calculate Emma Co’s cash flow ratio as at 31 December 20X2. State your answer to 1 decimal
place.
Solution
Net cash inflow from operating activities 48,000
Total debt = 502,000 × 100 = 9.6%
Note. Note that to provide useful information in respect of the company, this ratio would need to
be compared to the cash flow ratio calculated using prior year financial information, budget
and/or industry benchmarks.
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There is also the practical problem that few businesses keep historical cash flow information in the
form needed to prepare a historical statement of cash flows and so extra record keeping is likely to
be necessary.
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Chapter summary
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Knowledge diagnostic
2. Formats
There are two methods of presenting statements of cash flows, the indirect method (which
reconciles profit to operating cash flows) and the direct method (which shows actual operating
cash flows). Only the indirect method is examined in your Financial Reporting studies.
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Further study guidance
Question practice
Now try the following from the Further question practice bank (available in the digital edition of
the Workbook):
32 Elmgrove Co
Further reading
ACCA has prepared a useful technical article on analysing a statement of cash flows, which is
available on its website:
Analysing cash flows
www.accaglobal.com
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Activity answers
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Specialised, not-for-
22 profit and public sector
entities
22
Learning objectives
On completion of this chapter, you should be able to:
Exam context
In the exam, you are likely to get an OTQ on the types of performance indicator used by not-for-
profit companies. You may also get asked to analyse a set of not-for-profit company financial
statements, commenting on any differences between the profit and not-for-profit ratios and
performance indicators used in each case.
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Specialised, not-for-profit and public sector entities
Non-profit focused IFRS Standards form the basis Three Es: Economy, efficiency,
for accounting standards effectiveness
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1 Primary aims of not-for-profit and public sector entities
Not-for-profit or public sector organisations are focussed on meeting the needs of various,
specialised groups, such as hospital users and local communities. You have already seen how
many profit-making companies use ratios to analyse performance, such as return on capital. In
this chapter, the focus is on analysing the performance of companies where the main driver is not
meeting shareholder expectations for dividends, instead the question is how the company
resources have been used or whether performance targets have been met (such as bed
occupancy in hospitals or staff training).
Examples:
• Government departments and agencies, both at national and regional levels
• Local councils
• Public-funded bodies providing health/social services (eg NHS in the UK)
• Education institutions (schools, universities, colleges)
• Charities
• Sporting bodies such as national teams or associations
Aims:
• Quality of service provision is often more important than profit
• Efficiency of use of resources is key
• Focus is often on breakeven rather than profit-making
• Need to satisfy a wide group of stakeholders
2 Regulatory framework
IFRS Standards are designed ‘to help participants in the various capital markets of the world and
other users of the information to make economic decisions’ (IASB, IASB Objectives).
The world’s capital markets tend to focus on profit and fair value (buy; hold; sell decisions) which
are concepts that are not so relevant to not-for-profit and public sector entities.
However, accountability is still very important for these entities as they often handle public funds.
The use of IFRS Standards, which are designed for ‘general purpose financial statements’, would
make the performance of not-for-profit and public sector entities more accountable and
comparable.
Accounting regimes that apply IFRS do not normally require the use of IFRS Standards for these
entities.
Other international or national bodies publish specific standards for these entities which are
applicable in some national regimes, eg:
(a) The International Federation of Accountants (IFAC) publishes International Public Sector
Accounting Standards (IPSAS), based on IFRS Standards, but adapted to the public sector.
National governments can choose to apply them.
(b) The UK publishes a Statement of Recommended Practice (SORP) for charities which, while
not compulsory, is seen as best practice.
3 Performance measurement
Profit is clearly not the key objective of a ‘not-for-profit’ organisation.
However, such organisations produce budgets, which their performance can be assessed against
and many of the performance indicators relating to efficiency (eg inventory management) will be
relevant to a not-for-profit organisation.
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3.1 The Three Es
The ‘Three Es’ (or value for money) are often a useful way of assessing performance for not-for-
profit and public sector entities:
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Activity 1: Council KPIs
Public sector entities have performance measures laid down by government, based on KPIs.
Which FOUR of the following are likely to be financial KPIs for a local council?
Rent receipts outstanding
Interest paid
P/E ratio
Interest cover
Dividend cover
Financial actuals against budget
Return on capital employed
Essential reading
There are additional activities and information available in Chapter 23 of the Essential reading.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
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Chapter summary
Non-profit focused IFRS Standards form the basis Three Es: Economy, efficiency,
• Government departments for accounting standards effectiveness
• Local councils • IPSAS 42 standards in issue • KPIs will be dependent on the
• Public funded bodies • SORP in the UK (non type of entity and the sector in
• Educational institutions compulsory) which they operate
• Charities • Problems with reporting can be
• Sporting bodies caused by:
– Multiple objectives
– Difficult of non-financial
indicators
– Comparison may be difficult
– Financial constraints
– Social, political and legal
barriers
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Knowledge diagnostic
2. Regulatory framework
IFAC produces a framework, based upon IFRS Standards, but which has additional guidance on
topics which are covered only in the not-for-profit and public sector (such as guidance on
governmental reporting).
3. Performance measurement
• The Three Es (economy, efficiency and effectiveness)
• Wide range of KPIs available which will be reported on dependent on the main objectives of the
entity
• Problems in reporting the performance include external issues such as political and legal
barriers, problems with comparison between different charities and the often limited resources
of the entity restricting the achievement of the objectives
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Further study guidance
Question practice
Now try the following from the Further question practice bank (available in the digital edition of
the Workbook):
3(b) Standard setters
33 Measurement
Further reading
ACCA has useful articles online, including two which are Performance Management articles, but
relevant to the FR qualification:
Not for profit organisations (part 1)
Not for profit organisations (part 2)
Performance appraisal (Financial Reporting article)
www.accaglobal.com
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Activity answers
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3
Tangible non-current
assets
Essential reading
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1.2 Definitions
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1.3 Recognition
The recognition of property, plant and equipment depends on two criteria:
It is probable that future economic benefits The cost of the asset to the entity
and
associated with the asset will flow to the entity can be measured reliably
The degree of certainty attached to the flow It is generally easy to measure the cost of an
of future economic benefits must be assessed. asset as the transfer amount on purchase, ie
This should be based on the evidence what was paid for it.
available at the date of initial recognition Self-constructed assets can also be measured
(usually the date of purchase). easily by adding together the purchase price
The entity will receive the rewards attached to of all the constituent parts (labour, material
the asset and it incur the associated risks, only etc) paid to external parties.
when the asset is controlled by the entity. See Section 1.6 below
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1.6.1 Components of cost
The standard lists the components of the cost of an item of property, plant and equipment.
The following costs will not be part of the cost of property, plant or equipment unless they can be
attributed directly to the asset’s acquisition or bringing it into its working condition.
• Administration and other general overhead costs
• Start-up and similar pre-production costs
• Initial operating losses before the asset reaches planned performance
All of these will be recognised as an expense rather than an asset (IAS 16: para. 11).
Note that IAS 16 was amended in May 2020 to make it clear that if a company incurs costs of
testing whether an asset is functioning properly, any proceeds earned by the company in selling
any items produced as a result of that testing should be accounted for in profit or loss.
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1.6.4 Exchanges of assets
If items of property, plant and equipment are exchanged, IAS 16 requires them to be measured at
fair value, unless:
Carry the asset at its historic cost less Carry the asset at a revalued amount, being its fair
• depreciation and value at the date of the revaluation less
• any accumulated impairment loss • depreciation and
• any accumulated impairment loss
The revised IAS 16 makes clear that the revaluation
model is available only if the fair value of the item
can be measured reliably.
1.7.2 Valuations
The market value of land and buildings usually represents fair value, assuming existing use and
line of business. Such valuations are usually carried out by professionally qualified valuers.
In the case of plant and equipment, fair value can also be taken as market value. Where a market
value is not available, however, depreciated replacement cost should be used. There may be no
market value where types of plant and equipment are sold only rarely or because of their
specialised nature (ie they would normally only be sold as part of an ongoing business) (IAS 16:
paras. 31–36).
Calculating revaluation gains and losses and the accounting for revaluations is covered in
Chapter 3 of the main workbook.
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1.8 Depreciation and impairment
The standard states:
• The depreciable amount of an item of property, plant and equipment should be allocated on a
systematic basis over its useful life.
• The depreciation method used should reflect the pattern in which the asset’s economic
benefits are consumed by the entity.
• The depreciation charge for each period should be recognised as an expense unless it is
included in the carrying amount of another asset.
(IAS 16: para. 48)
Land and buildings are dealt with separately even when they are acquired together because land
normally has an unlimited life and is therefore not depreciated. By contrast buildings do have a
limited life and must be depreciated. Any increase in the value of land on which a building is
standing will have no impact on the determination of the building’s useful life (IAS 16: para. 58).
Depreciation is covered in more detail in Section 2 below.
1.10 Derecognition
An entity is required to derecognise the carrying amount of an item of property, plant or
equipment that it disposes of on the date the criteria for the sale in IFRS 15 Revenue from
Contracts with Customers would be met. This also applies to parts of an asset (IAS 16: para. 68A).
An entity cannot classify as revenue a gain it realises on the disposal of an item of property,
plant and equipment (IAS 16: para. 68).
1.11 Disclosure
The standard has a long list of disclosure requirements, for each class of property, plant and
equipment.
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(a) Measurement bases for determining the gross carrying amount (if more than one, the gross
carrying amount for that basis in each category)
(b) Depreciation methods used
(c) Useful lives or depreciation rates used
(d) Gross carrying amount and accumulated depreciation (aggregated with accumulated
impairment losses) at the beginning and end of the period
(e) Reconciliation of the carrying amount at the beginning and end of the period showing:
(i) Additions
(ii) Disposals
(iii) Acquisitions through business combinations
(iv) Increases/decreases during the period from revaluations and from impairment losses
(v) Impairment losses recognised in profit or loss
(vi) Impairment losses reversed in profit or loss
(vii) Depreciation
(viii) Net exchange differences (from translation of statements of a foreign entity)
(ix) Any other movements
The financial statements should also disclose the following:
(a) Any recoverable amounts of property, plant and equipment
(b) Existence and amounts of restrictions on title, and items pledged as security for liabilities
(c) Accounting policy for the estimated costs of restoring the site
(d) Amount of expenditures on account of items in the course of construction
(e) Amount of commitments to acquisitions
Revalued assets require further disclosures.
(a) Basis used to revalue the assets
(b) Effective date of the revaluation
(c) Whether an independent valuer was involved
(d) Nature of any indices used to determine replacement cost
(e) Carrying amount of each class of property, plant and equipment that would have been
included in the financial statements, had the assets been carried at cost less accumulated
depreciation and accumulated impairment losses
(f) Revaluation surplus, indicating the movement for the period and any restrictions on the
distribution of the balance to shareholders
The standard also encourages disclosure of additional information, which the users of financial
statements may find useful.
(a) The carrying amount of temporarily idle property, plant and equipment
(b) The gross carrying amount of any fully depreciated property, plant and equipment that is
still in use
(c) The carrying amount of property, plant and equipment retired from active use and held for
disposal
(d) The fair value of property, plant and equipment when this is materially different from the
carrying amount
(IAS 16: paras. 73–77)
The following format (with notional figures) is commonly used to disclose non-current assets
movements.
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Land and Plant and
Total buildings equipment
$ $ $
Cost or valuation
At 1 January 20X4 50,000 40,000 10,000
Revaluation 12,000 12,000 –
Additions in year 4,000 – 4,000
Disposals in year (1,000) – (1,000)
At 31 December 20X4 65,000 52,000 13,000
Depreciation
At 1 January 20X4 16,000 10,000 6,000
Charge for year 4,000 1,000 3,000
Eliminated on disposals (500) – (500)
At 31 December 20X4 19,500 11,000 8,500
Carrying amount
At 31 December 20X4 45,500 41,000 4,500
At 1 January 20X4 34,000 30,000 4,000
2.2 Scope
Depreciation accounting is governed by IAS 16. These are some of the IAS 16 definitions
concerning depreciation.
Depreciation: The result of systematic allocation of the depreciable amount of an asset over
KEY
TERM its estimated useful life. Depreciation for the accounting period is charged to net profit or loss
for the period, either directly or indirectly.
Depreciable assets: Assets which:
• Are expected to be used during more than one accounting period
• Have a limited useful life
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• Are held by an entity for use in the production or supply of goods and services, for rental to
others, or for administrative purposes
Useful life: One of two things:
• The period over which a depreciable asset is expected to be used by the entity, or
• The number of production or similar units expected to be obtained from the asset by the
entity.
Depreciable amount: The depreciable amount of an asset is the historical cost or other
amount substituted for cost in the financial statements, less its estimated residual value (IAS
16: paras. 50–54).
An ‘amount substituted for cost’ will normally be a current market value after a revaluation has
taken place.
2.3 Depreciation
IAS 16 requires the depreciable amount of a depreciable asset to be allocated on a systematic
basis to each accounting period during the useful life of the asset. Every part of an item of
property, plant and equipment with a cost that is significant in relation to the total cost of the
item must be depreciated separately (IAS 16: para. 44).
One way of defining depreciation is to describe it as a means of spreading the cost of a non-
current asset over its useful life, and so matching the cost against the full period during which it
earns profits for the business. Depreciation charges are an example of the application of the
accrual assumption to calculate profits.
The need for depreciation of non-current assets arises from the accruals assumption. If money is
expended in purchasing an asset, then the amount expended must at some time be charged
against profits. If the asset is one which contributes to an entity’s revenue over a number of
accounting periods, it would be inappropriate to charge any single period with the whole of the
expenditure. Thus, this is a method where the cost is spread over the useful life of the asset.
There are situations where, over a period, an asset has increased in value, ie its current value is
greater than the carrying amount in the financial statements. You might think that in such
situations it would not be necessary to depreciate the asset. The standard states, however, that
this is irrelevant, and that depreciation should still be charged to each accounting period, based
on the depreciable amount, irrespective of a rise in value (IAS 16: para. 52).
An entity is required to begin depreciating an item of property, plant and equipment when it is
available for use and to continue depreciating it until it is derecognised, even if it is idle during the
period (IAS 16: para. 55).
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programme and so on. Other factors to be considered include obsolescence (due to technological
advances/improvements in production/reduction in demand for the product/service produced by
the asset) and legal restrictions, eg length of a related lease (IAS 16: para. 57).
Bashful Co acquired a non-current asset on 1 January 20X2 for $80,000. It had no residual value
and a useful life of ten years.
On 1 January 20X5, the remaining useful life was reviewed and revised to four years.
Required
What will be the depreciation charge for 20X5?
Solution
$
Original cost 80,000
Depreciation 20X2 – 20X4 (80,000 × 3/10) (24,000)
Carrying amount at 31 December 20X4 56,000
Remaining life 4 years
Depreciation charge years 20X5 – 20X8 (56,000/4) 14,000
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method should be changed to suit this changed pattern. When such a change in depreciation
method takes place, the change should be accounted for as a change in accounting estimate
and the depreciation charge for the current and future periods should be adjusted (IAS 16: para.
61).
2.7 Disclosure
An accounting policy note should disclose the valuation bases used for determining the amounts
at which depreciable assets are stated, along with the other accounting policies.
IAS 16 also requires the following to be disclosed for each major class of depreciable asset.
• Depreciation methods used
• Useful lives or the depreciation rates used
• Total depreciation allocated for the period
• Gross amount of depreciable assets and the related accumulated depreciation
(IAS 16: paras. 73–78)
Activity 7: Depreciation
A lorry bought for Titan Co cost $17,000. It is expected to last for five years and then be sold for
scrap for $2,000. Usage over the five years is expected to be:
Year 5 40 days
Required
Calculate the depreciation to be charged each year under:
(1) The straight-line method
(2) The reducing balance method (using a rate of 35%)
(3) The machine hour method
Solution
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3 Investment property (IAS 40)
3.1 Fair value model
Fair value model: After initial recognition, an entity that chooses the fair value model should
KEY
TERM measure all of its investment property at fair value, except in the extremely rare cases where
this cannot be measured reliably. In such cases, it should apply the IAS 16 cost model.
A gain or loss arising from a change in the fair value of an investment property should be
recognised in net profit or loss for the period in which it arises.
The fair value of investment property should reflect market conditions at the end of the
reporting period (IAS 40: paras. 33, 35, 40).
The fair value model for investment property is not the same as a revaluation, where increases in
carrying amount above a cost-based measure are recognised as revaluation surplus. Under the
fair-value model, all changes in fair value are recognised in profit or loss.
The standard elaborates on issues relating to fair value.
(a) Fair value assumes that an orderly transaction has taken place between market participants,
ie both buyer and seller are reasonably informed about the nature and characteristics of the
investment property.
(b) A buyer participating in an orderly transaction is motivated but not compelled to buy. A
seller participating in an orderly transaction is neither an over-eager nor a forced seller, nor
one prepared to sell at any price or to hold out for a price not considered reasonable in the
current market.
(c) Fair value is not the same as ‘value in use’ as defined in IAS 36 Impairment of Assets. Value in
use reflects factors and knowledge specific to the entity, while fair value reflects factors and
knowledge relevant to the market.
(d) In determining fair value, an entity should not double count assets. For example, elevators or
air conditioning are often an integral part of a building and should be included in the
investment property, rather than recognised separately.
(e) When a lessee uses the fair value model to measure an investment property that is held as a
right-of-use asset, it shall measure the right-of-use asset, and not the underlying property,
at fair value.
(f) In those rare cases where the entity cannot determine the fair value of an investment
property reliably, the cost model in IAS 16 must be applied until the investment property is
disposed of. The residual value must be assumed to be zero.
(g) When lease payments are at market rates, the fair value of an investment property held by a
lessee as a right-of-use asset, net of all expected lease payments, should be zero (IAS 40:
paras. 50–55).
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3.3 Changing models
Once the entity has chosen the fair value or cost model, it should apply it to all its investment
property. It should not change from one model to the other, unless the change will result in a
more appropriate presentation. IAS 40 states that it is highly unlikely that a change from the fair
value model to the cost model will result in a more appropriate presentation (IAS 40: para. 31).
4 Borrowing costs
4.1 Commencement of capitalisation
Three events or transactions must be taking place for capitalisation of borrowing costs to be
started.
(a) Expenditure on the asset is being incurred
(b) Borrowing costs are being incurred
(c) Activities are in progress that are necessary to prepare the asset for its intended use or sale
Expenditure must result in the payment of cash, transfer of other assets or assumption of interest-
bearing liabilities. Deductions from expenditure will be made for any progress payments or grants
received in connection with the asset. IAS 23 allows the average carrying amount of the asset
during a period (including borrowing costs previously capitalised) to be used as a reasonable
approximation of the expenditure to which the capitalisation rate is applied in the period.
Presumably, more exact calculations can be used.
Activities necessary to prepare the asset for its intended sale or use extend further than physical
construction work. They encompass technical and administrative work prior to construction, eg
obtaining permits. They do not include holding an asset when no production or development that
changes the asset’s condition is taking place, eg where land is held without any associated
development activity (IAS 23: paras. 17–19).
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Activity answers
Activity 7: Depreciation
(1) Under the straight line method, depreciation for each of the five years is:
Annual depreciation = $(17,000 – 2,000)/5 = $3,000
(2) Under the reducing balance method, depreciation for each of the five years is:
Year Depreciation
1 35% × $17,000 $5,950
2 35% × ($17,000 - $5,950) = 35% × $11,050 $3,868
3 35% × ($11,050 - $3,868) = 35% × $7,182 $2,514
4 35% × ($7,182 - $2,514) = 35% × $4,668 $1,634
Balance to bring carrying amount down to $2,000 = $4,668 - $1,634 -
5 $2,000 $1,034
(3) Under the machine hour method, depreciation for each of the five years is calculated as
follows.
Total usage (days) = 200 + 100 + 100 + 150 + 40 = 590 days
Depreciation per day = $(17,000 – 2,000)/ 590 = $25.42
Note. The answer does not come to exactly $15,000 because of the rounding carried out at the
‘depreciation per day’ stage of the calculation.
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4
Intangible assets
Essential reading
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2.1 Research
Research activities by definition do not meet the criteria for recognition under IAS 38. This is
because, at the research stage of a project, it cannot be certain that future economic benefits will
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probably flow to the entity from the project. There is too much uncertainty about the likely
success or otherwise of the project. .
Research costs should therefore be written off as an expense as they are incurred
Examples of research costs from IAS 38:
(a) Activities aimed at obtaining new knowledge
(b) The search for, evaluation and final selection of, applications of research findings or other
knowledge
(c) The search for alternatives for materials, devices, products, processes, systems or services
(d) The formulation, design evaluation and final selection of possible alternatives for new or
improved materials, devices, products, systems or services
(IAS 38: paras. 54–56)
2.2 Development
Development costs may qualify for recognition as intangible assets provided that the following
strict ‘PIRATE’ criteria can be demonstrated.
Probable future economic benefits for the entity. The entity should demonstrate the existence of a
market for the output of the intangible asset or the intangible asset itself or the usefulness of the
intangible asset to the business.
Intention to complete the intangible asset and use or sell it.
Resources (technical, financial and other) are available to complete the development and to use
or sell the intangible asset.
Ability to use or sell the intangible asset.
Technical feasibility of the project and the ability to complete the project to generate an asset for
use or sale.
Expenditure attributable to the intangible asset during its development can be measured reliably.
In contrast with research costs, development costs are incurred at a later stage in a project, and
the probability of success should be more apparent. Examples of development costs include:
(a) The design, construction and testing of pre-production or pre-use prototypes and models
(b) The design of tools, jigs, moulds and dies involving new technology
(c) The design, construction and operation of a pilot plant that is not of a scale economically
feasible for commercial production
(d) The design, construction and testing of a chosen alternative for new or improved materials,
devices, products, processes, systems or services
(IAS 38: paras. 57–62)
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5
Impairment of assets
Essential reading
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2 Further activities
Activity 5: Impairment loss individual asset
Grohl Co, a company that extracts natural gas and oil, has a drilling platform in the Caspian
Sea. It is required by legislation of the country concerned to remove and dismantle the platform at
the end of its useful life. Accordingly, Grohl Co has included an amount in its accounts for
removal and dismantling costs and is depreciating this amount over the platform’s useful life.
Grohl Co is carrying out an exercise to establish whether there has been an impairment of the
platform.
(1) Its carrying amount in the statement of financial position is $3 million.
(2) The company has received an offer of $2.8 million for the platform from another oil company.
The bidder would take over the responsibility (and costs) for dismantling and removing the
platform at the end of its life.
(3) The value in use of the estimated cash flows from the platform’s continued use is $3.3 million
(before adjusting for dismantling costs of $0.6 million).
Required
That should be the value of the drilling platform in the statement of financial position, and what, if
anything, is the impairment loss?
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Solution
Biscuit Co has acquired another business for $4.5 million: non-current assets are valued at $4.0
million and goodwill at $0.5 million.
An asset with a carrying amount of $1 million is destroyed in a terrorist attack. The asset was not
insured. The loss of the asset, without insurance, has prompted the company to assess whether
there has been an impairment of assets in the acquired business and what the amount of any
such loss is.
The recoverable amount of the business (a single cash-generating unit) is measured as $3.1
million.
Required
Calculate the impairment loss and revised carrying amounts of the tangible assets and goodwill
in the revised financial statements. Note. Extracts are not required.
Solution
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Activity answers
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6
Revenue and
government grants
Essential reading
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Arturo Co receives a government grant representing 50% of the cost of a depreciating asset which
costs $40,000. How will the grant be recognised if Arturo Co depreciates the asset:
1 Over four years straight line; or
2 At 40% reducing balance?
Note. The residual value is nil. The useful life is four years.
Solution
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Activity 10: Accounting for grants related to assets
StarStruck Co receives a 20% grant towards the cost of a new item of machinery, which cost
$100,000. The machinery has a useful life of four years and a nil residual value. The expected
profits of Starstruck Co, before accounting for depreciation on the new machine or the grant,
amount to $50,000 per annum in each year of the machinery’s life.
Required
Show the effect on profit and the accounting treatment if the grant is accounted for by
1 Offsetting the grant income against the cost of the asset
2 Treating the grant as deferred income
Solution
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Activity answers
Straight line
Depreciation Grant income
$ $
Year 1 10,000 5,000
Year 2 10,000 5,000
Year 3 10,000 5,000
Year 4 10,000 5,000
Reducing balance
Depreciation Grant income
$ $
Year 1 16,000 8,000
Year 2 9,600 4,800
Year 3 5,760 2,880
Year 4 (remainder) 8,640 4,320
*The depreciation charge on a straight line basis, for each year, is ¼ of $(100,000 - 20,000) =
$20,000.
Statement of financial position at year end (extract)
$ $ $ $
Non-current asset 80,000 80,000 80,000 80,000
Depreciation 25% 20,000 40,000 60,000 80,000
Carrying amount 60,000 40,000 20,000 –
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2
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7
Introduction to groups
Essential reading
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2 Goodwill
2.1 What is goodwill?
Goodwill is created by good relationships between a business and its customers.
(a) By building up a reputation (by word of mouth perhaps) for high quality products or high
standards of service
(b) By responding promptly and helpfully to queries and complaints from customers
(c) Through the personality of the staff and their attitudes to customers
The value of goodwill to a business might be considerable. However, goodwill is not usually valued
in the accounts of a business at all, and we should not normally expect to find an amount for
goodwill in its statement of financial position. For example, the welcoming smile of the bar staff
may contribute more to a bar’s profits than the fact that a new electronic cash register has
recently been acquired. Even so, whereas the cash register will be recorded in the accounts as a
non-current asset, the value of staff would be ignored for accounting purposes.
On reflection, we might agree with this omission of goodwill from the accounts of a business.
(a) The goodwill is inherent in the business but it has not been paid for, and it does not have an
‘objective’ value. We can guess at what such goodwill is worth, but such guesswork would be
a matter of individual opinion, and not based on hard facts.
(b) Goodwill changes from day to day. One act of bad customer relations might damage
goodwill and one act of good relations might improve it. Staff with a favourable personality
might retire or leave to find another job, to be replaced by staff who need time to find their
feet in the job, etc. Since goodwill is continually changing in value, it cannot realistically be
recorded in the accounts of the business.
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either buy their own long-term assets and inventory and set up their business from scratch, or
they can buy up an existing business from a proprietor willing to sell it. When a buyer purchases
an existing business, he will have to purchase not only its long-term assets and inventory (and
perhaps take over its accounts payable and receivable too) but also the goodwill of the business.
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3 Consistent accounting policies and year ends
3.1 Accounting policies
As the group reports a single economic entity, uniform accounting policies must be used in the
consolidated financial statements (IFRS 10: para. 19).
If a member of the group does not use the same accounting policies as used in the consolidated
financial statements, consolidation adjustments must be made to align them.
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8
The consolidated
statement of financial
position
Essential reading
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Example
The parent acquired 75% of the subsidiary’s 80 million $1 shares on 1 January 20X6. It paid $3.50
per share and agreed to pay a further $108 million on 1 January 20X7.
The parent company’s cost of capital is 8%.
In the financial statements for the year to 31 December 20X6, the cost of the combination will be:
$m
80m shares × 75% × $3.50 210
Deferred consideration: $108m × 1/1.08 100
Total consideration 310
At 31 December 20X6, $8 million will be charged to finance costs, being the unwinding of the
discount on the deferred consideration. The deferred consideration was discounted by $8 million
to allow for the time value of money. At 1 January 20X7, the full amount becomes payable.
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1.3 Share exchange
Example
Assume the parent has acquired 12,000 $1 shares in the subsidiary by issuing five of its own $1
shares for every four shares in the subsidiary. The market value of the parent company’s shares is
$6.
Consideration:
$
12,000 × 5/4 × $6 90,000
Note that this is credited to the share capital and share premium of the parent company as
follows:
Debit Credit
Investment in subsidiary 90,000
Share capital ($12,000 × 5/4) 15,000
Share premium ($12,000 × 5/4 × 5) 75,000
Level 1 Quoted prices in active markets for identical assets that the entity can access
at the measurement date (IFRS 13: para. 76)
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Level 2 Inputs other than quoted prices that are directly or indirectly observable for the
asset (IFRS 13: para. 81)
Level 3 Unobservable inputs for the asset (IFRS 13: para. 86)
We will look at the requirements of IFRS 3 regarding fair value in more detail below. First, let us
look at a practical example.
Illustration 6: Land
Anscome Co has acquired land in a business combination. The land is currently developed for
industrial use as a site for a factory. The current use of land is presumed to be its highest and best
use unless market or other factors suggest a different use. Nearby sites have recently been
developed for residential use as sites for high-rise apartment buildings. On the basis of that
development and recent zoning and other changes to facilitate that development, Anscome
determines that the land currently used as a site for a factory could be developed as a site for
residential use (ie for high-rise apartment buildings) because market participants would take into
account the potential to develop the site for residential use when pricing the land.
Required
How would the highest and best use of the land be determined?
Solution
The highest and best use of the land would be determined by comparing both of the following:
(1) The value of the land as currently developed for industrial use (ie the land would be used in
combination with other assets, such as the factory, or with other assets and liabilities).
(2) The value of the land as a vacant site for residential use, taking into account the costs of
demolishing the factory and other costs (including the uncertainty about whether the entity
would be able to convert the asset to the alternative use) necessary to convert the land to a
vacant site (ie the land is to be used by market participants on a stand-alone basis).
The highest and best use of the land would be determined on the basis of the higher of those
values.
2.1 IFRS 3
IFRS 3 sets out general principles for arriving at the fair values of a subsidiary’s assets and
liabilities (IFRS 3: para. 18). The acquirer should recognise the acquiree’s identifiable assets,
liabilities and contingent liabilities at the acquisition date only if they satisfy the following criteria.
(a) In the case of an asset other than an intangible asset, it is probable that any associated
future economic benefits will flow to the acquirer, and its fair value can be measured
reliably.
(b) In the case of a liability other than a contingent liability, it is probable that an outflow of
resources embodying economic benefits will be required to settle the obligation, and its fair
value can be measured reliably.
(c) In the case of an intangible asset or a contingent liability, its fair value can be measured
reliably.
The acquiree’s identifiable assets and liabilities might include assets and liabilities not previously
recognised in the acquiree’s financial statements. For example, a tax benefit arising from the
acquiree’s tax losses that was not recognised by the acquiree may be recognised by the group if
the acquirer has future taxable profits against which the unrecognised tax benefit can be applied.
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IFRS 3 explains that a plan to restructure a subsidiary following an acquisition is not a present
obligation of the acquiree at the acquisition date. Neither does it meet the definition of a
contingent liability. Therefore, an acquirer should not recognise a liability for such a
restructuring plan as part of allocating the cost of the combination unless the subsidiary was
already committed to the plan before the acquisition.
This prevents creative accounting. An acquirer cannot set up a provision for restructuring or
future losses of a subsidiary and then release this provision to the profit or loss in subsequent
periods in order to reduce losses or smooth profits.
On 1 January 20X5, Sutherland Co acquired 80,000 $1 shares in Underhill Co at $4.50 per share.
Consideration was paid in cash and in full on the acquisition date.
The financial statements prepared by Underhill Co as at 31 December 20X4 showed retained
earnings of $220,000 with total ordinary share capital of $100,000.
On 22 November 20X4, legal proceedings commenced against Underhill Co, which the legal team
have estimated to be a potential liability against the company of $80,000. A contingent liability in
respect of the legal proceedings was disclosed in the Notes to the financial statements of Underhill
Co as at 31 December 20X4. The fair value of the contingent liability has been assessed as
$80,000 at the date of acquisition.
It is group policy to recognise NCI at full (fair) value.
Required
Calculate the goodwill on the acquisition of Underhill Co that will be included in the consolidated
financial statements of the Sutherland Co group for the year ended 31 December 20X5.
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Solution
The draft statements of financial position of Ping Co and Pong Co on 30 June 20X8 were as
follows:
STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE 20X8
Ping Co Pong Co
$ $
Assets
Non-current assets
Property, plant and equipment 50,000 40,000
20,000 ordinary shares in Pong Co at cost 30,000
80,000
Current assets
Inventories 3,000 8,000
Owed by Ping Co 10,000
Trade receivables 16,000 7,000
Cash and cash equivalents 2,000 –
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Ping Co Pong Co
$ $
21,000 25,000
Total assets 101,000 65,000
Equity and liabilities
Equity
Ordinary shares of $1 each 45,000 25,000
Revaluation surplus 12,000 5,000
Retained earnings 26,000 28,000
83,000 58,000
Current liabilities
Owed to Pong Co 8,000 –
Trade and other payables 10,000 7,000
18,000 7,000
Total equity and liabilities 101,000 65,000
Ping Co acquired its investment in Pong Co on 1 July 20X7 when the retained earnings of Pong Co
stood at $6,000. The agreed consideration was $30,000 cash and a further $10,000 on 1 July
20X9. Ping Co’s cost of capital is 7%. Pong Co has an internally-developed brand name – ‘Pongo’
– which was valued at $5,000 at the date of acquisition. There have been no changes in the share
capital or revaluation surplus of Pong Co since that date. At 30 June 20X8, Pong Co had invoiced
Ping Co for goods to the value of $2,000 and Ping Co had sent payment in full but this had not
been received by Pong Co.
There is no impairment of goodwill. It is group policy to value NCI at full fair value. At the
acquisition date the NCI was valued at $9,000.
Required
Prepare the consolidated statement of financial position of Ping Co as at 30 June 20X8.
Solution
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Activity 10: Consolidated statement of financial position II
On 1 September 20X7, Tyzo Co acquired six million $1 shares in Kono Co at $2.00 per share. At
that date Kono Co produced the following interim financial statements:
$m $m
Property, plant and equipment Trade payables 3.2
(note (i)) 16.0 Taxation 0.6
Inventories (note (ii)) 4.0 Bank overdraft 3.9
Receivables 2.9 Long-term loans 4.0
Cash in hand 1.2 Share capital ($1 shares) 8.0
Retained earnings 4.4
24.1 24.1
Notes.
1 The following information relates to the property, plant and equipment of Kono Co at 1
September 20X7 (see table below).
2 The inventories of Kono Co which were shown in the interim financial statements are raw
materials at cost to Kono Co of $4 million. They would have cost $4.2 million to replace at 1
September 20X7.
3 On 1 September 20X7, Tyzo Co took a decision to rationalise the group to integrate Kono Co.
The costs of the rationalisation were estimated to total $3 million and the process was due to
start on 1 March 20X8. No provision for these costs has been made in the financial statements
given above.
4 It is group policy to recognise NCI at full (fair) value.
$m
Gross replacement cost 28.4
Net replacement cost (gross replacement cost less depreciation) 16.6
Economic value 18.0
Net realisable value 8.0
Required
Compute the goodwill on consolidation of Kono Co that will be included in the consolidated
financial statements of the Tyzo Co group for the year ended 31 December 20X7, explaining your
treatment of the items mentioned above. You should refer to the provisions of relevant accounting
standards.
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Solution
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Activity answers
$000 $000
Consideration ($4.50 × 80,000) 360,000
Fair value of net assets acquired
Share capital 100,000
Pre-acquisition reserves 220,000
Less contingent liability (80,000)
(240,000)
Goodwill 120,000
Group
$
Consideration transferred (W2) 38,734
Fair value of NCI 9,000
Net assets acquired as represented by:
Ordinary share capital 25,000
Revaluation surplus on acquisition 5,000
Retained earnings on acquisition 6,000
Intangible asset – brand name 5,000
(41,000)
Goodwill 6,734
$
Cash paid 30,000
Fair value of deferred consideration (10,000 × 1/(1.072*)) 8,734
38,734
*Note that the deferred consideration has been discounted at 7% for two years (1 July 20X7 to 1
July 20X9).
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However, at the date of the current financial statements, 30 June 20X8, the discount for one year
has unwound. The amount of the discount unwound is:
$
(10,000 × 1/1.07) – 8,734 612
This amount will be charged to finance costs in the consolidated financial statements and the
deferred consideration under liabilities will be shown as $9,346 ($8,734 + $612).
(3) Calculate consolidated reserves
Consolidated revaluation surplus
$
Ping Co 12,000
Share of Pong Co’s post acquisition revaluation surplus –
12,000
Ping Pong
$ $
Retained earnings per question 26,000 28,000
Less pre-acquisition (6,000)
22,000
Discount unwound – finance costs (612)
Share of Pong: 80% × $22,000 17,600
42,988
$
Fair value of NCI 9,000
Share of post-acquisition retained earnings (22,000 × 20%) 4,400
13,400
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(6) Prepare the consolidated statement of financial position.
PING CO
CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE 20X8
$ $
Assets
Non-current assets
Property, plant and equipment (50,000 + 40,000) 90,000
Intangible assets: Goodwill (W1) 6,734
Brand name (W1) 5,000
Current assets
Inventories (3,000 + 8,000) 11,000
Trade receivables (16,000 + 7,000) 23,000
Cash and cash equivalents (2,000 + 2,000) 4,000
38,000
Total assets 139,734
Equity and liabilities
Equity
Ordinary shares of $1 each 45,000
Revaluation surplus (W3) 12,000
Retained earnings (W3) 42,988
99,988
NCI (W4) 13,400
113,388
Current liabilities
Trade and other payables (10,000 + 7,000) 17,000
Deferred consideration (W2) 9,346
Total equity and liabilities 139,734
$m $m
Consideration transferred ($2.00 × 6m) 12.0
NCI ($2.00 × 2m) 4.0
Fair value of net assets acquired
Share capital 8.0
Pre-acquisition reserves 4.4
Fair value adjustments
Property, plant and equipment (16.6 – 16.0) 0.6
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$m $m
Inventories (4.2 – 4.0) 0.2
(13.2)
Goodwill 2.8
Notes.
1 Share capital and pre-acquisition profits represent the carrying amount of the net assets of
Kono Co at the date of acquisition. Adjustments are then required to this book value in order to
give the fair value of the net assets at the date of acquisition. For short-term monetary items,
fair value is their carrying value on acquisition.
2 IFRS 3 states that the fair value of property, plant and equipment should be determined by
market value or, if information on a market price is not available (as is the case here), then by
reference to depreciated replacement cost, reflecting normal business practice. The net
replacement cost (ie $16.6 million) represents the gross replacement cost less depreciation
based on that amount, and so further adjustment for extra depreciation is unnecessary.
3 IFRS 3 also states that raw materials should be valued at replacement cost. In this case, that
amount is $4.2 million.
4 The rationalisation costs cannot be reported in pre-acquisition results under IFRS 3 as they are
not a liability of Kono Co at the acquisition date.
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9
The consolidated
statement of profit or
loss and other
comprehensive income
Essential reading
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Dougal Co acquired 60% of the $100,000 equity of Ted Co on 1 April 20X5. The statements of
profit or loss of the two companies for the year ended 31 December 20X5 are set out below:
$ $
Dividends (paid 31 December) 12,000 6,000
Profit retained 30,600 18,000
Retained earnings brought forward 81,000 40,000
Retained earnings carried forward 111,600 58,000
Required
Prepare the consolidated statement of profit or loss and the retained earnings and non-controlling
interest extracts from the statement of changes in equity.
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Solution
PFY TCI
$ $
S’s PFY/TCI per the question X X
Consolidation adjustments affecting the subsidiary’s profit, eg:
(X) (X)
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PFY TCI
$ $
• Impairment loss on goodwill for the year (if NCI is measured
at fair value at acquisition)
• Provision for unrealised profit (if the subsidiary is the seller) (X) (X)
• Fair value adjustment – movement in the year (X)/X (X)/X
A B
NCI share NCI % × A NCI % × B
P acquired 60% of the ordinary share capital of S on 1 January 20X0. At 1 January 20X0, the fair
value of S’s net assets was the same as their carrying amount with the exception of a factory. The
fair value of the factory was $500,000 higher than its carrying amount. At acquisition, the
remaining useful life of the factory was 20 years. Depreciation on the factory is presented in cost
of sales.
In the year ended 31 December 20X4, P and S had cost of sales of $900,000 and $700,000
respectively and profits for the year of $3.9 million and $2.1 million respectively.
Required
Calculate the following figures for inclusion in the consolidated statement of profit or loss of the P
Group for the year ended 31 December 20X4:
Required
Calculate the following figures for inclusion in the consolidated statement of profit or loss of the P
Group for the year ended 31 December 20X4:
(1) Cost of sales
(2) Profit for the year attributable to non-controlling interest
Solution
Step 1: Calculate the movement in the fair value adjustments in the year
= $500,000 fair value adjustment on factory × 1/20 depreciation = $25,000
Step 2: Calculate consolidated cost of sales
$’000
P 900
S 700
Fair value adjustment - movement in the year (25)
1,575
$’000
Per question 2,100
Fair value adjustment - movement in the year (25)
2,075
NCI share × 40%
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$’000
= 830
Tutorial note. It is only the depreciation of the fair value adjustment for one year that is
relevant to the consolidated SPLOCI
WX acquired 90% of YZ’s ordinary shares on 1 January 20X9. The following fair value adjustments
were required for YZ’s net assets:
$’000
Property, plant and equipment (remaining useful life of 10 years) 400
Intangible assets not previously recognised (useful life of five years) 100
Inventories (sold in the year ended 31 December 20X9) 50
Contingent liability (settled in the year ended 31 December 20X9) (80)
In the year ended 31 December 20X9, YZ made a profit before tax of $2,800,000 and a profit for
the year of $2 million. WX’s profit before tax was $6.1 million.
Required
Calculate the following figures for inclusion in the consolidated statement of profit or loss of the
WX Group for the year ended 31 December 20X9:
Solution
1
$’000
WX
YZ
PFY
$’000
Per question
NCI share
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Working
Fair value adjustment - movement in the year
$’000
Inventories
Contingent liability
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Activity answers
$
Revenue (170 + 60) 230,000
Cost of sales (65 + 27) (92,000)
Gross profit 138,000
Administrative expenses (43 + 9) (52,000)
Profit before tax 86,000
Income tax expense (23 + 6) (29,000)
Profit for the year 57,000
Profit attributable to:
Owners of the parent (balancing figure) 49,800
Non-controlling interest (18 × 40%) 7,200
57,000
Non-controlling
Retained earnings interest
$ $
Balance at 1 January 20X5 81,000 –
Dividends paid (NCI: 6,000 × 40%) (12,000) (2,400)
Total comprehensive income for the year 49,800 7,200
Added on acquisition of subsidiary (W) – 58,400
Balance at 31 December 20X5 118,800 63,200
Note that all of Ted Co’s profits brought forward are pre‑acquisition.
Working
NCI on acquisition of subsidiary
$
Added on acquisition of subsidiary:
Share capital 100,000
Retained earnings brought forward 40,000
Profits Jan-March 20X5 (24,000 – 18,000) 6,000
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$
146,000
Non-controlling share 40% 58,400
$’000
WX 6,100
YZ 2,800
8,870
PFY
$’000
1,970
= 197
Working
Fair value adjustment - movement in the year
$’000
Inventories (50)
Contingent liability 80
(30)
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10
Accounting for
associates
Essential reading
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The statements of financial position of John Co and its investee companies, Paul Co and George
Co, at 31 December 20X5 are shown below.
STATEMENTS OF FINANCIAL POSITION AS AT 31 DECEMBER 20X5
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John Co Paul Co George Co
$’000 $’000 $’000
Cash and cash equivalents 50 120 20
955 710 655
Total assets 5,200 2,335 1,440
Equity and liabilities
Equity
Share capital – $1 shares 2,000 1,000 750
Retained earnings 1,460 885 390
3,460 1,885 1,140
Non-current liabilities
12% loan stock 500 100 –
Current liabilities
Trade and other payables 680 350 300
Bank overdraft 560 – –
1,240 350 300
Total equity and liabilities 5,200 2,335 1,440
Additional information
(1) John Co acquired 600,000 ordinary shares in Paul Co on 1 January 20X0 for $1,000,000
when the retained earnings of Paul Co were $200,000.
(2) At the date of acquisition of Paul Co, the fair value of its freehold property was considered to
be $400,000 greater than its value in Paul Co’s statement of financial position. Paul Co had
acquired the property in January 20W0 and the buildings element (comprising 50% of the
total value) is depreciated on cost over 50 years.
(3) John Co acquired 225,000 ordinary shares in George Co on 1 January 20X4 for $500,000
when the retained earnings of George Co were $150,000.
(4) Paul Co manufactures a component, the Ringo, used by both John Co and George Co.
Transfers are made by Paul Co at cost plus 25%. John Co held $100,000 inventory of the
Ringo at 31 December 20X5. In the same period, John Co sold goods to George Co, of which
George Co had $80,000 in inventory at 31 December 20X5. John Co had marked these
goods up by 25%.
(5) The goodwill in Paul Co is impaired and should be fully written off. An impairment loss of
$92,000 is to be recognised on the investment in George Co.
(6) Non-controlling interest is valued at full fair value. Paul Co shares were trading at $1.60 just
prior to the acquisition by John Co.
Required
Prepare, using the proformas below, in a format suitable for inclusion in the annual report of the
John Group, the consolidated statement of financial position at 31 December 20X5.
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Solution
1
$’000
Non-current assets
Current assets
Inventories (W3)
Receivables
Total assets
Equity
Share capital
Non-current liabilities
Current liabilities
Workings
1 Group structure
2 Freehold property
$’000
John Co
Paul Co
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$’000
Additional depreciation
3 Inventory
$’000
John Co
Paul Co
$’000
$’000 $’000
Property
Additional depreciation:
6 Goodwill
$’000 $’000
Paul Co
Consideration transferred
Non-controlling interest
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$’000 $’000
Share capital
Retained earnings
Goodwill at acquisition
Impairment loss
7 Investment in associate
$’000
Cost of investment
Less PUP
8 Retained earnings
Adjustments
Paul Co:
George Co:
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John Co Paul Co George
Co
$’000
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Activity answers
$’000
Non-current assets
5,215.20
Current assets
1,645.00
Equity
3,792.20
4,670.20
Non-current liabilities
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Workings
1 Group structure
John Co
1.1.X0 1.1.X4
60% 30%
(6 years ago) (2 years ago)
Paul Co George Co
2 Freehold property
$’000
John Co 1,950
Paul Co 1,250
3,570
3 Inventory
$’000
John Co 575
Paul Co 300
855
$’000
$’000 $’000
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Difference at Difference now
acquisition
$’000 $’000
400 370
$’000 $’000
Paul Co
1,640
(1,600)
Goodwill at acquisition 40
7 Investment in associate
$’000
475.20
8 Retained earnings
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John Co Paul Co George
Co
Adjustments
795.0 390.0
1,792.20
$’000
878.00
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11
Financial instruments
Essential reading
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Ishmail Co issues $20 million of 4% convertible loan notes at par on 1 January 20X7. The loan
notes are redeemable for cash or convertible into equity shares on the basis of 20 shares per $100
of debt at the option of the loan note holder on 31 December 20X9. Similar but non-convertible
loan notes carry an interest rate of 9%.
The present value of $1 receivable at the end of the year, based on discount rates of 4% and 9%,
can be taken as:
4% 9%
$ $
End of year:
1 0.96 0.92
2 0.93 0.84
3 0.89 0.77
Cumulative 2.78 2.53
Required
Show how these loan notes should be accounted for in the financial statements at 31 December
20X7.
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Solution
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4 Financial assets further activities
Activity 7: Financial assets at FVTPL and FVTOCI
In February 20X8, Bonce Co purchased 20,000 $1 listed equity shares at a price of $4 per share.
Transaction costs were $2,000. At the year end of 31 December 20X8, these shares were trading
at $5.50. A dividend of 20c per share was received on 30 September 20X8.
Required
Show the financial statement extracts of Bonce Co at 31 December 20X8 relating to this
investment on the basis that:
1 The shares were bought for trading (conditions for FVTOCI have not been met)
2 Conditions for FVTOCI have been met
Solution
On 1 January 20X1, Abacus Co purchases a debt instrument for its fair value of $1,000. The debt
instrument is due to mature on 31 December 20X5. The instrument has a principal amount of
$1,250 and the instrument carries fixed interest at 4.72% that is paid annually. The effective rate
of interest is 10%.
Required
How should Abacus Co account for the debt instrument over its five-year term?
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Solution
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Activity answers
Workings
1 Equity and liability elements
$’000
3 years interest (20,000 × 4% × 2.53) 2,024
Redemption (20,000 × 0.77) 15,400
Liability element 17,424
Equity element (β) 2,576
Proceeds of loan notes 20,000
$’000
Liability element (W1) 17,424
Interest for the year at 9% 1,568
Less interest paid (20,000 × 4%) (800)
Carrying amount at 31 December 20X7 18,192
$
Statement of profit or loss
Investment income (20,000 × (5.5 – 4.0)) 30,000
Dividend income (20,000 × 20c) 4,000
Transaction costs (2,000)
Statement of financial position
Investments in equity instruments (20,000 × 5.5) 110,000
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2
$
Statement of profit or loss
Dividend income 4,000
Other comprehensive income
Gain on investment in equity instruments
(20,000 × 5.5) – ((20,000 × 4) + 2,000) 28,000
Statement of financial position
Investments in equity instruments (20,000 × 5.5) 110,000
Each year, the carrying amount of the financial asset is increased by the interest income for the
year, and reduced by the interest actually received during the year.
This is a financial asset that has passed the cash flow test for measurement at amortised cost. If
Abacus Co was also holding this instrument for trading, the IFRS 9 business model would allow it
to be carried at fair value through other comprehensive income.
In this case, fair value changes will go through other comprehensive income; interest charges will
be measured at amortised cost and go through profit or loss.
For instance, if at 1 January 20X2 the fair value of the debt instrument was $1,080, the difference
of $39 (1,080 – 1,041) would go to OCI and the asset would be shown in the statement of financial
position at $1,080.
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12
Leasing
Essential reading
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YES
YES
NO
YES
Broketown Council has recently made substantial cuts to its community transport service. It will
now provide such services only in cases of great need, assessed on a case-by-case basis. It has
entered into a two-year contract with Fleetcar Co for the use of one of its minibuses for this
purpose. The minibus must seat ten people, but Fleetcar Co can use any of its ten-seater
minibuses when required.
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Required
Is this a lease?
Solution
This is not a lease. There is no identifiable asset. Fleetcar can exchange one minibus for another.
Therefore, Broketown Council should account for the rental payments as an expense in profit or
loss.
Illustration 3: Lion Co
Lion Co enters into a five-year lease of a building, which has a remaining useful life of ten years.
Lease payments are $50,000 per annum, payable at the beginning of each year.
Lion Co incurs initial direct costs of $20,000 and receives lease incentives of $5,000. There is no
transfer of the asset at the end of the lease and no purchase option.
The interest rate implicit in the lease is not immediately determinable but the lessee’s incremental
borrowing rate is 5%, with the value of $1 having a cumulative present value in four years’ time of
$3.546. The value of $1 has a cumulative present value in five years’ time of $4.329.
At the commencement date, Lion Co pays the initial $50,000, incurs the direct costs and receives
the lease incentives.
Required
Calculate and show the transactions to be reflected in the financial statements
Solution
Step 1: Calculate the lease liability
The lease liability is measured at the present value of the remaining four payments:
$50,000 × $3.546 = $177,300
Step 2: Calculate the initial carrying amount of the right-of-use asset
$
Initial payment 50,000
PV of future lease payments 177,300
Initial direct costs 20,000
Incentives received (5,000)
242,300
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Debit Credit
$ $
Right-to-use asset 242,300
Lease liability 177,300
Cash (50,000 + 20,000 – 5,000) - 65,000
242,300 242,300
$
Opening balance 177,300
Interest 5% 8,865
186,165
The right-of-use asset will be depreciated over five years, being the shorter of the lease term and
the useful life of the underlying asset.
Now we will see how this would work out if the lease payments were made in arrears.
At the commencement date, the lessee would incur the direct costs and receive the lease
incentives.
Step 1: Calculate the lease liability
The lease would be measured at the present value in five years:
$50,000 × $4.329 = $216,450
Step 2: Calculate the value of the right-of-use asset
PVFLP 216,450
Direct costs 20,000
Lease incentives (5,000)
231,450
Debit Credit
$ $
Right-of-use asset 231,450
Lease liability 216,450
Cash (20,000 – 5,000) - 15,000
231,450 231,450
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$
Opening balance 216,450
Interest 5% 10,823
Lease payment year 1 (50,000)
Year-end balance 177,273
In order to ascertain the split between non-current and current liabilities, we work out the balance
at the end of year 2:
$
Opening balance 177,273
Interest 5% 8,864
Lease payment year 2 (50,000)
Year-end balance 136,137
$
Non-current liability 136,137
Current liability (177,273 – 136,137) 41,136
177,273
Note that when payments are made in arrears, the next instalment due will contain interest, so
this is effectively deducted to arrive at the capital repayment.
Activity 7: Sidcup Co
On 1 January 20X6, Sidcup Co sold its head office building to Eltham Co for $3 million and
immediately leased it back on a 10-year lease. On that date, the carrying value of the building
was $2.6 million and its fair value was $3 million. The present value of the lease payments was
calculated as $2.1 million. The remaining useful life of the building at 1 January 20X6 was 15
years. The transaction constituted a sale in accordance with IFRS 15
Required
1 A right-of-use asset must be recognised in respect of the leased building. At what value should
this right-of-use asset be recognised on 1 January 20X6 in the financial statements of Sidcup
Co?
A $2,100,000
B $1,820,000
C $3,000,000
D $280,000
E $400,000
F Nil
G $280,000
H $120,000
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2 Sale and leaseback not on market terms
This is a fairly complex area and will not be examined in your FR exam. However, it will be useful to
have a high-level understanding for your future studies.
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Activity answers
Activity 7: Sidcup Co
1 The correct answer is:
IFRS 16 requires that, at the start of the lease, Sidcup should measure the right-of-use asset
arising from the leaseback of the building at the proportion of the previous carrying amount of
the building that relates to the right of use retained. This is calculated as carrying amount ×
discounted lease payments/fair value. The discounted lease payments were given in the
question as $2.1 million.
Sidcup only recognises the amount of gain that relates to the rights transferred.
Stage 1: Gain is $3,000,000 – $2,600,000 = $400,000
Stage 2: Gain relating to rights retained $(400,000 × 2,100,000/3,000,000) = $280,000
Stage 3: Gain relating to rights transferred $(400,000 – 280,000) = $120,000
2
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13
Provisions and events
after the reporting
period
Essential reading
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1.2 Issue
Prior to the introduction of IAS 37 Provisions, Contingent Liabilities and Contingent Assets in 1998,
there was little meaningful guidance on when a provision must (and must not) be made.
This caused problems with companies choosing to make then release provisions in order to smooth
profits.
Which of the following best describes a provision according to IAS 37 Provisions, Contingent
Liabilities and Contingent Assets?
A provision is a liability of uncertain timing or amount.
A provision is a possible obligation of uncertain timing or amount.
A provision is a credit balance set up to offset a contingent asset so that the effect on the
statement of financial position is nil.
A provision is a possible asset that arises from past events.
Solution
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1.3 Probable transfer of economic benefits
A transfer of economic benefits is regarded as ‘probable’ if the event is more likely than not to
occur (IAS 37: paras. 23–24). This appears to indicate a probability of more than 50%. However,
where there is a number of similar obligations the probability should be based on a consideration
of the population as a whole, rather than one single item.
Start
YES
YES
NO
YES
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Activity 12: Case OTQ Provisions
(1) Proviso Co issued a one-year guarantee for faulty workmanship on an item of specialist
equipment that it delivered to its customer. At the company’s year-end, the company is being
sued by the customer for refusing to replace or repair the item of equipment within the
guarantee period, as Proviso Co believes the fault is not covered by the guarantee, but
instead has arisen because of the customer not following the operating instructions.
The company’s lawyer has advised Proviso Co that it is more likely than not that they will be
found liable. This would result in the company being forced to replace or repair the
equipment plus pay court costs and a fine amounting to approximately $10,000.
Based on past experience with similar items of equipment, the company estimates that there
is a 70% chance that the central core would need to be replaced which would cost $40,000
and a 30% chance that the repair would only cost about $15,000.
(2) The company also manufactures small items of equipment which it sells via a retail network.
The company sold 12,000 items of this type this year, which also have a one-year guarantee
if the equipment fails. Based on past experience, 5% of items sold are returned for repair or
replacement. In each case, one-third of the items returned are able to be repaired at a cost of
$50, while the remaining two-thirds are scrapped and replaced. The manufacturing cost of a
replacement item is $150.
Required
1 What is a constructive obligation?
An obligation whereby past practice has created a valid expectation that the entity will
discharge its responsibilities
An obligation whereby the entity is legally required to discharge its responsibilities
An obligation whereby the entity commits to construct an asset
An obligation whereby past policies commit the entity to continue to discharge its
responsibilities
2 How much should be provided for the equipment guarantee?
$
3 State whether the following statements regarding the legal claim are true or false.
TRUE OR FALSE
A present obligation exists
No provision is required
1.5 Measurement
In the main workbook, Activity 1 discounts the provision. This can be a trickier concept to
understand, but this more detailed explanation will take you through the main steps, including the
double entry and reviewing the overall impact on the financial statements.
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Example – Discounting the provision
Cambridge Co is preparing the financial statements for the year ended 31 December 20X5.
Cambridge Co knows that when it ceases a certain operation in five years’ time it will have to pay
environmental clean-up costs of $5 million. These clean up costs are in relation to a fracking drill.
The relevant discount rate in this case is 10%.
The discounted values of $1 are as follows:
$1 in five years = $0.621
$1 in four years = $0.683
Initial recognition: The company will need to pay $5 million in five-years’ time. Because of the time
value of money, the value of the provision on Day 1 is less than $5 million. IAS 37 requires the
present value of the provision to be calculated using a discount rate, in this case 10%.
The present value of $5 million payable in five years is: $5m × 0.621 = $3,105,000
The clean-up costs are in relation to a drill, which will have been capitalised as part of property,
plant and equipment. IAS 37 permits the provision to be capitalised as part of the cost of the
factory,
The provision is initially recognised by:
$ $
DR PPE cost of the asset 3,105,000
CR Provision 3,105,000
Note. If the provision was not related to the cost of an asset, it would have been debited to the
statement of profit or loss as an expense.
Subsequent recognition: As time passes, and it gets closer to making the payment of the
environmental clean-up costs, the present value of the provision will go up. This is referred to as
‘unwinding the discount’ which is calculated as:
Note. The c/fwd provision could also have been calculated using the four-year discount factor:
$5m x 0.683 = $3,415,000
The change in the provision for the year ended 31 December 20X6 is recorded by:
$ $
DR Finance cost 310,500
CR Provision 310,500
The resulting provision of $3,415,500 is carried as a liability in the books of Cambridge Co.
This is repeated throughout the five-year period, so the entries for the whole period will look like
this:
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Bfwd provision Finance cost 10% Cfwd provision
$ $ $
Y1 3,105,000 310,500 3,415,500
Y2 3,415,500 341,550 3,757,050
Y3 3,757,050 375,705 4,132,755
Y4 4,132,755 413,275 4,546,031
Y5 4,546,031 453,969 5,000,000
At the end of Year 5, there will be a provision held on the statement of financial of $5 million.
Treatment of capitalised provision: Usually a provision is debited to the statement of profit or loss
on initial recognition. However, if the provision relates to an asset, as in this case, it is capitalised
as part of the cost of the asset. Subsequently it is debited to the statement of profit or loss, as
part of the depreciation charge, over the life of the asset.
$ $
DR Amortisation/Depreciation expense (3.105m/5 years) 621,000
CR Accumulated depreciation/amortisation 621,000
Over the five-year period, there will be a finance charge and a depreciation charge in the
statement of profit or loss each year relating to the provision. The cost of the provision is spread
across the five years rather than incurring the cost just in year five. This supports the accrual
concept whereby income and the expenses are matched across the period of the economic
benefit.
$ $
DR Provision 5,000,000
CR Cash 5,000,000
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2 Contingent liabilities (IAS 37)
2.1 Definition
‘A contingent liability is either:
(a) A possible obligation arising from past events whose existence will be confirmed only by the
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 economic benefits will be required to settle the
obligation; or
(ii) The amount of the obligation cannot be measured with sufficient reliability’ (IAS 37: para.
10).
2.2 Recognition
A contingent liability is not recognised. A contingent liability is disclosed unless the possibility of
an outflow of economic benefits is remote.
After a wedding in 20X8, ten people died possibly as a result of food poisoning from products sold
by Callow Co. Legal proceedings are started seeking damages from Callow but it disputes
liability. Up to the date of approval of the financial statements for the year to 31 December 20X8,
Callow’s lawyers advise that it is probable that it will not be found liable. However, when Callow
prepares the financial statements for the year to 31 December 20X9, its lawyers advise that,
owing to developments in the case, it is probable that it will be found liable.
Required
What is the required accounting treatment?
1 At 31 December 20X8
2 At 31 December 20X9
Solution
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3 Contingent assets (IAS 37)
3.1 Definition
A contingent asset is a possible asset arising from past events whose existence will only be
confirmed by the occurrence of one or more uncertain future events not wholly within the control
of the entity.
3.2 Recognition
• A contingent asset is not recognised because it could result in the recognition of profits that
may never be realised. However, where the realisation of profit is virtually certain, then the
related asset is not a contingent asset and recognition is appropriate.
• A contingent asset is disclosed where an inflow of economic benefits is probable.
4.1 Definition
Events occurring after the reporting period are those events, both favourable and unfavourable,
that occur between the end of the reporting period and the date on which the financial
statements are authorised for issue. Two types of events can be identified:
• Those that provide evidence of conditions that existed at the end of the reporting period –
adjusting
• Those that are indicative of conditions that arose after the reporting period – non-adjusting
(IAS 10: para. 3)
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• Determination after the year end of the sale or purchase price of assets sold or purchased
before the year-end
• Evidence of a permanent diminution in the value of a long-term investment prior to the year-
end
• Discovery of error or fraud which shows that the financial statements were incorrect
(IAS 10: para. 9)
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Adjusting events Non-adjusting events
the reporting date • Ordinary share transactions including the
• The determination of a bonus payment if issue of shares
there was a constructive obligation to pay • Changes in asset prices, foreign exchange
it at the reporting date rates or tax rates
• The discovery of fraud or errors resulting in • The commencement of litigation arising
incorrect financial statements from an event after the reporting period
• Declaration of dividends after the end of
the reporting period
5 Additional activities
You are likely to be asked a question on IAS 37 or IAS 10 as part of an objective test question in
either Section A or section B. You may also be asked to adjust a set of financial statements for
errors, post year-end information, or be able to explain the impact of a provision or event after the
end of the reporting period as part of the interpretation question in Section C.
Ergonomic Co prepares its financial statements to 31 December each year. During the years
ended 31 December 20X0 and 31 December 20X1, the following event occurred:
Ergonomic Co is involved in extracting minerals in a number of different countries. The process
typically involves some contamination of the site from which the minerals are extracted.
Ergonomic Co makes good this contamination only where legally required to do so by legislation
passed in the relevant country.
The company has been extracting minerals in Golden Sands since January 20W8 and expects its
site to produce output until 31 December 20X5. On 23 December 20X0, it came to the attention of
the directors of Ergonomic Co that the government of Golden Sands was virtually certain to pass
legislation requiring the making good of mineral extraction sites. The legislation was duly passed
on 15 March 20X1. The directors of Ergonomic Co estimate that the cost of making good the site in
Golden Sands will be $2 million. This estimate is of the actual cash expenditure that will be
incurred on 31 December 20X5.
Required
Summarise the criteria that Ergonomic Co need to satisfy before a provision in respect of the
environmental clean-up costs is recognised.
Solution
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Activity 15: OTQ
Toad Co’s year-end is 30 December 20X4 and the following potential liabilities have been
identified:
Which TWO of the following should Toad Co recognise as liabilities as at 30 December 20X4?
The signing of a non-cancellable contract in December 20X4 to supply goods in the following
year on which, due to a pricing error, a loss will be made
The cost of a reorganisation which was communicated to interested parties or announced
publicly, and approved by the board in November 20X4. However, it has not yet been
implemented.
An amount of deferred tax relating to the gain on the revaluation of a property during the
current year. Toad Co has no intention of selling the property in the foreseeable future.
The balance on the warranty provision which related to products for which there are no
outstanding claims and whose warranties had expired by 30 December 20X4
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Activity answers
1 The correct answer is: An obligation whereby past practice has created a valid expectation
that the entity will discharge its responsibilities
2 $ 70,000
A present obligation exists at the end of the reporting period based on historical evidence of
items being repaired under the guarantee agreement.
Here, a large population of items is involved. A provision is therefore made for the expected
value of the outflow:
12,000 × 5% × 1/3 × $50 = $10,000
12,000 × 5% × 2/3 × $150 = $60,000
$70,000
TRUE OR FALSE
A present obligation exists TRUE
At the end of the reporting period, Proviso Co disputes the liability (and therefore whether a
present obligation exists).
However, given that it is more likely than not that Proviso will be found guilty, a present
obligation is assumed to exist (IAS 37: paras. 15–16).
Given that a single obligation is being measured, a provision is made for the outflow of the
most likely outcome (IAS 37: para. 40).
Consequently, a provision is recognised for $10,000 + $40,000 = $50,000.
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Activity 13: Recognition and measurement of provisions
1 On the basis of the evidence available when the financial statements were approved, there is
no obligation as a result of past events. No provision is recognised. The matter is disclosed as a
contingent liability unless the probability of any transfer is regarded as remote.
2 On the basis of the evidence available, there is a present obligation. A transfer of economic
benefits in settlement is probable.
A provision is recognised for the best estimate of the amount needed to settle the present
obligation.
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14
Inventories and
biological assets
Essential reading
TT2021
3 Biological assets
Biological assets are the core income-producing assets of agricultural activities, held for their
transformative capabilities. Biological transformation leads to various different outcomes (IAS 41:
para. 7):
• Asset changes:
- Growth: increase in quantity and or quality
- Degeneration: decrease in quantity and/or quality
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• Creation of new assets:
- Production: producing separable non-living products
- Procreation: producing separable living animals
We can distinguish between the importance of these by saying that asset changes are critical to
the flow of future economic benefits both in and beyond the current period, but the relative
importance of new asset creation will depend on the purpose of the agricultural activity.
The Standard distinguishes, between two broad categories of agricultural production system (IAS
41: para. 44).
(a) Consumable: animals/plants themselves are harvested eg wheat, pigs for meat.
(b) Bearer: animals/plants bear produce for harvest eg dairy cattle, grapevines.
A few further points are made (IAS 41: para. 25):
(a) Biological assets are usually managed in groups of animal or plant classes, with
characteristics (eg male/female ratio) which allow sustainability in perpetuity.
(b) Land often forms an integral part of the activity itself in pastoral and other land-based
agricultural activities.
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TT2021
640 Financial Reporting (FR)
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TT2021
14: Essential Reading 641
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TT2021
642 Financial Reporting (FR)
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15
Taxation
Essential reading
TT2021
Activity 9: Cyclon Co
Cyclon Co purchased land on 1 January 20X7 for $400,000. On 31 December 20X8, the land was
revalued to $500,000. In the tax regime in which the company operates, revaluations do not
affect either the tax base of the asset or taxable profits.
The income tax rate is 30%.
Required
Prepare the accounting entry to record the deferred tax in relation to this revaluation for the year
ended 31 December 20X8.
Solution
Zebra Co owns a property which has a carrying amount at the beginning of 20X9 of $1.5 million.
At the year-end, it has entered into a contract to sell the property for $1,800,000. The tax rate is
30%.
Required
How will this gain on the property revaluation be shown in the financial statements?
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Solution
Ginger Co has an asset with a carrying amount of $80,000 and a tax base of $50,000. The
current tax rate is 30% and the rate is being reduced to 25% in the next tax year. Ginger Co plans
to dispose of the asset for its carrying amount and will do so after the tax rate falls.
Required
What is the deferred tax arising in relation to this asset?
Solution
TT2021
15: Essential Reading 645
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Activity 12: Norman Kronkest Co
For the year ended 31 July 20X4, Norman Kronkest Co made taxable trading profits of $1.2 million
on which income tax is payable at 30%.
(1) A transfer of $20,000 will be made to the deferred taxation account. The balance on this
account was $100,000 before making any adjustments for items listed in this paragraph.
(2) The estimated tax on profits for the year ended 31 July 20X3 was $80,000, however tax has
now been agreed at $84,000 and fully paid.
(3) Tax on profits for the year to 31 July 20X4 is payable on 1 May 20X5.
(4) In the year to 31 July 20X4 the company made a capital gain of $60,000 on the sale of some
property. This gain is taxable at a rate of 30%.
Required
1 Calculate the tax charge for the year to 31 July 20X4.
2 Prepare extracts from the statement of profit or loss of Norman Kronkest for the year ended 31
July 20X4
3 Calculate the tax liabilities in the statement of financial position of Norman Kronkest as at 31
July 20X4.
Solution
TT2021
646 Financial Reporting (FR)
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Activity answers
Activity 9: Cyclon Co
Working
Deferred tax
$
Carrying amount of asset 500,000
Less tax base (400,000)
Temporary difference 100,000
Deferred tax (liability) (30% × 100,000) (30,000)
$’000
Profit for the year X
Other comprehensive income:
Gains on property revaluation 300
Income tax relating to components of other comprehensive income (300 × 30%) (90)
Other comprehensive income for the year net of tax 210
Debit Credit
$’000 $’000
Property, plant and equipment 300
Deferred tax 90
210
Revaluation surplus
In this case, the deferred tax has been deducted from the revaluation surplus rather than being
charged to profit or loss.
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Activity 12: Norman Kronkest Co
1 Tax charge:
$
Tax on trading profits (30% of 1,200,000) 360,000
Tax on capital gain (30% of 60,000) 18,000
Deferred taxation 20,000
398,000
Underprovision of taxation in previous years $(84,000 – 80,000) 4,000
Tax charge on profit for the period 402,000
$
Profit before tax (1,200,000 + 60,000) 1,260,000
Income tax expense (402,000)
Profit for the year 858,000
3 Deferred taxation
$
Balance brought forward 100,000
Transferred from profit or loss 20,000
Deferred taxation in the statement of financial position 120,000
$
Payable on 1 May 20X5
Tax on profits (30% of $1,200,000) 360,000
Tax on capital gain (30% of $60,000) 18,000
Due on 1 May 20X5 378,000
Summary
$
Current liabilities
Tax, payable on 1 May 20X5 378,000
Non-current liabilities
Deferred taxation 120,000
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It may be helpful to show the journal entries for these items.
$ $
DEBIT Tax charge (statement of profit or loss) 402,000
CREDIT Tax payable *382,000
Deferred tax liability 20,000
*This account will show a debit balance of $4,000 until the under provision is recorded, since
payment has already been made: (360,000 + 18,000 + 4,000). The closing balance will
therefore be $378,000.
TT2021
15: Essential Reading 649
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TT2021
650 Financial Reporting (FR)
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16
Presentation of
published financial
statements
Essential reading
TT2021
TT2021
652 Financial Reporting (FR)
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(b) The fact that the comparative figures given are not in fact comparable (IAS 1: para. 36)
For practical purposes, some entities prefer to use a period which approximates to a year, eg 52
weeks, and the IAS allows this approach, as it will produce statements not materially different
from those produced on an annual basis. (IAS 1: para. 37)
1.5 Timeliness
If the publication of financial statements is delayed too long after the reporting period, their
usefulness will be severely diminished. An entity with consistently complex operations cannot use
this as a reason for its failure to report on a timely basis. Local legislation and market regulation
imposes specific deadlines on certain entities.
IAS 1 looks at the statement of financial position and statement of profit or loss and other
comprehensive income. We will not give all the detailed disclosures, as some are outside the scope
of the Financial Reporting syllabus. Instead, we will look at a proforma set of accounts based on
the Standard.
20X2 20X1
$’000 $’000
ASSETS
Non-current assets
Property, plant and equipment X X
Goodwill X X
Other intangible assets X X
Investments in associates X X
Investments in equity instruments X X
X X
Current assets
Inventories X X
Trade receivables X X
Other current assets X X
Cash and cash equivalents X X
X X
Total assets X X
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20X2 20X1
$’000 $’000
Total equity X X
Non-current liabilities
Long-term borrowings X X
Deferred tax X X
Long-term provisions X X
Total non-current liabilities X X
Current liabilities
Trade and other payables X X
Short-term borrowings X X
Current portions of long-term borrowings X X
Current tax payable X X
Short-term provisions X X
Total current liabilities X X
Total liabilities X X
Total equity and liabilities X X
20X2 20X1
$’000 $’000
Revenue X X
Cost of sales (X) (X)
Gross profit X X
Other income X X
Distribution costs (X) (X)
Administrative expenses (X) (X)
Other expenses (X) (X)
Finance costs (X) (X)
Profit before tax X X
Income tax expense (X) (X)
PROFIT FOR THE YEAR X X
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20X2 20X1
$’000 $’000
Other comprehensive income:
Gains/(losses) on property revaluations X (X)
Investments in equity instruments (X) X
Income tax relating to items of other comprehensive income (X) (X)
Other comprehensive income for the year, net of tax X X
TOTAL COMPREHENSIVE INCOME FOR THE YEAR X X
XYZ GROUP – STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20X2
(Illustrating presentation in two statements)
20X2 20X1
$’000 $’000
Revenue X X
Cost of sales (X) (X)
Gross profit X X
Other income X X
Distribution costs (X) (X)
Administrative expenses (X) (X)
Other expenses (X) (X)
Finance costs (X) (X)
Profit before tax X X
Income tax expense (X) (X)
PROFIT FOR THE YEAR X X
XYZ GROUP – STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
YEAR ENDED 31 DECEMBER 20X2
20X2 20X1
$’000 $’000
Profit for the year X X
Other comprehensive income:
Gains/(losses) on property revaluations X (X)
Investments in equity instruments (X) X
Income tax relating to items of other comprehensive income (X) (X)
Other comprehensive income for the year, net of tax X X
TOTAL COMPREHENSIVE INCOME FOR THE YEAR X X
Note. The nature and amount of material items of income and expense must be disclosed
separately.
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2.3 Information presented in the statement of profit or loss
The standard lists the following as the minimum to be disclosed on the face of the statement of
profit or loss.
(a) Revenue
(b) Finance costs
(c) Share of profits and losses of associates and joint ventures accounted for using the equity
method
(d) A single amount for the total of discontinued operations
(e) Tax expense
(IAS 1: para. 82)
The following items must be disclosed as allocations of profit or loss for the period.
• Profit or loss attributable to non-controlling interest
• Profit or loss attributable to owners of the parent
(IAS 1: para. 81)
The allocated amounts must not be presented as items of income or expense. (These relate to
group accounts, covered separately in this Workbook.)
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2.5 Dividends
IAS 1 also requires disclosure of the amount of dividends paid during the period covered by the
financial statements. This is shown either in the statement of changes in equity or in the notes.
(IAS 1: para. 107)
* Included to illustrate positioning for exam questions. Technically, the adjustment is made at the
beginning of the prior period where the information is available and three statements of financial
position are required.
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3.1 Contents of notes
The notes to the financial statements will amplify the information given in the statement of
financial position, statement of profit or loss and other comprehensive income and statement of
changes in equity. To some extent, the contents of the notes will be determined by the level of
detail shown on the face of the statements.
3.2 Structure
The notes to the financial statements should perform the following functions:
(a) Present information about the basis on which the financial statements were prepared and
which specific accounting policies were chosen and applied to significant transactions/events
(b) Disclose any information, not shown elsewhere in the financial statements, which is required
by IFRSs
(c) Show any additional information that is relevant to understanding which is not shown
elsewhere in the financial statements
(IAS 1: para. 112)
The way the notes are presented is important. They should be given in a systematic manner and
cross-referenced back to the related figure(s) in the statement of financial position, statement of
comprehensive income or statement of cash flows. (IAS 1: para. 113)
Notes to the financial statements will amplify the information shown therein by giving the
following:
(a) More detailed analysis or breakdowns of figures in the statements
(b) Narrative information explaining figures in the statements
(c) Additional information, eg contingent liabilities and commitments
IAS 1 suggests a certain order for notes to the financial statements. This will assist users when
comparing the statements of different entities.
(a) Statement of compliance with IFRSs
(b) Statement of the measurement basis (bases) and accounting policies applied
(c) Supporting information for items presented in each financial statement in the same order as
each line item and each financial statement is presented
(d) Other disclosures, eg:
(i) Contingent liabilities, commitments and other financial disclosures
(ii) Non-financial disclosures
The order of specific items may have to be varied occasionally, but a systematic structure is still
required. (IAS 1: para. 114)
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3.4 Other disclosures
An entity must disclose in the notes:
(a) The amount of dividends proposed or declared before the financial statements were
authorised for issue but not recognised as a distribution to owners during the period, and the
amount per share
(b) The amount of any cumulative preference dividends not recognised
(IAS 1: para. 137)
IAS 1 ends by listing some specific disclosures which will always be required if they are not shown
elsewhere in the financial statements.
(a) The domicile and legal form of the entity, its country of incorporation and the address of the
registered office (or, if different, principal place of business)
(b) A description of the nature of the entity’s operations and its principal activities
(c) The name of the parent entity and the ultimate parent entity of the group
(IAS 1: para. 138)
TT2021
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TT2021
660 Financial Reporting (FR)
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TT2021
16: Essential Reading 661
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TT2021
662 Financial Reporting (FR)
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17
Reporting financial
performance
Essential reading
TT2021
Activity 6: Tabby Co
Tabby Co has always valued inventory on a first in, first out (FIFO) basis. In 20X9, it decides to
switch to the weighted average method of valuation. Gross profit in the 20X8 financial statements
was calculated as follows:
$’000 $’000
Revenue 869
Cost of sales:
Opening inventory 135
Purchases 246
Closing inventory (174) (207)
Gross profit 662
Required
Restate the 20X8 comparative figures to show the effect of the change in accounting policy.
Solution
1
$’000 $’000
Revenue
Cost of sales:
Opening inventory
Purchases
Closing inventory
TT2021
664 Financial Reporting (FR)
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2 Errors
Activity 7: Correction of errors
During 20X7, Global Co discovered that certain items had been included in inventory at 31
December 20X6, valued at $4.2 million, which had in fact been sold before the year-end. The
following figures for 20X6 (as reported) and 20X7 (draft) are as follows:
Retained earnings at 1 January 20X6 were $13 million. The cost of goods sold for 20X7 includes
the $4.2 million error in opening inventory. The income tax rate was 30% for 20X6 and 20X7. No
dividends have been declared or paid.
Required
Show the statement of profit or loss for 20X7, with the 20X6 comparative, and retained earnings.
Solution
TT2021
17: Essential Reading 665
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3 IFRS 5 Non-current Assets Held for Sale and
Discontinued Operations
3.1 Classification of assets held for sale
On 1 December 20X3, ManiCo became committed to a plan to sell a manufacturing facility and
has already found a potential buyer. ManiCo does not intend to discontinue the operations
currently carried out in the facility. At 31 December 20X3, there is a backlog of uncompleted
customer orders. The company will not be able to transfer the facility to the buyer until after it
ceases to operate the facility and has eliminated the backlog of uncompleted orders. This is not
expected to occur until spring 20X4.
Required
Can the manufacturing facility be classified as ‘held for sale’ at 31 December 20X3?
Solution
20X3 20X2
$’000 $’000
Revenue X X
Cost of sales (X) (X)
Gross profit X X
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20X3 20X2
$’000 $’000
Other income X X
Distribution costs (X) (X)
Administrative expenses (X) (X)
Other expenses (X) (X)
Finance costs (X) (X)
Profit before tax X X
Income tax expense (X) (X)
Profit for the year from continuing operations X X
Loss for the year from discontinued operations (X) (X)
PROFIT FOR THE YEAR X X
Other comprehensive income for the year, net of tax X X
TOTAL COMPREHENSIVE INCOME FOR THE YEAR X X
20X3 20X2
$’000 $’000
Revenue X X
Cost of sales (X) (X)
Gross profit X X
Other income X X
Distribution costs (X) (X)
Administrative expenses (X) (X)
Other expenses (X) (X)
Finance costs (X) (X)
Loss before tax (X) (X)
Income tax expense X X
Loss after tax (X) (X)
Post-tax gain on remeasurement and disposal of assets X X
LOSS FOR THE YEAR (X) (X)
Other comprehensive income for the year, net of tax X X
TOTAL COMPREHENSIVE INCOME FOR THE YEAR X X
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3.2.3 Proforma disclosure – on the face
XYZ GROUP – STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
YEAR ENDED 31 DECEMBER 20X3
Continuing Discontinued
operations operations Entity as a whole
20X3 20X2 20X3 20X2 20X3 20X2
$’000 $’000 $’000 $’000 $’000 $’000
Revenue X X X X X X
Cost of sales (X) (X) (X) (X) (X) (X)
Gross profit X X X X X X
Other income X X X X X X
Distribution costs (X) (X) (X) (X) (X) (X)
Administrative expenses (X) (X) (X) (X) (X) (X)
Other expenses (X) (X) (X) (X) (X) (X)
Finance costs (X) (X) (X) (X) (X) (X)
Profit/(loss) before tax X X (X) (X) X X
Income tax expense (X) (X) X X (X) (X)
Profit/(loss) after tax X X (X) (X) X X
Post-tax gain on
remeasurement and disposal
of assets and disposal
groups – – X – X –
TOTAL COMPREHENSIVE
INCOME FOR THE YEAR X X X X X X
On 20 October 20X3, the directors of Largo Co made a public announcement of plans to close a
steel works. The closure means that the group will no longer carry out this type of operation,
which until recently has represented about 10% of its total revenue. The works will be gradually
shut down over a period of several months, with complete closure expected in July 20X4. At 31
December, output had been significantly reduced and some redundancies had already taken
place. The cash flows, revenues and expenses relating to the steel works can be clearly
distinguished from those of the subsidiary’s other operations.
Required
How should the closure be treated in the financial statements for the year ended 31 December
20X3?
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Solution
TT2021
17: Essential Reading 669
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TT2021
670 Financial Reporting (FR)
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Activity answers
Activity 6: Tabby Co
$’000 $’000
Revenue 869
Cost of sales:
Purchases 246
644
In order to prepare comparative figures for 20X8 showing the change of accounting policy, it is
necessary to recalculate the amounts for 20X7, so that the opening inventory for 20X8 is valued
on a weighted average basis.
It is established that opening inventory for 20X8 based on the weighted average method would be
$122,000 and closing inventory would be $143,000. So, the 20X8 gross profit now becomes:
This shows $18,000 lower gross profit for 20X8 which will reduce net profit and retained earnings
by the same amount. The opening inventory for 20X9 will be $143,000 rather than $174,000 and
the statement of changes in equity for 20X9 will show an $18,000 adjustment to opening retained
earnings.
20X6 20X7
$’000 $’000
Revenue 47,400 67,200
Cost of sales (W1) (38,770) (51,600)
Profit before tax 8,630 15,600
Income tax (W2) (2,620) (4,660)
Profit for the year 6,010 10,940
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Workings
1 Cost of sales
20X6 20X7
$’000 $’000
As stated in question 34,570 55,800
Inventory adjustment 4,200 (4,200)
38,770 51,600
2 Income tax
20X6 20X7
$’000 $’000
As stated in question 3,880 3,400
Inventory adjustment (4,200 × 30%) (1,260) 1,260
2,620 4,660
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18
Earnings per share
Essential reading
TT2021
Flame Co is a company with a called up and paid up capital of 100,000 ordinary shares of $1
each and 20,000 10% redeemable preference shares of $1 each.
The gross profit was $200,000 and trading expenses were $50,000. Flame Co paid the required
preference share dividend and an ordinary dividend of 42c per share. The tax charge for the year
was estimated at $40,000.
Required
Calculate basic eps for the year.
Solution
TT2021
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(c) To calculate the number of shares in the eps calculation, you should: (i) Multiply the number
of shares before the rights issue by the bonus fraction and pro-rate based on the number of
months in the year prior to the date of the rights issue and (ii) Pro-rate the number of shares
after the rights issue by the number of months in the year after the date of the rights issue
and add to the figure arrived at in (i).
(d) The total earnings should then be divided by the total number of shares calculated to give the
eps for the year.
Marcoli Co has produced the following net profit figures for the years ending 31 December:
$m
20X6 1.1
20X7 1.5
20X8 1.8
On 1 January 20X7, the number of shares outstanding was 500,000. During 20X7, the company
announced a rights issue with the following details.
Rights: 1 new share for each 5 outstanding (100,000 new shares in total)
Exercise price is $5.00.
Last date to exercise rights: 1 March 20X7.
The market (fair) value of one share in Marcoli Co immediately prior to exercise on 1 March 20X7 =
$11.00.
Required
Calculate the eps for 20X6, 20X7 and 20X8.
Solution
TT2021
18: Essential Reading 675
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3 Diluted eps
Activity 8: Diluted eps – Convertible debt
Ardent Co has five million ordinary shares of 25 cents each in issue, and also had in issue in 20X4:
(1) $1 million of 14% convertible loan stock, convertible in three years’ time at the rate of two
shares per $10 of loan stock
(2) $2 million of 10% convertible loan stock, convertible in one year’s time at the rate of three
shares per $5 of loan stock
The total earnings in 20X4 were $1.75 million.
The rate of income tax is 35%.
Required
Calculate the basic eps and diluted eps.
Solution
Brand Co has the following results for the year ended 31 December 20X7:
Required
Calculate both basic and diluted earnings per share.
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Solution
4 Disclosure
An entity should disclose the following:
(a) The amounts used as the numerators in calculating basic and diluted eps, and a
reconciliation of those amounts to the net profit or loss for the period
(b) The weighted average number of ordinary shares used as the denominator in calculating
basic and diluted eps, and a reconciliation of these denominators to each other
(IAS 33: para. 70)
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TT2021
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Activity answers
$
Gross profit 200,000
Expense (50,000 + 2,000 preference dividend) (52,000)
Profit before tax 148,000
Income tax expense (40,000)
Profit for the year 108,000
Basic eps
= $108,000 / 100,000 = $1.08 per share
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(2) We must decide which of the potential ordinary shares (ie the loan stocks) are dilutive (ie
would decrease the eps if converted).
For the 14% loan stock, incremental eps = 0.65 × 140,000 / 200,000 shares = $0.46
For the 10% loan stock, incremental eps = 0.65 × 200,000 /1,200,000 shares = $0.11
The effect of converting the 14% loan stock is therefore to increase the eps figure, since the
incremental eps of $0.46 is greater than the basic eps of $0.35. The 14% loan stock is not dilutive
and is therefore excluded from the diluted eps calculation.
The 10% loan stock is dilutive.
Diluted eps = ($1.75m + $0.13m) / 5m + 1.2m = $0.3
Note. The calculation of diluted eps (deps) should always be based on the maximum number of
shares that can be issued.
*The earnings have not been increased as the total number of shares has been increased only by
the number of shares (25,000) deemed for the purpose of the computation to have been issued
for no consideration.
TT2021
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19
Interpretation of
financial statements
Essential reading
TT2021
TT2021
682 Financial Reporting (FR)
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The liquidity ratios and working capital turnover ratios are used to test a company’s liquidity,
length of cash cycle, and investment in working capital. The cash cycle is also referred to as the
operating cycle.
Now suppose that each company makes a profit before interest and tax of $50,000, and the rate
of tax on company profits is 30%. Amounts available for distribution to equity shareholders will be
as follows.
If in the subsequent year profit before interest and tax falls to $40,000, the amounts available to
ordinary shareholders will become as follows.
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Alpha Co Brava Co Charlie Co
$’000 $’000 $’000
Taxable profit 30 10 4
Taxation at 30% 9 3 1
Profit for the year 21 7 3
The more highly geared the company, the greater the risk that little (if anything) will be
available to distribute by way of dividend to the ordinary shareholders. The example clearly
displays this fact in so far as the more highly geared the company, the greater the percentage
change in profit available for ordinary shareholders for any given percentage change in profit
before interest and tax. The relationship similarly holds when profits increase, and if PBIT had risen
by 20% rather than fallen, you would find that once again the largest percentage change in profit
available for ordinary shareholders (this means an increase) will be for the highly geared
company. This means that there will be greater volatility of amounts available for ordinary
shareholders, and presumably therefore greater volatility in dividends paid to those shareholders,
where a company is highly geared. That is the risk: you may do extremely well or extremely badly
without a particularly large movement in the PBIT of the company.
The risk of a company’s ability to remain in business was referred to earlier. Gearing or leverage is
relevant to this. A highly geared company has a large amount of interest to pay annually
(assuming that the debt is external borrowing rather than preference shares). If those borrowings
are ‘secured’ in any way (and loan notes in particular are secured), then the holders of the debt
are perfectly entitled to force the company to realise assets to pay their interest if funds are not
available from other sources. Clearly the more highly geared a company the more likely this is to
occur when and if profits fall.
Debt ratio: The ratio of a company’s total debts to its total assets.
KEY
TERM (a) Assets consist of non-current assets at their carrying amount, plus current assets
(b) Debts consist of all payables, whether they are due within one year or after more than
one year
You can ignore other non-current liabilities, such as deferred taxation.
There is no absolute guide to the maximum safe debt ratio, but as a very general guide, you
might regard 50% as a safe limit to debt. In practice, many companies operate successfully
with a higher debt ratio than this, but 50% is nonetheless a helpful benchmark. In addition, if
the debt ratio is over 50% and getting worse, the company’s debt position will be worth looking
at more carefully.
In the exam, it is important to look at the reasons for the changes which are specific to the
information given in the question and to consider the logic of whether an increase in one
element is justified by a reason in another.
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684 Financial Reporting (FR)
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3 Further activities interpretation
Activity 9: Debt ratios
The following information has been extracted from the recently published accounts of Doolittle Co
EXTRACTS FROM THE STATEMENTS OF PROFIT OR LOSS TO 30 APRIL
20X9 20X8
$’000 $’000
Revenue 11,200 9,750
Cost of sales 8,460 6,825
Net profit before tax 465 320
This is after charging:
Depreciation 360 280
Loan note interest 80 60
Interest on bank overdraft 15 9
Audit fees 12 10
20X9 20X8
$’000 $’000 $’000 $’000
Assets
Non-current assets 1,850 1,430
Current assets
Inventories 640 490
Trade receivables 1,230 1,080
Cash and cash equivalents 80 120
1,950 1,690
Total assets 3,800 3,120
Equity and liabilities
Equity
Ordinary share capital 800 800
Retained earnings 1,310 930
2,110 1,730
Non-current liabilities
10% loan stock 800 600
Current liabilities
Bank overdraft 110 80
Trade and other payables 750 690
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20X9 20X8
$’000 $’000 $’000 $’000
Taxation 30 20
890 790
Total equity and liabilities 3,800 3,120
The following ratios are those calculated for Doolittle Co, based on its published accounts for the
previous year, and also the latest industry average ratios:
Industry
Doolittle Co average
30 April 20X8
ROCE (capital employed = equity and debentures) 16.30% 18.50%
Net profit margin 3.90% 4.73%
Asset turnover 4.18 times 3.91 times
Current ratio 2.10 1.90
Quick ratio 1.52 1.27
Gross profit margin 30.00% 35.23%
Accounts receivable collection period 40 days 52 days
Accounts payable payment period 37 days 49 days
Inventory turnover 13.90 times 18.30 times
Gearing 25.75% 32.71%
Required
1 Calculate comparable ratios (to two decimal places where appropriate) for Doolittle Co for the
year ended 30 April 20X9. All calculations must be clearly shown.
2 Write a report to your board of directors analysing the performance of Doolittle Co,
comparing the results against the previous year and against the industry average.
Solution
TT2021
686 Financial Reporting (FR)
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TT2021
19: Essential Reading 687
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TT2021
688 Financial Reporting (FR)
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Activity answers
2 REPORT
TT2021
19: Essential Reading 689
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Receivables collection period is unchanged from 20X8 and are considerably lower than the
industry average. Consequently, there is probably little opportunity to reduce this further and
there may be pressure in the future from customers to increase the period of credit given. The
period of credit taken from suppliers has fallen from 37 days’ purchases to 32 days’ and is
much lower than the industry average; thus, it may be possible to finance any additional
receivables by negotiating better credit terms from suppliers.
Inventory turnover has fallen slightly and is much slower than the industry average and this
may partly reflect stocking up ahead of a significant increase in sales. Alternatively, there is
some danger that the inventory could contain certain obsolete items that may require writing
off. The relative increase in the level of inventory has been financed by an increased overdraft
which may reduce if the inventory levels can be brought down.
The high levels of inventory, overdraft and receivables compared to that of payables suggests
a labour-intensive company or one where considerable value is added to bought‑in products.
Gearing
The level of gearing has increased only slightly over the year and is below the industry
average. Since the return on capital employed is nearly twice the rate of interest on the loan
stock, profitability is likely to be increased by a modest increase in the level of gearing.
TT2021
690 Financial Reporting (FR)
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20
Limitations of financial
statements and
interpretation
techniques
Essential reading
TT2021
TT2021
692 Financial Reporting (FR)
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The managers of a company can choose accounting policies initially to suit the company or the
type of results they want to get. Any changes in accounting policy must be justified, but some
managers might try to change accounting policies just to manipulate the results.
TT2021
20: Essential Reading 693
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TT2021
694 Financial Reporting (FR)
U1332120M
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TT2021
20: Essential Reading 695
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TT2021
696 Financial Reporting (FR)
U1332120M
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21
Statement of cash
flows
Essential reading
TT2021
$
Cash flows from operating activities
Profit before taxation X
Adjustments for:
Depreciation X
Investment income (X)
Finance cost X
X
Increase in trade receivables (X)
Decrease in inventories X
Decrease in trade payables (X)
Cash generated from operations X
Interest paid (X)
Income taxes paid (X)
Net cash from operating activities X
It is important to understand why certain items are added and others subtracted. Note the
following.
(a) Depreciation is not a cash expense, but is deducted in arriving at profit. It makes sense,
therefore, to eliminate it by adding it back.
(b) By the same logic, a loss on a disposal of a non-current asset (arising through underprovision
of depreciation) needs to be added back and a profit deducted.
TT2021
698 Financial Reporting (FR)
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(c) An increase in inventories means less cash - you have spent cash on buying inventory.
(d) An increase in receivables means the company’s debtors have not paid as much, and
therefore there is less cash.
(e) If we pay off payables, causing the figure to decrease, again we have less cash.
Activity 3: Thorstved Co
Below are the statements of financial position for Thorstved Co at 31 December 20X7 and 31
December 20X8 and the statement of profit or loss and other comprehensive income for the year
ended 31 December 20X8.
TT2021
21: Essential Reading 699
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STATEMENTS OF FINANCIAL POSITION
20X8 20X7
$’000 $’000
908 730
Current assets
Inventories 313 280
Trade receivables 208 186
Cash 111 4
632 470
Total assets 1,540 1,200
Non-current liabilities
4% loan notes 250 100
Deferred tax 76 54
Provision for warranties 30 26
356 180
Current liabilities
Trade payables 152 146
Current tax payable 26 24
Interest payable 5 –
183 170
Total equity and liabilities 1,540 1,200
$’000
Revenue 1,100
Cost of sales (750)
Gross profit 350
Expenses (247)
Finance costs (10)
TT2021
700 Financial Reporting (FR)
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$’000
Profit on sale of equipment 7
Profit before tax 100
Income tax expense (30)
PROFIT FOR THE YEAR 70
Other comprehensive income:
Gain on property revaluation 60
Income tax relating to gain on property revaluation (18)
Other comprehensive income for the year, net of tax 42
TOTAL COMPREHENSIVE INCOME FOR THE YEAR 112
Notes.
1 Depreciation of property, plant and equipment during 20X8 was $54,000 and deferred
development expenditure amortised was $25,000.
2 Proceeds from the sale of equipment were $58,000, giving rise to a profit of $7,000. No other
items of property, plant and equipment were disposed of during the year.
3 Finance costs represent interest paid on the loan notes. New loan notes were issued on 1
January 20X8.
4 The company revalued its property at the year end. Company policy is to treat revaluations
as realised profits when the asset is retired or disposed of.
Required
Prepare a statement of cash flows for Thorstved Co for the year ended 31 December 20X8, using
the indirect method in accordance with IAS 7.
Solution
1
THORSTVED CO
STATEMENT OF CASH FLOWS FOR YEAR ENDED 31 DECEMBER 20X8
(INDIRECT METHOD)
$’000 $’000
Adjustments for:
Depreciation
Amortisation
Interest expense
TT2021
21: Essential Reading 701
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$’000 $’000
Workings
1 Assets
$’000 $’000
b/d
Depreciation/amortisation
SPLOCI – OCI
Non-cash additions
Disposals
TT2021
702 Financial Reporting (FR)
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Property, plant & Development costs
equipment
$’000 $’000
Cash paid/(rec’d) β
c/d
2 Equity
$’000 $’000
b/d
SPLOCI
Non-cash
Cash (paid)/rec’d β
c/d
3 Liabilities
b/d
SPLOCI – P/L
– OCI
Non-cash
Cash (paid)/rec’d β
c/d
b/d
Increase/(decrease) β
TT2021
21: Essential Reading 703
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Inventories Trade Trade Provisions
receivable payables
s
c/d
TT2021
704 Financial Reporting (FR)
U1332120M
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Activity answers
Activity 3: Thorstved Co
THORSTVED CO
STATEMENT OF CASH FLOWS FOR YEAR ENDED 31 DECEMBER 20X8
(INDIRECT METHOD)
$’000 $’000
Adjustments for:
Depreciation 54
Amortisation 25
Interest expense 10
182
TT2021
21: Essential Reading 705
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Net cash from financing activities 189
Workings
1 Assets
$’000 $’000
b/d 638 92
SPLOCI – OCI 60
Non-cash additions – –
2 Equity
$’000 $’000
SPLOCI 70
Non-cash – –
3 Liabilities
TT2021
706 Financial Reporting (FR)
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Loan notes Income tax Interest
payable payable
SPLOCI – P/L 30 10
– OCI 18
Non-cash – – –
Increase/(decrease) β 33 22 6 4
TT2021
21: Essential Reading 707
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TT2021
708 Financial Reporting (FR)
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22
Specialised, not-for-
profit and public
sector entities
Essential reading
TT2021
2 Regulatory framework
Regulation of public not-for-profit entities, principally local and national governments and
governmental agencies, is undertaken by the International Public Sector Accounting Standards
Board (IPSASB), which comes under IFAC.
TT2021
710 Financial Reporting (FR)
U1332120M
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2.1 International public sector accounting standards
The IPSASB is developing a set of International Public Sector Accounting Standards (IPSASs),
based on IFRSs. To date 42, IPSASs have been issued, closely reflecting the relevant IFRS reporting
standard. For example, IPSAS 1 Presentation of Financial Statements, is aligned to IAS 1. There are
some IPSAS which are specific to the public sector, such as IPSAS 22, Disclosure of Financial
Information about the General Government Sector, and, issued in January 2019, IPSAS 42, Social
benefits, which do not have equivalent IFRS Standards.
Users and user groups • The primary user group for not-for-profit entities is
providers of funds.
• In the case of public bodies, such as government
departments, this primary group will consist of taxpayers.
• In the case of private bodies such as charities it will be
financial supporters, and also potential future financial
supporters.
• Another user group will be the recipients of the goods and
services provided by the not-for-profit entity
Cash flow focus • The resources the entity has available to deliver future
goods and services
• The cost and effectiveness of the objectives the entity has
delivered in the past
• The degree to which the entity is meeting its objectives
• The financial statements of not-for-profit entities need to
provide information which will enable users to assess an
entity’s ability to generate net cash inflows.
TT2021
22: Essential Reading 711
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3 Performance measurement
Not-for-profit and public sector entities produce financial statements in the same way as profit-
making entities do but, while they are expected to remain solvent, their performance cannot be
measured simply by the bottom line.
A public sector entity is not expected to show a profit or to underspend its budget. In practice,
central government and local government departments know that if they underspend the budget,
next year’s allocation will be correspondingly reduced. This pressure to meet a target can lead to
sub-optimal decision-making, for example, activity designed to ensure that spending or saving
targets are met just before the date at which performance is assessed. This leads to a rash of
digging up the roads and other expenditure just before the end of the financial year as councils
strive to spend any remaining funds.
Private and public sector entities are sometimes judged principally on the basis of what they have
achieved, not how much or how little they have spent in achieving it.
Which ONE of the following is a potential problem when analysing the performance of the
financial statements of a charity?
Lack of consistent accounting standards
Inability to see how restricted funds have been used by the charity
Difficulty in comparing similarly sized charities, for example a charity supporting homeless
people, and one supporting hospice care
As the charity is non-profit making, it is not a going concern
The Royal Charlotte Hospital files financial statements with details of its key performance
indicators. Which of the following key performance indicators are expected to be found in its
financial statements?
Return on capital employed
Dividend yield
Interest cover
PE ratio
Solution
TT2021
712 Financial Reporting (FR)
U1332120M
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TT2021
22: Essential Reading 713
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TT2021
714 Financial Reporting (FR)
U1332120M
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Activity answers
This is because the charities are likely to have different aims and different key performance
indicators, so that it is difficult to compare the efficiency of one charity with another at face
value.
Charities do follow a set of accounting standards, such as those issued by IPSAS which build on
the IFRS Standards but also cover other key areas not covered by IFRS.
Charities are expected to be self-sufficient, and there will be requirements to state how they will
cover the costs going forward just as any other company would be required to state. Charities are
also required to state where the assets will go in the event of it being wound up (such as another
local charity).
Restricted funds must be disclosed in the financial statements of the charity, including stating
what they may be used for and whether there has been any movement in the year.
TT2021
22: Essential Reading 715
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TT2021
716 Financial Reporting (FR)
U1332120M
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Further question
practice
TT2021
2 Which one of the following is not an item which is required to be shown on the face of the
statement of financial position according to IAS 1 Presentation of Financial Statements?
Inventories
Biological assets
Irrecoverable debt allowance
Investment property
3 What is the correct treatment of equity dividends paid under IAS 1 Presentation of Financial
Statements?
Dividends paid are shown on the face of the statement of profit or loss
Dividends paid are deducted from retained earnings
Dividends paid are included in administrative expenses
Dividends paid are deducted from ‘other comprehensive income’
4 Watson Co acquired a property on 1 January 20X1 for $250,000, being $200,000 for the building
and $50,000 for the land. The building was estimated to have a useful life of 50 years. On 1
January 20X6 the property was independently valued which resulted in an increase of $100,000
to the carrying amount of the building and $50,000 to the carrying amount of the land. The
useful life is unchanged.
Required
What is the depreciation charge for the year ended 31 December 20X6?
$5,520
$6,222
$6,273
$6,818
TT2021
718 Financial Reporting (FR)
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6 An asset has a carrying amount of $1.2 million. Its replacement cost is $1 million, its fair value is
$800,000 and its value in use is $950,000. The legal expenses involved in selling the asset are
estimated at $20,000.
Required
What is the amount of the impairment loss suffered by the asset?
$250,000
$420,000
$200,000
$270,000
7 A discontinued operation was disposed of in the current year. How should this be presented in the
statement of profit or loss?
A one-line entry showing post-tax profit or loss of the operation and the post-tax gain or loss
on disposal
A separate column showing the results of the discontinued operation, with the gain or loss on
disposal included under ‘other income’
A one-line entry showing the pre-tax profit or loss of the operation and the pre-tax gain or loss
on disposal included under ‘other income’. Tax effects included in ‘income tax expense’
A one-line entry showing pre-tax profit or loss of the operation and pre-tax gain or loss on
disposal, with tax effects included under ‘income tax expense’
8 Mammoth Co acquired 80% of the 100,000 $1 equity shares of Minor Co on 1 January 20X7. The
consideration consisted of one Mammoth Co share for each two shares in Minor Co and
$300,000 cash. The market price of a Mammoth Co share at 1 January 20X7 was $2.50 and the
market price of a Minor Co share on the same date was $1.75. Mammoth Co measure non-
controlling interest at fair value based on share price. At the acquisition date Minor Co had
retained earnings of $85,000 and $100,000 in revaluation surplus. Its head office building had a
fair value $60,000 in excess of its carrying amount.
Required
What was the goodwill on acquisition?
$190,000
$55,000
$90,000
$75,000
9 Catfish Co has owned 75% of Shark Co for a number of years. During the year to 31 December
20X8 Shark Co sold goods to Catfish Co for $75,000. Catfish Co had resold 40% of these goods
by the year end. Shark Co applies a 25% mark-up on all sales.
Required
By what amount should the consolidated retained earnings of Catfish Co at 31 December 20X8
be reduced in respect of these intragroup sales?
$33,750
$6,750
$8,438
$9,000
10 Frog Co acquired 80% of Tadpole Co on 1 April 20X7. The individual financial statements of Frog
Co and Tadpole Co for the year ended 31 December 20X7 showed revenue of $280,000 and
TT2021
23: FQP Chapter 719
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$190,000 respectively. In the post-acquisition period Tadpole Co sold goods priced at $40,000 to
Frog Co. 50% of these goods were still held in inventory by Frog Co at the end of the year.
Required
What was group revenue in the consolidated statement of profit or loss for the year ended 31
December 20X7?
$392,500
$402,500
$450,000
$382,500
11 Python Co obtained 30% of the equity shares of Cobra Co on 1 June 20X8 for $700,000. It is able
to exercise significant influence over Cobra Co. During the year to 31 May 20X9 Cobra Co made
sales of $200,000 to Python Co, priced at cost plus 25% mark-up. Python Co still had 50% of
these goods in inventory at the year end. Cobra Co’s statement of profit or loss for the year
ended 31 May 20X9 shows profit for the year of $650,000.
Required
What amount should be shown as ‘Investment in associate’ in the consolidated statement of
financial position of Python Co as at 31 May 20X9?
$895,000
$875,000
$835,000
$870,000
13 A contract in which performance obligations are satisfied over time was commenced on 1 April
20X7 for a price of $2.5 million. At 31 December 20X7 the contract was certified as 40% complete
and costs incurred to date amounted to $0.8 million. The contract is expected to be profit making
overall.
Invoices amounting to $300,000 have been issued but no payment has yet been received.
Required
What amount should be shown in the statement of financial position as at 31 December 20X7 in
respect of ‘contract asset/liability’?
$700,000 contract liability
$700,000 contract asset
$100,000 contract liability
$100,000 contract asset
TT2021
720 Financial Reporting (FR)
U1332120M
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14 Cracker Co set up a gas exploration site on 1 January 20X1 which will operate for five years. At
the end of five years the site will need to be dismantled and the landscape restored. The amount
required for dismantling and restoration, discounted at the company’s cost of capital of 8%, is
$1.2 million and a provision is set up for this amount.
Required
What is the total amount charged to profit or loss for the year ended 31 December 20X2 in
respect of these dismantling and restoration costs?
$343,680
$336,000
$103,680
$96,000
15 How are financial assets initially measured under IFRS 9 Financial Instruments (excluding assets
held for trading or subject to a specific designation)?
Fair value
Fair value plus transaction costs
Fair value minus transaction costs
Amortised cost
16 On 1 April 20X7 Lastgo Co rents a warehouse under a ten-month lease for $24,000 per month and
elects to use the short term lease exemption under IFRS 16 Leases. As an incentive to sign the
contract it is given the first month rent-free.
Required
What amount in respect of lease rental should be charged to profit or loss for the quarter ended
30 June 20X7?
$64,800
$48,000
$72,000
$43,200
17 Tangier Co had 200,000 shares in issue at 1 January 20X4. On 1 April 20X4 it made a 1 for 4 rights
issue at a price of $1.20. The market value immediately prior to the issue was $1.80. Profit for the
year ended 31 December 20X4 was $560,000.
Required
What is EPS for the year?
$2.32
$2.24
$2.61
$2.80
TT2021
23: FQP Chapter 721
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19 On 1 April 20X7 Thames Co sold all of its shares in Avon Co for $200,000, when Avon Co’s
retained earnings amounted to $140,000.
Required
What is the loss on disposal that should be recognised in the consolidated statement of profit or
loss of Thames Co for the year ended 31 March 20X7? (2 marks)
$16,000
$12,000
$22,000
$70,000
TT2021
722 Financial Reporting (FR)
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Section B (2 marks each)
20 The following scenario relates to questions 1–5.
Figaro Co is preparing its financial statements for the year ended 31 December 20X6. A number of
issues must be accounted for before they can be finalised.
The following circumstances have arisen during the year:
(1) Figaro Co has entered into a contract to supply a company in China with specialised vehicle
components. Unfortunately, the raw material that it needs to manufacture these components
has risen substantially in price and Figaro Co now expects to produce and sell the
components at a loss.
(2) Figaro Co has a machine that needs regular overhauls every year in order to be allowed to
operate. Each overhaul costs $5,000.
(3) Figaro Co has set up a new division to produce a product for which the market is still small. It
expects this division to run at a loss for two years.
(4) Figaro Co sells goods with a one-year warranty which guarantees the goods will perform as
expected during the warranty period. Customers are not required to pay additional amounts
for the warranty. Goods may require minor or major repairs during the warranty period. If all
of the goods sold during the year to 30 December 20X6 were to require minor repairs, the
total cost would be $50,000. If all of the goods sold required major repairs the cost would be
$120,000. In any year Figaro Co expects 5% of goods sold to be returned for major repairs
and 16% to be returned for minor repairs.
(5) Figaro Co has acquired 100% of a new subsidiary. At the date of acquisition, the acquiree
had a contingent liability which was reliably valued at $150,000.
Required
(a) Which of circumstances (1) to (3) above will give rise to a provision?
(1) only
(2) only
(1) and (2)
(2) and (3)
(b) How do provisions differ from other liabilities?
They do not arise as a result of past events.
They involve uncertain timing or amount.
An outflow of resources is not probable.
They are not charged to profit for the year.
(c) What amount should be shown as a warranty provision in the statement of financial position
of Figaro Co at 31 December 20X6?
$2,500
$8,000
$14,000
$19,200
(d) A provision arises from a legal or constructive obligation. In the case of Figaro Co which of
the following would be an obligation giving rise to a provision?
A new law will be enacted on 1 August 20X6 to combat air pollution. Figaro Co must fit new
air filters to be in compliance with this law.
The Board of Figaro Co, in a meeting on 27 June 20X6, decided to restructure and close
one of its divisions on 1 September 20X6. This will involve redundancies, but the decision
has not yet been communicated outside the Board.
TT2021
23: FQP Chapter 723
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Figaro Co carries out certain work that entails environmental damage. It is not a legal
requirement to clean up this damage but most firms in the industry do so. Figaro Co does
not.
Figaro Co is being sued by an ex-employee on health and safety grounds. Lawyers have
advised that the employee has a 55% chance of success.
(e) How should the contingent liability in (5) above be accounted for by Figaro Co?
It should be disclosed, but not recognised
It should be recognised
It should be recognised if an outflow of resources is probable, otherwise just disclosed
It should not be recognised or disclosed
TT2021
724 Financial Reporting (FR)
U1332120M
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Defer profit and amortise over the lease term
Recognise proportion relating to right-of-use transferred
Recognise proportion relating to right-of-use retained
Recognise whole amount of profit immediately in profit or loss
(d) What is the initial measurement of the right-of-use asset in respect of the warehouse?
$35,660
$55,660
$50,660
$30,660
(e) What is the gain that will be recognised in the statement of profit or loss in respect of the sale
and leaseback of the machine?
$60,000
$52,570
$42,000
$7,430
10.11.20X7 €1.13 : $
10.12.20X7 €1.18 : $
31.12.20X7 €1.12 : $
Required
(a) What amount should be charged as depreciation on the building in (1) for the year ended 31
December 20X7?
$22,300
$22,128
$22,000
$21,176
(b) What are the deferred tax implications of this revaluation?
Deferred tax on the surplus of $100,000 should be charged to profit or loss for the year.
Deferred tax on the surplus of $100,000 should be charged to the revaluation surplus.
Deferred tax on the surplus will not arise until the building is sold.
There are no deferred tax implications.
TT2021
23: FQP Chapter 725
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(c) When carrying out an impairment review, assets are measured at their recoverable amount.
Which of these options describes recoverable amount?
Higher of fair value less costs of disposal and value in use
Higher of carrying amount and fair value less costs of disposal
Lower of fair value less costs of disposal and value in use
Lower of carrying amount and fair value less costs of disposal
(d) Because of the loss of production caused by the damaged machine, Orfeo Co lost customers
and it was decided that the whole factory unit was impaired by $120,000. Orfeo Co’s
accountant has to decide how to allocate this impairment loss.
The carrying amounts of the assets of the factory unit at the date of the impairment review,
including the damaged machine, were:
$
Goodwill 20,000
Factory building 440,000
Plant and machinery 160,000
Net current assets 100,000
720,000
Required
What will be the carrying amount of plant and machinery when the impairment loss has been
allocated?
$129,000
$130,000
$144,000
$114,000
(e) What should be the total amount of exchange gain or loss recognised during the year to 31
December 20X7 in respect of the transaction in (3) above?
$592 loss
$2,813 gain
$2,221 gain
$1,186 gain
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Practice questions
It should be noted that these questions are not intended to replicate the type of exam questions
you may face in Section C of the FR exam (which will comprise 2 × 20 mark questions covering the
preparation of financial statements and interpretation of financial statements).
Instead, these questions are intended as useful practice to test your understanding of the material
in the chapters. The Practice & Revision Kit has a large number of exam format questions.
(b) Explain in general terms what the IASB’s Conceptual Framework is trying to achieve.
(4 marks)
(Total = 10 marks)
(b) Discuss whether or not the financial statements of not-for-profit entities should be subject to
regulation. (5 marks)
(Total = 10 marks)
$ $
Authorised and issued 300,000 ordinary shares of $1 each, fully
paid 300,000
100,000 8.4% cumulative redeemable preference shares of $1
each, fully paid 100,000
Revaluation surplus 50,000
Share premium 100,000
Other components of equity 50,000
Retained earnings – 31 May 20X7 283,500
Patents and trademarks 215,500
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$ $
Land at cost 250,000
Head office at cost 75,000
Accumulated depreciation – head office – 31 May 20X7 15,000
Factory plant and equipment at cost 150,000
Accumulated depreciation – plant and equipment – 31 May 20X7 68,500
Furniture and fixtures at cost 50,000
Accumulated depreciation – furniture and fixtures – 31 May 20X7 15,750
Motor vehicles at cost 75,000
Accumulated depreciation – motor vehicles – 31 May 20X7 25,000
10% loan notes (20Y0 – 20Y5) 100,000
Trade receivables/ trade payables 177,630 97,500
Bank overdraft 51,250
Inventories – raw materials at cost – 31 May 20X7 108,400
Purchases – raw materials 750,600
Carriage inwards – raw materials 10,500
Manufacturing wages 250,000
Manufacturing overheads 125,000
Cash 5,120
Work in progress – 31 May 20X7 32,750
Sales 1,526,750
Administrative expenses 158,100
Selling and distribution expenses 116,800
Legal and professional expenses 54,100
Allowance for irrecoverable debts– 31 May 20X8 5,750
Inventories – finished goods – 31 May 20X7 184,500 -
2,789,000 2,789,000
Additional information:
(1) Inventories at 31 May 20X8 were:
$
Raw materials 112,600
Finished goods 275,350
Work in progress 37,800
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Motor vehicles 20% on reducing balance
– 25% admin
– 75% selling and distribution
$
Solicitors’ fees for purchase of freehold land during year 5,000
(4) Provision is to be made for a full year’s interest on the loan notes.
(5) Income tax on the profits for the year is estimated at $40,000 and is due for payment on 28
February 20X9.
(6) The directors recommended on 30 June that a dividend of 3.5c per share be paid on the
ordinary share capital. No ordinary dividend was paid during the year ended 31 May 20X7.
Required
From the information given above, prepare the statement of profit or loss and other
comprehensive income of Polymer for the year to 31 May 20X8 and a statement of financial
position at that date for publication in accordance with International Financial Reporting
Standards. (25 marks)
$’000
Profit before interest and tax 792
Finance income 24
Finance cost (10)
Profit before tax 806
Income tax expense (240)
PROFIT FOR THE YEAR 566
Other comprehensive income:
Gain on property revaluation 120
TOTAL COMPREHENSIVE INCOME FOR THE YEAR 686
$
Carrying amount at revaluation 30,000
Revaluation 50,000
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$
80,000
Depreciation (80,000/10) × 3) (24,000)
56,000
Gains Co has been following paragraph 41 of IAS 16 which allows a reserve transfer of the realised
revaluation surplus (the difference between depreciation based on revalued amount and
depreciation based on cost) as the asset is used to retained earnings.
Revaluations during the year related to land.
$
Original cost 120,000
Revaluation surplus 40,000
Value at 1.1.20X9 160,000
The properties had a valuation on 31 December 20X9 of $110,000. Gains Co previously accounted
for its investment properties by crediting gains to a revaluation surplus as allowed by local GAAP.
Gains Co now wishes to apply the fair value model of IAS 40 which states that gains and losses
should be accounted for in profit or loss. The elimination of the previous revaluation surplus is to
be treated as a change in accounting policy in accordance with IAS 8. No adjustment has yet
been made for the change in accounting policy or subsequent fall in value.
(3) Share capital
During the year the company had the following changes to its capital structure:
• An issue of 200,000 $1 ordinary bonus shares capitalising its share premium
• An issue of 400,000 $1 ordinary shares (issue price $1.40 per share)
(4) Equity
The carrying amount of equity at the start of the year was as follows:
$
Share capital 2,800,000
Share premium 1,150,000
Retained earnings 2,120,000
Revaluation surplus 750,000
6,820,000
(5) Dividends
Dividends paid during the year amounted to $200,000.
Required
Using the information above prepare the Statement of changes in equity for Gains Co for the
year ended 31 December 20X9. (10 marks)
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Biogenics Co is a publicly listed pharmaceutical company. During the year to 31 December 20X9
the following transactions took place:
(1) $6 million was spent on developing a new anti-obesity drug which received clinical approval
on 1 July 20X9 and is proving commercially successful. The directors expect the project to be
in profit within 12 months of the approval date. The patent was registered on 1 July 20X9. It
cost $1.5 million and remains in force for three years.
(2) A research project was set up on 1 October 20X9 which is expected to result in a new cancer
drug. $200,000 was spent on computer equipment and $400,000 on staff salaries. The
equipment has a useful life of four years.
(3) On 1 September 20X9 Biogenics Co acquired an up-to-date list of GPs at a cost of $500,000
and has been visiting them to explain the new obesity drug. The list is expected to generate
sales throughout the life-cycle of the drug.
Required
(a) In accordance with IAS 38, discuss whether internally-developed intangible assets should be
recognised, and if so how they should be initially recorded and subsequently accounted for.
(3 marks)
(b) Prepare extracts from the statement of financial position of Biogenics Co at 31 December
20X9 relating to the above items and summarise the costs to be included in the statement of
profit or loss for that year. (7 marks)
(Total = 10 marks)
$’000
Goodwill 200
Operating licence 1,200
Property – train stations and land 300
Rail track and coaches 300
Two steam engines 1,000
Purchase consideration 3,000
The operating licence is for ten years. It was renewed on 1 January 20X0 by the transport
authority and is stated at the cost of its renewal. The carrying amount of the property and rail
track and coaches are based on their value in use. The engines are valued at their net selling
prices.
On 1 February 20X0 the boiler of one of the steam engines exploded, completely destroying the
whole engine. Fortunately, no one was injured, but the engine was beyond repair. Due to its age a
replacement could not be obtained. Because of the reduced passenger capacity, the estimated
value in use of the whole of the business after the accident was assessed at $2 million.
Passenger numbers after the accident were below expectations even allowing for the reduced
capacity. A market research report concluded that tourists were not using the railway because of
their fear of a similar accident occurring to the remaining engine. In the light of this the value in
use of the business was re-assessed on 31 March 20X0 at $1.8 million. On this date Multiplex Co
received an offer of $900,000 in respect of the operating licence (it is transferable). The realisable
value of the other net assets has not changed significantly.
TT2021
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Required
Calculate the carrying amount of the assets of Steamdays Co (in Multiplex Co’s consolidated
statement of financial position) at 1 February 20X0 and 31 March 20X0 after recognising the
impairment losses. (15 marks)
Hewlett Co’s trial balance from the general ledger at 31 December 20X2 showed the
following balances:
$m $m
Revenue 2,648
Purchases 1,669
Inventories at 1 January 20X2 444
Distribution costs 514
Administrative expenses 345
Loan note interest paid 3
Rental income 48
Land and buildings: – cost (including $90m land) 840
– accumulated depreciation at 1 January 20X2 120
Plant and equipment: – cost 258
– accumulated depreciation at 1 January 20X2 126
Investment property at 1 January 20X2 548
Trade receivables 541
Cash and cash equivalents 32
50c ordinary shares 100
Share premium 244
Retained earnings at 1 January 20X2 753
Interim dividend paid 6
Other components of equity 570
4% loan note repayable 20X8 (issued 20X0) 150
Trade and other payables 434
Proceeds from sale of equipment 7
5,200 5,200
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(2) At the beginning of the year, Hewlett Co disposed of some malfunctioning equipment for $7
million. The equipment had cost $15 million and had accumulated depreciation brought
forward at 1 January 20X2 of $3 million.
There were no other additions or disposal to property, plant and equipment in the year.
(3) The company treats depreciation on plant and equipment as a cost of sale and on land and
buildings as an administrative cost. Depreciation rates as per the company’s accounting
policy note are as follows:
Hewlett Co’s accounting policy is to charge a full year’s depreciation in the year of an asset’s
purchase and none in the year of disposal. Hewlett Co’s buildings were eight years old on 1
January 20X2.
(4) On 31 December 20X2 the company revalued its land and buildings to $760 million (including
$100 million for the land). The company follows the revaluation model of IAS 16 for its land
and buildings, but no revaluations had previously been necessary. The company wishes to
treat the revaluation surplus as being realised on disposal of the assets. The company has
previously undertaken no revaluations.
(5) Due to a change in Hewlett Co’s product portfolio plans, an item of plant with a carrying
amount $22 million at 31 December 20X2 (after adjusting for depreciation for the year) may
be impaired due to a change in use. An impairment test conducted at 31 December, revealed
its fair value less costs of disposal to be $16 million. The asset is now expected to generate an
annual net income stream of $3.8 million for the next five years at which point the asset
would be disposed of for $4.2 million. An appropriate discount rate is 8%. Five-year discount
factors at 8% are:
Simple Cumulative
0.677 3.993
(6) The income tax charge (current and deferred tax) for the year is estimated at $45 million (of
which $17 million relates to future payable tax on the revaluation, to be charged to other
comprehensive income (and the revaluation surplus)).
(7) An interim dividend of 3c per share was paid on 30 June 20X2. A final dividend of 1.5c per
share was declared by the directors on 28 January 20X3. No dividends were paid or declared
in 20X1.
(8) During the year on 1 July 20X2, Hewlett Co made a 1 for 4 bonus issue, capitalising its other
components of equity. This transaction had not yet been accounted for. The fair value of the
company’s shares on the date of the bonus issue was $7.50 each.
(9) Hewlett uses the fair value model of IAS 40. The fair value of the investment property at 31
December 20X2 was $588 million.
Required
Prepare the statement of profit or loss and other comprehensive income and statement of
changes in equity for Hewlett Co for the year to 31 December 20X2 and a statement of financial
position at that date in accordance with IFRSs insofar as the information permits.
Notes.
1 Notes to the financial statements are not required, but all workings should be clearly shown.
(25 marks)
2 Work to the nearest $1m. Comparative information is not required. (25 marks)
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31 Barcelona Co and Madrid Co (22 mins)
Barcelona Co acquired 60% of Madrid Co’s ordinary share capital on 1 October 20X2 at a price of
$1.06 per share. The balance on Madrid Co’s retained earnings at that date was $115 million.
Their respective statements of financial position as at 30 September 20X6 are:
Barcelona Co Madrid Co
$m $m
Non-current assets
Property, plant & equipment 2,848 354
Patents 45 –
Investment in Madrid 159 –
3,052 354
Current assets
Inventories 895 225
Trade and other receivables 1,348 251
Cash and cash equivalents 212 34
2,455 510
5,507 864
Equity
Share capital (20c ordinary shares) 920 50
Retained earnings 2,861 440
3,781 490
Non-current liabilities
Long-term borrowings 558 168
Current liabilities
Trade and other payables 1,168 183
Current portion of long-term borrowings – 23
1,168 206
5,507 864
At the date of acquisition the fair values of some of Madrid Co’s assets were greater than their
carrying amounts. One line of Madrid Co’s inventory had a fair value of $8 million above its
carrying amount. This inventory had all been sold by 30 September 20X6. Madrid Co’s land and
buildings had a fair value $26 million above their carrying amount. $20 million of this is
attributable to the buildings, which had a remaining useful life of ten years at the date of
acquisition.
It is group policy to value non-controlling interests at full (or fair) value. The fair value of the non-
controlling interests at acquisition was $86 million.
Annual impairment tests have revealed cumulative impairment losses relating to recognised
goodwill of $20 million to date.
Required
Produce the consolidated statement of financial position for the Barcelona Group as at 30
September 20X6. (12 marks)
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32 Reprise Group (25 mins)
Reprise Co purchased 75% of Encore Co for $2,000,000 ten years ago when the balance on its
retained earnings was $1,044,000. The statements of financial position of the two companies as
at 31 March 20X4 are:
Reprise Co Encore Co
$’000 $’000
Non-current assets
Investment in Encore 2,000 –
Land and buildings 3,350 –
Plant and equipment 1,010 2,210
Motor vehicles 510 345
6,870 2,555
Current assets
Inventories 890 352
Trade receivables 1,372 514
Cash and cash equivalents 89 51
2,351 917
9,221 3,472
Equity
Share capital – $1 ordinary shares 1,000 500
Retained earnings 4,225 2,610
Revaluation surplus 2,500 –
7,725 3,110
Non-current liabilities
10% debentures 500 –
Current liabilities
Trade and other payables 996 362
9,221 3,472
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Required
Prepare the consolidated statement of financial position for the Reprise group of companies as at
31 March 20X4. It is the group policy to value the non-controlling interests at full (or fair) value.
(14 marks)
Fallowfield Co Rusholme Co
$ $
Revenue 403,400 193,000
Cost of sales (201,400) (92,600)
Gross profit 202,000 100,400
Distribution costs (16,000) (14,600)
Administrative expenses (24,250) (17,800)
Dividends from Rusholme 15,000
Profit before tax 176,750 68,000
Income tax expense (61,750) (22,000)
PROFIT FOR THE YEAR 115,000 46,000
Fallowfield Co Rusholme Co
Retained Retained
earnings earnings
$ $
Balance at 1 July 20X7 163,000 61,000
Dividends (40,000) (25,000)
Profit for the year 115,000 46,000
Balance at 30 June 20X8 238,000 82,000
Additional information:
During the year Rusholme Co sold some goods to Fallowfield Co for $40,000, including 25%
mark-up. Half of these items were still in inventories at the year end.
Required
Produce the consolidated statement of profit or loss of Fallowfield Co and its subsidiary for the
year ended 30 June 20X8, and an extract from the statement of changes in equity, showing
retained earnings. Goodwill is to be ignored. (15 marks)
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The statements of profit or loss and other comprehensive income of Panther Co and Sabre
Co for the year ended 31 December 20X4 are:
Panther Co Sabre Co
$’000 $’000
Revenue 22,800 4,300
Cost of sales (13,600) (2,600)
Gross profit 9,200 1,700
Distribution costs (2,900) (500)
Administrative expenses (1,800) (300)
Finance costs (200) (70)
Finance income 50 –
Profit before tax 4,350 830
Income tax expense (1,300) (220)
PROFIT FOR THE YEAR 3,050 610
Other comprehensive income for the year, net of tax 1,600 180
TOTAL COMPREHENSIVE INCOME FOR THE YEAR 4,650 790
Historically, Sabre Co had been a significant trading partner of Panther Co. During 20X4,
Panther Co purchased $640,000 of goods from Sabre Co. Of these, $60,000 remained in
inventories at the year end. Sabre Co makes a mark-up on cost of 20% under the transfer pricing
agreement between the two companies. The fair value of the identifiable net assets of Sabre Co
on purchase were $200,000 greater than their carrying amounts. The difference relates to
properties with a remaining useful life of 20 years.
On 1 January 20X4 (to protect its supply lines), Panther Co had advanced a loan to Sabre Co
amounting to $800,000 at a market interest rate of 5%. The loan is due for repayment in 20X9.
Panther Co Sabre Co
Reserves Reserves
$’000 $’000
Balance at 1 January 20X4 12,750 2,480
Dividend paid (900) –
Total comprehensive income for the year 4,650 790
Balance at 31 December 20X4 16,500 3,270
Panther Co and Sabre Co had $400,000 and $150,000 of share capital in issue throughout the
period respectively.
Required
Prepare the consolidated statement of profit or loss and other comprehensive income and
statement of changes in equity (extract for reserves) for the Panther Group for the year ended 31
December 20X4.
Notes.
1 No adjustments for impairment losses were necessary in the group financial statements.
(15 marks)
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2 Assume income and expenses (other than intragroup items) accrue evenly. (15 marks)
$’000
Depreciation arising on the fair value adjustment to non-current assets since this date is $5,000.
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(4) During the year, Hever Co sold inventories to Spiro Co for $16,000, which originally cost Hever
Co $10,000. Three‑quarters of these inventories have subsequently been sold by Spiro Co.
(5) No impairment losses on goodwill had been necessary by 31 December 20X4.
(6) It is group policy to value non-controlling interests at full (or fair) value. The fair value of the
non-controlling interests at acquisition was $90,000.
Required
Prepare the consolidated statement of financial position for the Hever group (incorporating the
associate). (20 marks)
Highveldt Co Samson Co
$m $m $m $m
Tangible non-current assets (note(1)) 420 320
Development costs (note (4)) nil 40
Investments (note (2)) 300 20
720 380
Current assets 133 91
Total assets 853 471
Equity and liabilities
Ordinary shares of $1 each 270 80
Reserves:
Share premium 80 40
Revaluation surplus 45 nil
Retained earnings – 1 April 20X4 160 134
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(1) Highveldt Co has a policy of revaluing land and buildings to fair value. At the date of
acquisition Samson Co’s land and buildings had a fair value $20 million higher than their
carrying amount and at 31 March 20X5 this had increased by a further $4 million (ignore
any additional depreciation).
(2) Included in Highveldt Co’s investments is a loan of $60 million made to Samson Co at the
date of acquisition. Interest is payable annually in arrears. Samson Co paid the interest due
for the year on 31 March 20X5, but Highveldt Co did not receive this until after the year end.
Highveldt Co has not accounted for the accrued interest from Samson Co.
(3) Samson Co had established a line of products under the brand name of Titanware. Acting on
behalf of Highveldt Co, a firm of specialists, had valued the brand name at a value of $40
million with an estimated life of ten years as at 1 April 20X4. The brand is not included in
Samson Co’s statement of financial position.
(4) Samson Co’s development project was completed on 30 September 20X4 at a cost of $50
million. $10 million of this had been amortised by 31 March 20X5. Development costs
capitalised by Samson Co at the date of acquisition were $18 million. Highveldt Co’s directors
are of the opinion that Samson Co’s development costs do not meet the criteria in IAS 38
Intangible Assets for recognition as an asset.
(5) Samson Co sold goods to Highveldt Co during the year at a profit of $6 million. One-third of
these goods were still in the inventory of Highveldt Co at 31 March 20X5.
(6) An impairment test at 31 March 20X5 on the consolidated goodwill concluded that it should
be written down by $22 million. No other assets were impaired.
(7) It is the group policy to value the non-controlling interest at full fair value. At the date of
acquisition, the directors estimated the fair value of the non-controlling interest to be $74
million.
Required
(a) Calculate the following figures as they would appear in the consolidated statement of
financial position of Highveldt Co at 31 March 20X5: (8 marks)
(i) Goodwill (8 marks)
(ii) Non-controlling interest (4 marks)
(iii) The following consolidated reserves:
• Share premium
• Revaluation surplus
• Retained earnings
(8 marks)
Note. Show your workings. (8 marks)
(b) Explain why consolidated financial statements are useful to the users of financial statements
(as opposed to just the parent company’s separate (entity) financial statements). (5 marks)
(Total = 33 marks)
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The company receives a 2.5% trade discount from its suppliers and it also takes advantage of
a 2% discount for prompt payment.
Required
Calculate the total value of products Arctic, Brassy and Chilly which should be shown in
inventory in the statement of financial position.
(b) Explain the difference that changing from a weighted average to FIFO method of inventory
valuation is likely to have on an entity’s profit or loss. (10 marks)
(Total = 10 marks)
TT2021
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Required
What is the total amount of the finance cost associated with the debt instrument? (3 marks)
(b) On 1 January 20X3 Dashing Co issued $600,000 loan notes. Issue costs were $200. The loan
notes do not carry interest, but are redeemable at a premium of $152,389 on 31 December
20X4. The effective finance cost of the loan notes is 12%.
Required
What is the finance cost in respect of the loan notes for the year ended 31 December 20X4?
(3 marks)
(c) On 1 January 20X1, Flustered Co issued 10,000 5% convertible bonds at their par value of
$50 each. The bonds will be redeemed on 1 January 20X6. Each bond is convertible to equity
shares at the option of the holder at any time during the five year period. Interest on the
bond will be paid annually in arrears.
The prevailing market interest rate for similar debt without conversion options at the date of
issue was 6%.
The discount factor for 6% at year 5 is 0.747.
The cumulative discount factor for years 1–5 at 6% is 4.212.
Required
At what value should the equity element of the hybrid financial instrument be recognised in
the financial statements in Flustered Co at the date of issue? (4 marks)
(Total = 10 marks)
(b) Explain with examples how IFRS seeks to limit creative accounting in each of the following
areas of accounting.
(i) Group accounting
(ii) Measurement and disclosure of current assets
(c) Alpha Co, a public listed corporation, is considering how it should raise $10m of finance
which is required for a major and vital non-current asset renewal scheme that will be
undertaken during the current year to 31 December 20X6. Alpha Co is particularly concerned
about how analysts are likely to react to its financial statements for the year to 31 December
20X6. Present forecasts suggest that Alpha Co’s earnings per share and its financial gearing
ratios may be worse than market expectations. Mr Wong, Alpha Co’s Finance Director, is in
favour of raising the finance by issuing a convertible loan. He has suggested that the coupon
(interest) rate on the loan should be 5%; this is below the current market rate of 9% for this
type of loan. In order to make the stock attractive to investors the terms of conversion into
equity would be very favourable to compensate for the low interest rate.
Required
Explain why the Finance Director believes the above scheme may favourably improve Alpha
Co’s earnings per share and gearing.
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(d) Describe how the requirements of IAS 33 Earnings per Share and IAS 32 Financial Instruments:
Presentation are intended to prevent the above effects. (10 marks)
(Total = 17 marks)
(b) Jenson Co has entered into the following transactions/agreements in the year to 31 March
20X5.
(1) Goods, which had a cost of $20,000, were sold to Lauda Co for $35,000 on 1 July 20X4.
Jenson Co has an option to repurchase the goods from Lauda Co at any time within the
next two years. The repurchase price will be $35,000 plus interest charged at 12% per
annum from the date of sale to the date of repurchase. It is expected that Jenson Co will
repurchase the goods.
(2) Jenson Co owns the rights to a fast food franchise. On 1 April 20X4 it sold the right to
open a new outlet to Mr Verstappen. The franchise is for five years. Jenson Co received
an initial fee of $50,000 for the first year and will receive $5,000 per annum thereafter.
Jenson Co has continuing service obligations on its franchise for advertising and product
development that amount to approximately $8,000 per annum for each franchised
outlet. A reasonable profit margin on the provision of the continuing services is deemed
to be 20% of revenues received.
(3) On 1 September 20X4 Jenson Co received subscriptions in advance of $240,000. The
subscriptions are for 24 monthly publications of a magazine produced by Jenson Co. At
the year-end Jenson Co had produced and despatched 6 of the 24 publications.
Required
Describe how Jenson Co should treat each of the above examples in its financial statements
in the year to 31 March 20X5. (13 marks)
(Total = 18 marks)
TT2021
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Aspire Bigga Construct
$’000 $’000 $’000
Costs incurred to date 500 500 320
Value of work certified to date 60% 50% 35%
Required
(a) Show how each contract would be reflected in the statement of financial position of Trontacc
Co at 30 September 20X7 under IFRS 15 Revenue from Contracts with Customers.
(b) Show how each contract would be reflected in the statement of profit or loss of Trontacc Co
for the year ended 30 September 20X7 under IFRS 15. (10 marks)
(Total = 10 marks)
$’000 $’000
Revenue 283,460
Inventory 1 October 20X0 12,400
Purchases 147,200
Distribution expenses 22,300
Administration expenses 34,440
Loan note interest paid 300
Interim dividends: ordinary 2,000
preference 480
Investment income 1,500
Building 56,250
Plant and equipment – cost 55,000
Computer system – cost 35,000
Investments at valuation 34,500
Depreciation 1 October 20X0 (note (2))
Building 18,000
Plant and equipment 12,800
Computer system 9,600
Trade accounts receivable 35,700
Bank overdraft 1,680
Trade accounts payable 17,770
Deferred tax (note (3)) 5,200
Ordinary shares of $1 each 20,000
Suspense account (note (4)) 26,000
6% loan notes (issued 1 October 20X0) 10,000
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$’000 $’000
8% preference shares (redeemable) 12,000
Revaluation surplus (note (3)) 3,400
Retained earnings 1 October 20X0 - 14,160
435,570 435,570
$
Normal sales at a mark-up on cost of 40% 1,400,000
Sales on a sale or return basis at a mark-up on cost of 30% 650,000
Goods received at cost 820,000
All sales and purchases had been correctly recorded in the period in which they occurred.
(2) Telenorth Co has a building depreciated over the useful term of 25 years on a straight line
basis. Depreciation has not yet been calculated for the current year.
Telenorth Co has the following depreciation policies.
Plant and equipment – five years straight line with residual values estimated at $5,000,000
Computer system – 40% per annum reducing balance
Depreciation of the building and plant is treated as cost of sales; depreciation of the computer
system is an administration cost.
(3) An income tax liability of $23.4 million for the year to 30 September 20X1 is required. The
deferred tax liability is to be increased by $2.2 million, of which $1 million is to be charged
direct to the revaluation surplus.
(4) The suspense account contains the proceeds of two share issues.
(i) The exercise of all the outstanding directors’ share options of four million shares on 1
October 20X0 at $2 each
(ii) A fully subscribed rights issue on 1 July 20X1 of 1 for 4 held at a price of $3 each. The
stock market price of Telenorth’s shares immediately before the rights issue was $4.
(iii) The finance charge relating to the preference shares is equal to the dividend payable.
Required
(a) The statement of profit or loss of Telenorth Co for the year to 30 September 20X1. (8 marks)
(c) Calculate the earnings per share in accordance with IAS 33 for the year to 30 September
20X1 (ignore comparatives). (5 marks)
(Total = 25 marks)
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a deposit of $9,000 on 1 January 20X1, and two annual instalments of $24,000 on 31 December
20X1, 20X2 and a final instalment of $20,391 on 31 December 20X3. Ownership will pass to Bulwell
Aggregates Co at the end of the lease term. The scrap value of the lorries after four years is
expected to be $4,000.
Interest is to be calculated at 25% on the balance outstanding on 1 January each year and paid
on 31 December each year.
The depreciation policy of Bulwell Aggregates Co is to depreciate the right-of-use asset arising
from the lease of the vehicles over a four year period using the straight line method.
Required
Show the entries in the statement of profit or loss and statement of financial position for the years
20X1, 20X2, 20X3. This is the only lease transaction undertaken by this company.
Note. Calculate to the nearest $ (10 marks)
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$ $
Profit before tax 2,530,000
Less income tax expense (1,127,000)
1,403,000
Transfer to reserves (230,000)
Dividends:
Paid preference interim dividend 138,000
Paid ordinary interim divided 414,000
Declared preference final dividend 138,000
(690,000)
Retained 483,000
On 1 January 20X4 the issued share capital of Pilum Co was 4,600,000 6% preference shares of
$1 each and 4,120,000 ordinary shares of $1 each.
Required
Calculate the earnings per share (on basic and diluted basis) in respect of the year ended 31
December 20X4 for each of the following circumstances (each of the three circumstances (1) to (3)
is to be dealt with separately).
(a) On the basis that there was no change in the issued share capital of the company during the
year ended 31 December 20X4.
(b) On the basis that the company made a rights issue of $1 ordinary shares on 1 October 20X4
in the proportion of 1 for every 5 shares held, at a price of $1.20. The market price for the
shares at close of trade on the last day of quotation cum rights was $1.78 per share.
(c) On the basis that Pilum Co made no new issue of shares during the year ended 31 December
20X4 but on that date it had in issue $1,500,000 10% convertible loan stock 20X8 – 20Y1. This
loan stock will be convertible into ordinary $1 shares as follows.
Note. Assume where appropriate that the income tax rate is 30%.
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STATEMENTS OF PROFIT OR LOSS FOR THE YEARS ENDED 30 JUNE
Other information
(1) Depreciation charged for the three years in question was:
(2) The other interest bearing borrowings are secured by a floating charge over the assets of
Biggerbuys Co. Their repayment is due on 30 June 20Y9.
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(3) Dividends of $30 million were paid in 20X7 and 20X8. A dividend of $20 million has been
proposed.
(4) The bank loans are unsecured. The maximum lending facility the bank will provide is $630
million.
(5) Over the past three years the level of credit sales has been:
The entity offers extended credit terms for certain products to maintain market share in a highly
competitive environment.
Given the steady increase in the level of bank loans which has taken place in recent years, the
entity has recently written to its bankers to request an increase in the lending facility. The request
was received by the bank on 15 October 20X9, two weeks after the financial statements were
published. The bank is concerned at the steep escalation in the level of the loans and has asked
for a report on the financial performance of Biggerbuys Co for the last three years.
Required
As a consultant management accountant employed by the bankers of Biggerbuys Co, prepare a
report to the bank which analyses the financial performance of the company for the period
covered by the financial statements. Your report may take any form you wish, but you are aware
of the particular concern of the bank regarding the rapidly increasing level of lending. Therefore,
it may be appropriate to include aspects of prior performance that could have contributed to the
increase in the level of bank lending. (25 marks)
Cole Co Darwin Co
$’000 $’000 $’000 $’000
Sales revenue (note (1)) 3,000 4,400
Opening inventory 450 720
Purchases (note (2)) 2,030 3,080
2,480 3,800
Closing inventory (540) (850)
(1,940) (2,950)
Gross profit 1,060 1,450
Operating expenses (480) (964)
Profit from operations 580 486
Loan note interest (80) –
Overdraft interest – (10)
Net profit for year 500 476
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STATEMENT OF FINANCIAL POSITION
Cole Co Darwin Co
$’000 $’000 $’000 $’000
Non-current assets
Property, plant and equipment (notes (3)
and (4) 2,340 3,100
Current assets
Inventories 540 850
Trade receivables 522 750
Cash and cash equivalent 20 –
1,082 1,600
Total assets 3,422 4,700
Equity and liabilities
Equity
Equity shares of $1 each 1,000 500
Reserves
Revaluation surplus – 700
Retained earnings – 1 April 20X8 684 1,912
Profit – year to 31 March 20X9 500 476
2,184 3,588
Non-current liabilities
10% Loan note 800 –
Current liabilities
Trade and other payables 438 562
Overdraft – 550
438 1,112
Total equity and liabilities 3,422 4,700
Webster bases its preliminary assessment of target companies on certain key ratios. These are
listed below together with the relevant figures for Cole Co and Darwin Co calculated from the
above financial statements:
Cole Co Darwin Co
Return on capital
employed (500 + 80)/(2,184 + 800) (476/3,588)
× 100 19.4 % × 100 13.3 %
Asset turnover (3,000/2,984) 1.01 times (4,400/3,588) 1.23 times
Gross profit margin 35.3 % 33.0 %
Net profit margin 16.7 % 10.8 %
Accounts receivable
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Cole Co Darwin Co
collection period 64 days 62 days
Accounts payable
payment period 79 days 67 days
Capital employed is defined as shareholders’ funds plus non-current debt at the year-end; asset
turnover is sales revenues divided by gross assets less current liabilities.
The following additional information has been obtained.
(1) Cole Co is part of the Velox Group. On 1 March 20X9 it was permitted by its holding company
to sell goods at a price of $500,000 to Brander Co, a fellow subsidiary. The sale gave Cole
Co a gross profit margin of 40% instead of its normal gross margin of only 20% on these
types of goods. In addition Brander Co was instructed to pay for the goods immediately.
Cole Co normally allows three months credit.
(2) On 1 January 20X9 Cole Co purchased $275,000 (cost price to Cole Co) of its materials from
Advent Co, another member of the Velox Group. Advent Co was also instructed by the Velox
Group to depart from its normal trading terms, which would have resulted in a charge of
$300,000 to Cole Co for these goods. The Group’s finance director also authorised a four-
month credit period on this sale. Cole Co normally receives two months credit from its
suppliers. Cole Co had sold all of these goods at the year end.
(3) Non-current assets:
Details relating to the two companies’ non-current assets are:
Carrying
Cost/revaluation Depreciation amount
$’000 $’000 $’000
Cole Co: property 3,000 1,860 1,140
plant 6,000 4,800 1,200
2,340
Darwin Co: property 2,000 100 1,900
plant 3,000 1,800 1,200
3,100
The two companies own very similar properties. Darwin Co’s property was revalued to $2,000,000
at the beginning of the current year (ie 1 April 20X8). On this date Cole Co’s property, which is
carried at cost less depreciation, had a carrying amount of $1,200,000. Its current value (on the
same basis as Darwin Co’s property) was also $2,000,000. On this date (1 April 20X8) both
properties had the same remaining life of 20 years.
(4) Darwin Co purchased new plant costing $600,000 in February 20X9. In line with company
policy a full year’s depreciation at 20% per annum has been charged on all plant owned at
year end. The equipment is still being tested and will not come on-stream until next year. The
purchase of the plant was largely financed by an overdraft facility, which resulted in the
interest cost shown in the statement of profit or loss. Both companies depreciate plant over a
five-year life and treat all depreciation as an operating expense.
(5) The bank overdraft that would have been required but for the favourable treatment towards
Cole Co in respect of items in (1) and (2) above, would have attracted interest of $15,000 in
the year to 31 March 20X9.
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Required
(a) Restate the financial statements of Cole Co and Darwin Co in order that they may be
considered comparable for decision making purposes. State any assumptions you make.
(10 marks)
(b) Recalculate the key ratios used by Webster Co and, referring to any other relevant points,
comment on how the revised ratios may affect the assessment of the two companies.
(10 marks)
(Total = 20 marks)
$’000
Revenue 70,000
Cost of sales (45,000)
Gross profit 25,000
Operating costs (7,000)
Directors’ salaries (1,000)
Profit before taxation 17,000
Income tax expense (3,000)
Profit for the year 14,000
$’000 $’000
ASSETS
Non-current assets
Property, plant and equipment 32,400
Current assets
Inventories 7,500
Cash and cash equivalents 100
7,600
Total assets 40,000
EQUITY AND LIABILITIES
Equity
Equity shares of $1 each 1,000
Retained earnings 18,700
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$’000 $’000
19,700
Non-current liabilities
Directors’ loan accounts (interest free) 10,000
Current liabilities
Trade payables 7,500
Current tax payable 2,800
10,300
Total equity and liabilities 40,000
From the above financial statements Xpand Co has calculated for Hydan Co the ratios below for
the year ended 30 September 20X4. It has also obtained the equivalent ratios for the retail sector
average which can be taken to represent Hydan Co’s sector.
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STATEMENTS OF FINANCIAL POSITION AT 31 MARCH
20X7 20X6
$m $m
Non-current assets
Property, plant and equipment 4,200 3,700
Current assets
Inventories 1,500 1,600
Trade receivables 2,200 1,800
3,700 3,400
7,900 7,100
Equity
Share capital 1,200 1,200
Retained earnings 2,200 1,900
3,400 3,100
Non-current liabilities
Deferred tax 1,070 850
Lease liabilities 1,300 1,200
2,370 2,050
Current liabilities
Trade payables 1,250 1,090
Current tax 225 205
Lease liabilities 500 450
Bank overdraft 155 205
2,130 1,950
7,900 7,100
$m
Revenue 4,300
Cost of sales (2,000)
Gross profit 2,300
Operating expenses (1,000)
Finance costs (250)
Profit before tax 1,050
Income tax expense (450)
PROFIT FOR THE YEAR 600
Dividends paid in the year 300
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Further information:
(1) Depreciation charged for the year totalled $970m. There were no disposals of property, plant
and equipment in the period.
(2) There was no accrual of interest at the beginning or at the end of the year.
(3) Dundee Co finances a number (but not all) of its property, plant and equipment purchases
using leases. In the period, property, plant and equipment which would have cost $600m to
purchase outright was acquired under leases.
Required
Prepare the statement of cash flows for Dundee Co for the year ended 31 March 20X7 as per IAS 7
using the indirect method. (14 marks)
20X9 20X8
$m $m
Non-current assets
Property, plant and equipment 327 264
Current assets
Inventories 123 176
Trade receivables 95 87
Short term investments 65 30
Cash at bank and in hand 29 –
312 293
639 557
Equity
Share capital – $1 shares 200 120
Share premium 30 –
Revaluation surplus 66 97
Retained earnings 71 41
367 258
Non-current liabilities
10% Debentures 100 150
Current liabilities 172 149
639 557
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STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 MARCH 20X9
$m
Revenue 473
Cost of sales (229)
Gross profit 244
Distribution costs (76)
Administrative expenses (48)
Finance income 6
Finance costs (17)
Profit before tax 109
Income tax expense (47)
Profit for the year 62
Dividends paid in the period 32
(b) Write a memorandum to a director of Elmgrove Co summarising the major benefits a user
receives from a published statement of cash flows. (5 marks)
(Total = 25 marks)
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54 Measurement (16 mins)
(a) Explain the difference between historical cost and current value accounting. (3 marks)
(b) Give three disadvantages to the use of historical cost accounting in the financial statements.
(3 marks)
(c) Briefly explain the factors that management must consider when choosing a measurement
basis for the assets and liabilities in the financial statements (3 marks)
(Total = 9 marks)
55 Not-for-profit (9 mins)
A new Academy school, Aspiration High School, has been opened in an area of high social
deprivation, replacing a school which was closed as a result of poor academic performance.
Aspiration High School is funded directly by central government and some critics claim that too
much money has been spent on it.
Required
In what ways would you expect the Department of Education to monitor the performance of this
school? (5 marks)
Armstrong Co Miller Co
$000 $000
Non-current assets
Property, plant and equipment 392,000 168,000
Investments 240,000 -
Equity
Share capital – $1 shares 210,000 120,000
Revaluation surplus 82,000 8,000
Retained earnings 249,700 73,000
541,700 201,000
Non-current liabilities
Deferred consideration 40,000 -
Current liabilities 173,300 56,300
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Armstrong Co Miller Co
$000 $000
213,300 56,300
Total equity and liabilities 755,000 257,300
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Further question
solutions
TT2021
3 The correct answer is: Dividends paid are deducted from retained earnings
They are a distribution, not an expense. They are not shown on the face of the statement of profit
or loss or deducted from other comprehensive income.
$
Original cost – building 200,000
Depreciation X1 – X6 (200,000 × 5/50) (20,000)
180,000
Revaluation 1.1.X6 100,000
280,000
$’000 $’000
Proceeds 1,500
Less carrying amount of goodwill (76)
Less group share of carrying amount at date of disposal
Share capital 1,000
Retained earnings 460
1,460
Less NCI (1,460 × 20%) (292) (1,168)
Profit on disposal 256
$
Fair value less disposal cost (800,000 – 20,000) 780,000
Value in use 950,000
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7 The correct answer is: A one-line entry showing post-tax profit or loss of the operation and the
post-tax gain or loss on disposal
The discontinued operation should be shown as a one-line entry representing the profits for the
period of the operation and the post-tax gain or loss on disposal.
$ $
Consideration – cash 300,000
– shares (40,000 × 2.50) 100,000
400,000
Non-controlling interest (20,000 × 1.75) 35,000
435,000
Fair value of net assets:
Share capital 100,000
Retained earnings 85,000
Revaluation surplus 100,000
Fair value adjustments 60,000
(345,000)
90,000
$
Frog Co 280,000
Tadpole Co (190,000 × 9/12) 142,500
Intragroup (40,000)
382,500
$
Cost of investment 700,000
Share of post-acquisition retained earnings
(650,000 × 30%) 195,000
895,000
Note. The unrealised profit will be credited to group inventory, not investment in associate.
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12 The correct answer is: (1), (2), (3)
Distribution, storage and wastage costs will all be treated as expenses and not subsumed into
inventory.
$
Revenue recognised ($2.5 million × 40%) 1,000,000
Amounts invoiced (300,000)
Contract asset 700,000
$
Depreciation (1.2m / 5) 240,000
Unwinding of discount (1.2m × 1.08) × 8% 103,680
343,680
TERP
4 × 1.8 7.2
1 × 1.2 1.2
8.4 / 5 = 1.68
Shares
200,000 × 1.8/1.68 × 3/12 53,571
250,000 × 9/12 187,500
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Shares
241,071
18 The correct answer is: It matches related items in accordance with the accruals concept
Cash flow accounting does not apply the accruals concept. It deals with items at the point when
they are received or paid.
$ $
Consideration received 200,000
Net assets (100,000 + 140,000) 240,000
Goodwill (50,000 × 60%) 30,000
Less NCI (58,000)
(212,000)
Loss on disposal (12,000)
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Section B (2 marks each)
20 The following scenario relates to questions 1–5.
(a) The correct answer is: (1) only
(1) is an onerous contract and should be provided for.
In the case of (2) the overhauls should be capitalised as part of the cost of the machine and
amortised over the period to the next overhaul. This applies the accruals concept to the costs
of the overhaul – the overhaul will result in future benefits and the costs of the overhaul are
recognised in the same accounting period as the associated expected benefits (matching).
IAS 37 does not allow provisions to be made for expected future losses, so (3) would not be a
valid provision.
(b) The correct answer is: They involve uncertain timing or amount.
Provisions are liabilities of uncertain timing or amount.
(c) The correct answer is: $14,000
((50,000 × 16%) + (120,000 × 5%))
(d) The correct answer is: Figaro Co is being sued by an ex-employee on health and safety
grounds. Lawyers have advised that the employee has a 55% chance of success.
This would be a valid provision.
A is not valid as the law has not yet been enacted. B is not valid as the restructuring has not
yet been announced to those affected by it. In the case of C, Figaro Co has avoided the
constructive obligation, so no provision is needed.
(e) The correct answer is: It should be recognised
A contingent liability is normally simply disclosed but IAS 37 makes an exception for
contingent liabilities assumed as part of a business combination.
$
Initial measurement of liability 25,274
Interest 6% 1,516
Paid 30 June 20X6 (6,000)
Balance 30 June 20X6 20,790
Interest 6% 1,247
Paid 30 June 20X7 (6,000)
Liability due after one year 16,037
(c) The correct answer is: Recognise proportion relating to right-of-use transferred
(d) The correct answer is: $50,660
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$
Initial measurement of lease liability 35,660
Initial payment 20,000
Incentive received (5,000)
Measurement of right-of-use asset 50,660
$ $
Original cost 1.1.X0 1,000,000
Depreciation to 31.12.X6 (1,000,000 × 7/50) (140,000)
860,000
Depreciation to 30.6.X7 ((1,000,000/50) × 6/12) (10,000) 10,000
850,000
Revaluation surplus 100,000
950,000
Depreciation to 31.12.X7 (950,000 × 0.5/42.5) (11,176) 11,176
Total depreciation year to 31.12.X7 21,176
(b) The correct answer is: Deferred tax on the surplus of $100,000 should be charged to profit or
loss for the year.
As the revaluation surplus goes directly to equity, the same treatment is applied to the
deferred tax.
(c) The correct answer is: Higher of fair value less costs of disposal and value in use
(d) The correct answer is: $114,000
The goodwill and the damaged machine are written off in full and the balance is allocated
between the building and the rest of the plant and machinery.
(e) The correct answer is: $2,221 gain
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€ £ Gain/(loss)
Contract 10 Nov 150,000 132,743
Payment 10 Dec (75,000) (63,559) 2,813
At closing rate 31 Dec 75,000 66,964 (592)
Net gain for year 2,221
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Practice questions
It should be noted that these questions are not intended to replicate the type of exam questions
you may face in Section C of the FR exam (which will comprise 2 × 20 mark questions covering the
preparation of financial statements and interpretation of financial statements).
Instead, these questions are intended as useful practice to test your understanding of the material
in the chapters. The Practice & Revision Kit has a large number of exam format questions.
TT2021
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Local legislation
In most countries, companies have to comply with the local companies legislation, which lays
down detailed requirements on the preparation of accounts. Company law is often quite detailed,
partly because of external influences such as EU Directives. Another reason to increase statutory
regulation is that quoted companies are under great pressure to show profit growth and an
obvious way to achieve this is to manipulate accounting policies. If this involves breaking the law,
as opposed to ignoring professional guidance, company directors may think twice before bending
the rules – or, at least, this is often a government’s hope.
Standard-setters
Professional guidance is given by the national and international standard-setters. Prescriptive
guidance is given in accounting standards which must be applied in all accounts intended to show
a ‘true and fair view’ or ‘present fairly in all material respects’. International Financial Reporting
Standards and national standards are issued after extensive consultation and are revised as
required to reflect economic or legal changes. In some countries, legislation requires details of
non‑compliance to be disclosed in the accounts. ‘Defective’ accounts can be revised under court
order if necessary and directors signing such accounts can be prosecuted and fined (or even
imprisoned).
The potential for the IASB’s influence in this area is substantial. It must pursue excellence in
standards with absolute rigour to fulfil that potential.
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(b) A number of reasons could be advanced why the financial statements of not-for-profit
entities should not be subject to regulation:
• They do not have shares that are being traded, so their financial statements are not
produced with a share price in mind.
• They do not have chief executives with share options seeking to present favourable figures
to the market.
• They are not seeking to make a profit, so whether they have or not is perhaps irrelevant.
• They are perceived to be on slightly higher moral ground than profit-making entities, so
are less in need of regulation.
However, a closer look at this brings up the following points.
• Public sector bodies, such as local government organisations, are spending taxpayers’
money and should be required to account for it.
• The chief executives of public sector bodies are often highly rewarded and their
performance should be verified.
• Charities may not be invested in by the general public, but they are funded by the public,
often through direct debits.
• Charities are big business. In addition to regular public donations they receive large
donations from high-profile backers.
• They employ staff and executives at market rates and have heavy administrative costs.
Supporters are entitled to know how much of their donation has gone on administration.
• Any misappropriation of funds is serious in two ways. It is taking money from the donating
public, who thought they were donating to a good cause, and it is diverting resources
from the people who should have been helped.
• Not all charities are bona fide. For instance, some are thought to be connected to
terrorism.
For these reasons, it is important that the financial statements of not-for-profit entities are
subject to regulation.
$
Revenue 1,526,750
Cost of sales (W3) (1,048,000)
Gross profit 478,750
Distribution costs (W4) (124,300)
Administrative expenses (W5) (216,200)
Finance costs (W6) (18,400)
Profit before tax 119,850
Income tax expense (40,000)
PROFIT FOR THE YEAR 79,850
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POLYMER CO: STATEMENT OF FINANCIAL POSITION AS AT 31 MAY 20X8
$
ASSETS
Non-current assets
Property, plant and equipment (W7) 452,250
Intangible assets 215,500
667,750
Current assets
Inventories (W8) 425,750
Trade receivables (W9) 171,880
Cash and cash equivalents 5,120
602,750
Total assets 1,270,500
EQUITY AND LIABILITIES
Equity
Share capital 300,000
Share premium 100,000
Retained earnings (283,500 + 79,850) 363,350
Other equity 50,000
Revaluation surplus 50,000
863,350
Non-current liabilities
10% debentures 100,000
8.4% cumulative redeemable preference shares* 100,000
200,000
Current liabilities
Trade and other payables (W10) 115,900
Short-term borrowings 51,250
Current tax payable 40,000
207,150
Total equity and liabilities 1,270,500
Workings
1 Depreciation
$
Cost of sales: 8% × 150,000 12,000
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$
1/4 × 20% × 50,000 2,500
7,500
Distribution: 3/4 × 20% × 50,000 7,500
$
Opening inventories (108,400 + 32,750 + 184,500) 325,650
Purchases 750,600
Carriage inwards 10,500
Manufacturing wages 250,000
Manufacturing overheads 125,000
Depreciation of plant (W1) 12,000
Closing inventories (W9) (425,750)
1,048,000
4 Distribution costs
$
Per question 116,800
Depreciation (W1) 7,500
124,300
5 Administrative expenses
$ $
Per question 158,100
Legal expenses 54,100
Less: solicitors’ fees capitalised (5,000)
49,100
Depreciation (W1) 7,500
Depreciation of building (W2) 1,500
216,200
6 Finance costs
$
Interest expense on loan notes ($100,000 × 10%) 10,000
Dividend on redeemable preference shares ($100,000 × 8.4%) 8,400
18,400
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7 Property, plant and equipment
Carrying amount
31 May 20X8 255,000 58,500 69,500 29,250 40,000 452,250
8 Inventories
$
Raw materials 112,600
Work in progress 37,800
Finished goods 275,350
425,750
9 Trade receivables
$
Trade receivables (177,630 – 5,750 irrecoverable debts allowance) 171,880
$
Trade payables 97,500
Loan interest payable 10,000
Preference dividend payable 8,400
115,900
Tutorial note. Redeemable preference shares are presented under IAS 32 Financial Instruments:
Presentation as a loan payable, and dividends on them as interest payable. This point is
covered in Chapter 11.
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27 Gains Co (18 mins)
GAINS CO– STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 20X9
Workings
1 Loss on investment property
(160 – 110) = (50)
2 Calculation of profit realised on sale of revalued asset
$
Revaluation recognised in past 50,000
Less: amounts transferred to retained earnings:
(80,000/10 – 30,000/10) × 3 (15,000)
35,000
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$
Non-current assets
Property, plant and equipment (W1) 187,500
Intangible assets (W2) 6,691,000
$
Depreciation (W1) 12,500
Amortisation (W2) 1,309,000
Staff salaries 400,000
Workings
1 Computer equipment
$
Computer equipment
Cost 200,000
Depreciation (200 × 3/48) (12,500)
Carrying amount 187,500
2 Intangible assets
Development
Patent costs Customer list Total
$’000 $’000 $’000 $’000
Cost 1,500 6,000 500 8,000
Amortisation:
$1.5m × (6/36) (250) – (250)
$5m × (6/36) (1,000) (1,000)
$500,000 × (4/34) – – (59) (59)
1,250 5,000 441 6,691
Steam engines –
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Asset @ Assets @ Revised
1.1.20X0 1st loss (W1) 1.2.20X0 2nd loss (W2) asset
$’000 $’000 $’000 $’000 $’000
1,000 (500) 500 500
Workings
1 First impairment loss
$500,000 relates directly to an engine and its recoverable amount can be assessed directly (ie
zero) and it is no longer part of the cash-generating unit.
IAS 36 then requires goodwill to be written off. Any further impairment must be written off the
remaining assets pro rata, except the engine which must not be reduced below its net selling
price of $500,000.
2 Second impairment loss
The first $100,000 of the impairment loss is applied to the operating licence to write it down to
net selling price.
The remainder is applied pro rata to assets carried at other than their net selling prices, ie
$50,000 to both the property and the rail track and coaches.
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE YEAR
ENDED 31 DECEMBER 20X2
$m
Revenue 2,648
Cost of sales (W1) (1,765)
Gross profit 883
Distribution costs (W1) (514)
Administrative expenses (W1) (360)
Finance costs (150 × 4%) (6)
Fair value gain on investment properties (588 – 548) 40
Rental income 48
Profit before tax 91
Income tax expense (Note 6) (45 – 17) (28)
PROFIT FOR THE YEAR 63
Other comprehensive income:
Gain on property revaluation (W2) 55
Income tax relating to gain on property revaluation (17)
Other comprehensive income, net of tax 38
TOTAL COMPREHENSIVE INCOME FOR THE YEAR 101
HEWLETT CO
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STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20X2
$m
ASSETS
Non-current assets
Property, plant and equipment (W2) 852
Investment properties (Note 9) 588
1,440
Current assets
Inventories (388 – (21 – 14)) 381
Trade receivables 541
Cash and cash equivalents 32
954
2,394
EQUITY AND LIABILITIES
Equity
Share capital 125
Share premium 244
Retained earnings 810
Other components of equity 545
Revaluation surplus ((W2) 55 – 17) 38
1,762
Non-current liabilities
4% loan notes 20X8 150
Deferred tax 17
Current liabilities
Trade payables 434
Income tax payable (Note 6) 28
Interest payable ((4% × 150) – 3) 3
465
2,394
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HEWLETT CO
Retaine
Share d Other
Share premiu earning component Revaluatio
capital m s s of equity n surplus Total
$m $m $m $m $m $m
Balance at 1 January 20X2 100 244 753 570 – 1,667
Changes in equity for 20X2
Issue of share capital (W4) 25 (25) –
Dividends (W5) (6) (6)
Total comprehensive
income
for the year - - 63 - 38 101
Balance at 31 December
20X2 125 244 810 545 38 1,762
Workings
1 Expenses
Plant &
Land Buildings equipment Total
$m $m $m $m
Cost 90 750 258
Accumulated depreciation b/d – (120) (126)
Carrying amount b/d at 1 January 20X2 90 630 132
Disposal of equipment (15 – 3) - - (12)
90 630 120
Depreciation during year
Buildings ($750m / 50 years) (15)
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Plant &
Land Buildings equipment Total
$m $m $m $m
Plant & equipment ($120m × 20%) (24)
Impairment loss on plant (W3) - - (4)
90 615 92
Revaluation (balancing figure) 10 45 55
Carrying amount c/d at 31 December
20X2 (Buildings 760 – 100) 100 660 92 852
$m
Carrying amount 22
Recoverable amount (Value in use: (3.8m × 3.993) + (4.2m × 0.677)) (18)
(4)
Recoverable amount is the higher of value in use ($18m) and fair value less costs of disposal
($16m).
4 Bonus issue
Dr Other components of equity ($100m /$0.50 × 1/4 = 50m shares × $0.50) $25m
Cr Share capital $25m
5 Dividends (proof)
$m
Interim ($100m /$0.50 = 200m shares × $0.03) 6 per trial balance
The final dividend has not been paid and is not a liability of the company at the year end.
$m
Non-current assets
Property, plant & equipment (2,848 + 354 + (W4) 18) 3,220
Patents 45
Goodwill (W1 26
3,291
Current assets
Inventories (895 + 225) 1,120
Trade and other receivables (1,348 + 251) 1,599
Cash and cash equivalents (212 + 34) 246
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$m
2,965
6,256
Equity attributable to owners of the parent
Share capital 920
Retained earnings (W2) 3,034
3,954
Non-controlling interests (W3) 202
4,156
Non-current liabilities
Long-term borrowings (558 + 168) 726
Current liabilities
Trade and other payables (1,168 + 183) 1,351
Current portion of long-term borrowings 23
1,374
6,256
Workings
1 Goodwill
$m $m
Consideration transferred (250m × 60% × $1.06) 159
Non-controlling interests at fair value 86
Net assets at acquisition as represented by:
Share capital 50
Retained earnings 115
Fair value adjustments (W4) 34
(199)
Goodwill at acquisition 46
Impairment losses to date (20)
Goodwill at year end 26
2 Retained earnings
Barcelona Madrid
$m $m
Per question 2,861 440
Pre-acquisition (115)
Movement on fair value adjustment (W4) (16)
309
Group share of post-acquisition retained earnings:
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Barcelona Madrid
$m $m
Madrid Co (309 × 60%) 185
Less group impairment losses to date (20 × 60%) (12)
3,034
3 Non-controlling interests
$m
NCI at acquisition (W1 86
NCI share of post-acquisition:
Retained earnings ((W2) 309 × 40%) 124
Goodwill impairment (20 × 40%) (8)
202
*20 / 10 years × 4
$’000
Non-current assets
Land and buildings 3,350
Plant and equipment (1,010 + 2,210) 3,220
Motor vehicles (510 + 345) 855
Goodwill (W1) 826
8,251
Current assets
Inventories (890 + 352 – (W4) 7.2) 1,234.8
Trade receivables (1,372 + 514 – 39 – (W5) 36) 1,811
Cash and cash equivalents (89 + 39 + 51) 179
3,224.8
11,475.8
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$’000
Equity attributable to owners of the parent
Share capital 1,000
Retained earnings (W2) 5,257.3
Revaluation surplus 2,500
8,757.3
Non-controlling interests (W3) 896.5
9,653.8
Non-current liabilities
10% debentures 500
Current liabilities
Trade and other payables (996 + 362 – (W5) 36) 1,322
11,475.8
Workings
1 Goodwill
$’000 $’000
Consideration transferred 2,000
Non-controlling interests (at ‘full’ FV) (125k shares × $4.40) 550
Net assets at acquisition as represented by:
Share capital 500
Retained earnings 1,044
(1,544)
1,006
Impairment losses to date (180)
826
Reprise Co Encore Co
$’000 $’000
Per question 4,225 2,610
PUP (W4) (7.2)
Pre-acquisition retained earnings (1,044)
1,566
Group share of post-acquisition retained earnings:
Encore Co (1,566 × 75%) 1,174.5
Group share of impairment losses (180 × 75%) (135)
5,257.3
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3 Non-controlling interests
$’000
NCI at acquisition (W1) 550
NCI share of post-acquisition retained earnings ((W3) 1,566 × 25%) 391.5
NCI share of impairment losses (180 × 25%) (45)
896.5
CONSOLIDATED STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 30 JUNE 20X8
$
Revenue (403,400 + 193,000 – 40,000) 556,400
Cost of sales (201,400 + 92,600 – 40,000 + 4,000) (258,000)
Gross profit 298,400
Distribution costs (16,000 + 14,600) (30,600)
Administrative expenses (24,250 + 17,800) (42,050)
Profit before tax 225,750
Income tax expense (61,750 + 22,000) (83,750)
Profit for the year 142,000
Profit attributable to:
Owners of the parent 125,200
Non-controlling interests (W2) 16,800
142,000
Retained
earnings
$
Balance at 1 July 20X7 (W2) 190,000
Dividends (40,000)
Profit for the year 125,200
Balance at 30 June 20X8 (W3) 275,200
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Workings
1 Non-controlling interests
$
Rusholme – profit for the year 46,000
Less PUP (40,000 × ½ × 25/125) 4,000
42,000
Non-controlling interest share 40% 16,800
Fallowfield Co Rusholme Co
$ $
Per question 163,000 61,000
Pre-acquisition retained earnings (16,000)
45,000
Group share of post-acquisition retained earnings:
Rusholme Co (45,000 × 60%) 27,000
190,000
Fallowfield Co Rusholme Co
$ $
Per question 238,000 82,000
PUP – (4,000)
Pre-acquisition retained earnings (16,000)
62,000
Group share of post-acquisition retained earnings:
Rusholme Co (62,000 × 60%) 37,200
275,200
$’000
Revenue (22,800 + (4,300 × 6/12) – (640 × 6/12)) 24,630
Cost of sales (13,600 + (2,600 × 6/12) – (640 × 6/12) + (W2) 10 + (W4) 5) (14,595)
Gross profit 10,035
Distribution costs (2,900 + (500 × 6/12)) (3,150)
Administrative expenses (1,800 + (300 × 6/12)) (1,950)
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$’000
Finance costs (200 + (70 × 6/12) – (W3) 20 cancellation) (215)
Finance income (50 – (W3) 20 cancellation) 30
Profit before tax 4,750
Income tax expense (1,300 + (220 × 6/12)) (1,410)
Profit for the year 3,340
Other comprehensive income for the year, net of tax (1,600 + (180 × 6/12)) 1,690
Total comprehensive income for the year 5,030
Profit attributable to:
Owners of the parent (3,340 – 124) 3,216
Non-controlling interests (W1) 124
3,340
Total comprehensive income attributable to:
Owners of the parent (5,030 – 160) 4,870
Non-controlling interests (W1) 160
5,030
$’000
Reserves
Balance at 1 January 20X4 (Panther only) 12,750
Dividend paid (900)
Total comprehensive income for the year 4,878
Balance at 31 December 20X4 (W6) 16,728
Workings
1 Non-controlling interests
PFY TCI
$’000 $’000
Profit/TCI for the year (610 × 6/12) / (790 × 6/12) 305 395
Less PUP (W2) (10) (10)
Add back intragroup interest (W3) 20 20
Additional depreciation on fair value adjustment (W4) (5) (5)
310 400
NCI share (× 40%) 124 160
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2 Unrealised profit on intragroup trading
Adjust cost of sales and non-controlling interests in books of seller (Sabre Co).
Sabre Co to Panther Co= $60,000 × 20%/120% = $10,000
3 Interest on intragroup loan
The loan is an intragroup item for the last six months of the year (ie only since Sabre Co’s
acquisition by Panther Co):
Cancel in books of Panther Co and Sabre Co
4 Fair value adjustments
Sabre
Panther Co Co
$’000 $’000
Reserves per question 16,500 3,270
PUP (W2) (10)
Fair value movement (W) (5)
Pre-acquisition reserves [2,480 + ((610 + 180) × 6/12)] (2,875)
380
Group share of post-acquisition reserves:
Sabre Co (380 × 60%) 228
16,728
$’000
Non-current assets
Property, plant & equipment (370 + 190 + (W6) 45) 605
Goodwill (W1) 8
Investment in associate (W2) 165
778
Current assets
Inventories (160 + 100 – (W5) 1.5) 258.5
Trade receivables (170 + 90) 260
Cash and cash equivalents (50 + 40) 90
608.5
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$’000
1,386.5
Equity attributable to owners of the parent
Share capital 200
Share premium 100
Retained earnings (W3) 758.5
1,058.5
Non-controlling interests (W4) 168
1,226.5
Current liabilities
Trade and other payables (100 + 60) 160
1,386.5
Workings
1 Goodwill on consolidation – Spiro Co
$’000 $’000
Consideration transferred 128
Non-controlling interests (at ‘full’ fair value) 90
Net assets at acquisition:
Share capital 80
Retained earnings 20
Share premium 80
Fair value adjustments (W6) 30
(210)
Goodwill arising on consolidation 8
2 Investment in associate
$’000
Cost of associate 90
Share of post-acquisition retained reserves (W3) 75
165
3 Retained earnings
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Hever Co Spiro Co Aldridge Co
$’000 $’000 $’000
195 250
4 Non-controlling interests
$’000
NCI at acquisition (W1) 90
NCI share of post-acquisition ret’d earnings ((W4) 195 × 40%) 78
168
(a) $m $m
(a) (a) (a)
Consideration transferred
(a) (a) (a)
318
(a) (a) (a)
Non-controlling interest 74
(a) (a) (a)
Ordinary shares 80
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(a) (a)
(a) $m $m
(a) (a) (a)
Share premium 40
(a) (a) (a)
(296)
(a) (a) (a)
96
(a) (a) (a)
$m
NCI at acquisition (per question) 74
NCI share of post-acquisition retained earnings ((W3) 48 × 25%) 12
NCI share of post-acquisition revaluation surplus ((W3) 4 × 25%) 1
NCI share of goodwill impairment (22 × 25%) (6)
81
Revaluation surplus
$m
Parent’s own revaluation surplus 45
Group share of Samson Co’s post acquisition revaluation ($4m ×
75%) 3
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$m
48
Highveldt Co Samson Co
$m $m
Per question 350 76
Accrued interest from Samson Co ($60m × 10%) 6 –
Additional contingent consideration (116 – 108) (8) –
Amortisation of brand ($40m / 10 years) – (4)
Write off development expenditure as incurred ($50m –
$18m) – (32)
Write back amortisation of development expenditure – 10
Unrealised profit – (2)
348 48
Group share (75%) 36
Impairment of goodwill in Samson Co – group share
(22 × 75%) (16)
368
Working
Fair value adjustment
$m $m
Fair value adjustment:
Revaluation of land and buildings 20
Recognition of fair value of brands 40
Derecognition of capitalised development expenditure (18)
42
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Tutorial note. Make sure that you read the requirement carefully before doing anything.
You are not asked to prepare a statement of financial position; just the goodwill and
reserves. This makes the question easier to manage effectively as you are just doing the
workings without having to tie it all together in a set of financial statements. There are
quite a few complications to consider. For each calculation go through each of the six
additional pieces of information and make appropriate adjustments when relevant.
Examiner’s comments
This question was unusual in asking for extracts from the statement of financial position. Many
candidates were confused by this and wasted time preparing a full statement of financial
position. Other common errors were: fair value adjustments; consolidated reserves; revaluation
and share premium reserves; and the cost of the investment.
Cost less
2½% trade discount NRV Valuation
$ $ $
Product Arctic 3,510.00 5,100.00 3,510.00
Product Brassy 2,827.50 2,800.00 2,800.00
Product Chilly 4,095.00 4,100.00 4,095.00
10,405.00
(b) The weighted average method values items withdrawn from inventory at the average price of
all goods held in inventory at the time. Thus, it smooths out any fluctuations due to rising or
falling prices.
The FIFO method of inventory valuation assumes that items sold are the oldest ones received
from suppliers. Thus, any goods held at the year end will be assumed to have been
purchased recently. Thus, changing from weighted average to FIFO (assuming inventory
purchase prices are rising over time) is likely to increase the value of closing inventory (from
historical to current price levels). This would reduce the cost of sales figure in profit or loss and
increase the reported profit figure.
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Biological asset Agricultural produce
Bush Tea leaves
Vine Grapes
Chicken Eggs
(d) Consumable biological assets are those that are to be harvested as agricultural produce or
sold as biological assets. Examples include livestock intended for the production of meat,
livestock held for sale, fish in farms, crops such as maize and wheat and trees being grown
for lumber.
Bearer biological assets are those other than consumable biological assets. Examples include
livestock from which milk is produced or livestock held for breeding, vines, fruit trees and trees
from which firewood is harvested without felling.
Plant-based bearer biological assets are accounted for under IAS 16. These are assets which
are not in themselves consumed, but are used solely to grow produce over several periods.
This would apply to grape vines, tea bushes and fruit trees from the list above.
$m
Non-current assets
Quarry structures and access roads at cost
Construction cost 70.000
Provision for dismantling and restoration costs ($20m × 0.377) 7.540
77.540
$m
Provision for dismantling and restoration costs b/d 7.540
Interest ($7.54 × 5%) 0.377
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$m
Provision for dismantling and restoration costs c/d at 31 December 20X4 7.917
$m
Depreciation 3.877
Any change in the expected present value of the provision would be made as an adjustment
to the provision and to the asset value (affecting future depreciation charges).
$
Issue costs 120,000
Interest $6,000,000 × 3.5% × 7 1,470,000
Premium on redemption 1,100,000
Total finance cost 2,690,000
(b) The premium on redemption of the loan notes represents a finance cost. The effective rate of
interest must be applied so that the debt is measured at amortised cost (IFRS 9: para. 4.2.1).
At the time of issue, the loan notes are recognised at their net proceeds of $599,800 (600,000
– 200).
The finance cost for the year ended 31 December 20X4 is calculated as follows.
$
1.1.20X3 Proceeds of issue (600,000 – 200) 599,800
Interest at 12% 71,976
Balance 31.12.20X3 671,776
Interest at 12% 80,613
Balance at 31.12.20X4 752,389
$
Present value of principal $500,000 × 0.747 373,500
Present value of interest $25,000 × 4.212 105,300
Liability value 478,800
Principal amount 500,000
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$
Equity element 21,200
Tutorial note. The method to use here is to find the present value of the principal value of
the bond, $500,000 (10,000 × $50) and the interest payments of $25,000 annually (5% ×
$500,000) at the market rate for non-convertible bonds of 6%, using the discount factors.
The difference between this total and the principal amount of $500,000 is the equity
element.
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If the seller has the right to the benefits of the use of the asset, and the repurchase terms
are such that the repurchase is likely to take place, the transaction should be accounted
for as a loan.
Another example is the factoring of trade receivables. Where debts are factored, the
original creditor sells the receivables to the factor. The sales price may be fixed at the
outset or may be adjusted later. It is also common for the factor to offer a credit facility
that allows the seller to draw upon a proportion of the amounts owed.
In order to determine the correct accounting treatment it is necessary to consider
whether the benefit of the receivables has been passed on to the factor, or whether the
factor is, in effect, providing a loan on the security of the receivables. If the seller has to
pay interest on the difference between the amounts advanced to him and the amounts
that the factor has received, and if the seller bears the risks of non-payment by the
debtor, then the indications would be that the transaction is, in effect, a loan.
(c) The Finance Director may be right in believing that renewing the non-current assets of the
company will contribute to generating higher earnings and hence improved earnings per
share. However, this will not happen immediately as the assets will need to have been in
operation for at least a year for results to be apparent. Earnings will be higher because of the
loan being at a commercially unrealistic rate, namely 5% instead of 9%.
As regards gearing, the Finance Director may well wish to classify the convertible loan stock
as equity rather than debt; thus gearing will be lower. He may argue that because the loan is
very likely to be converted into shares, the finance should be treated as equity rather than as
debt.
(d) IAS 33 Earnings per Share requires the calculation of basic earnings per share (para. 9). The
Finance Director believes that the convertible loan he is proposing will not affect EPS and that
an interest cost of 5% will not impact heavily on gearing.
However, IAS 32 will require the interest cost to be based on 9% and IAS 33 also requires the
calculation and disclosure of diluted EPS (IAS 32: paras. 28–32).
The need to disclose diluted earnings per share arose because of the limited value of a basic
EPS figure when a company is financed partly by convertible debt. Because the right to
convert carries benefits, it is usual that the interest rate on the debt is lower than on straight
debt. Calculation of EPS on the assumption that the debt is non-convertible can, therefore,
be misleading since:
(1) Current EPS is higher than it would be under straight debt
(2) On conversion, EPS will fall – diluted EPS provides some information about the extent of
this future reduction, and warning shareholders of the reduction which will happen in the
future
IAS 32 Financial Instruments: Presentation affects the proposed scheme in that IAS 32
requires that convertible loans such as this should be split in the statement of financial
position and presented partly as equity and partly as debt. Thus the company’s gearing will
probably increase as the convertible loan cannot be ‘hidden’ in equity.
Tutorial note. Creative accounting and attempts to deal with it are important issues. You
must relate your answer to the situation given in part 3 of the question and not just write a
general essay. One or two examples would be enough in part 1.
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A performance obligation can be satisfied at a point in time, such as a contract for the sale of
goods, or satisfied over time, as in a construction contract. When a performance obligation is
satisfied over time, an entity must allocate revenue according to the amount of the
performance obligation that has been satisfied during a period.
The Conceptual Framework defines income and expenses in terms of increases in economic
benefits (income) and outflow or depletion of assets (expenses), not in terms of an earnings or
matching process (paras. 4.29–4.35). The statement of financial position thus assumes
primary importance in the recognition of earnings and profits. Income can only be
recognised if there is an increase in the equity (ie net assets) of an entity not resulting from
contributions from owners. Similarly, an expense is recognised if there is a decrease in the
ownership interest of an entity not resulting from distributions to owners. Thus, income arises
from recognition of assets and derecognition of liabilities, and expenses arise from
derecognition of assets and recognition of liabilities. The IASB explains that it is not possible to
reverse this definitional process, ie by defining assets and liabilities in terms of income and
expenses, because it has not been possible to formulate robust enough base definitions of
income and expenses (partly because the choice of critical event can be subjective).
Nevertheless, commentators often attempt to link the two approaches by asserting that
sufficient evidence for recognition or derecognition will be met at the critical event in the
operating cycle.
(b) Jenson Co’s treatments:
(1) This agreement is worded as a sale, but it is a repurchase agreement with a call option
that is likely to be exercised and a repurchase price that is above the original sale price.
It is therefore accounted for as a financing arrangement. Jenson Co should continue to
recognise the inventory in the statement of financial position and should treat the receipt
from Lauda Co as a loan, not revenue. Finance costs will be charged to profit or loss of
$35,000 × 12% × 9/12 = $3,150.
(2) The franchise agreement represents a performance obligation satisfied over time, so the
initial fee of $50,000 should be spread evenly over the term of the franchise. This will give
revenue of $10,000 in year 1 and $15,000 thereafter. The profit will therefore be 20% for
year 1 and approximately 46% for years 2–5.
(3) Jenson Co has received payment for 24 publications but only six have been despatched.
It has satisfied six out of 24 performance obligations. It can therefore recognise revenue
of $60,000 (240,000 × 6/24) and the remaining $180,000 should be presented as a
liability.
Tutorial note. This is an important subject and it is closely linked with the IASB’s
Conceptual Framework. You need to use your imagination to come up with examples in
part 2.
Notes
(1) Contract asset / liability
TT2021
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Aspire Bigga Construct
$’000 $’000 $’000
Revenue recognised (based on % completion) 600 500 350
Amounts invoiced 540 475 400
Contract asset/(liability) 60 25 (50)
Treatment of contracts in the statement of profit or loss of Trontacc Co for the year ended
30 September 20X7:
Contract
Aspire Bigga Construct Total
$’000 $’000 $’000 $’000
(W1) (W2) (W3)
Revenue 600 500 350 1,450
Expenses (500) (500) (320) (1,320)
Gross profit 100 30 130
$’000
Revenue 283,460
Cost of sales (W1) (155,170)
Gross profit 128,290
Other income 1,500
Distribution costs (22,300)
Administrative expenses (W2) (44,600)
Finance costs: (W10) (1,560)
Profit before tax 61,330
Income tax expense (W9) (24,600)
Profit for the year 36,730
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Working
Cost of sales
$’000
Opening inventory 12,400
Purchases 147,200
159,600
Closing inventory (W4) (16,680)
142,920
Depreciation of building and plant (W3) 12,250
155,170
(b) TELENORTH CO
STATEMENT OF FINANCIAL POSITION AS AT 30 SEPTEMBER 20X1
$’000 $’000
Assets
Non-current assets
Property, plant and equipment (W3) 83,440
Investments 34,500
117,940
Current assets
Inventories (W4) 16,680
Trade receivables 35,700
52,380
Total assets 170,320
Equity and liabilities
Equity
Ordinary shares of $1 each (W7) 30,000
Revaluation surplus 3,400 – 1,000 2,400
Share premium (W7) 16,000
Retained earnings (W8) 48,890
97,290
Non-current liabilities
8% preference shares 12,000
6% loan notes 10,000
Deferred tax: 5,200 + 2,200 7,400
29,400
Current liabilities
Trade and other payables (W5) 18,070
TT2021
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$’000 $’000
Current tax payable 23,400
Preference dividend payable (W6) 480
Bank overdraft 1,680
43,630
Total equity and liabilities 170,320
Workings
1 $’000
$’000
Per question 34,440
Depreciation of computer system (W3) 10,160
44,600
3 Closing inventory
No inventory count took place at the year end. To arrive at the figure for closing inventory,
the count needs to be adjusted for the movements between 30 September and 4 October,
making appropriate adjustments for mark ups.
$’000
Balance as at 4 October 20X1 16,000
Normal sales at cost: $1.4m × 100/140 1,000
Sale or return at cost: 650,000 × 100/130 500
Less goods received at cost (820)
Adjusted inventory value 16,680
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4 Current liabilities
$’000
Trade and other payables
Per question 17,770
Interest on loan note 300
18,070
5 Dividend payable
$’000
Preference: ($12m × 8%) – 480 480
Dr Cr
$’000 $’000
Suspense account (per trial balance) 26,000
Directors’ options: share capital (4m at $1) 4,000
share premium (4m at $1) 4,000
Rights issue: share capital
20m + 4m
4 6,000
Share premium 6m × (3 – 1) 12,000
26,000 26,000
$’000
As at 1 October 20X0 14,160
Net profit for the year (Part (1)(i)) 36,730
Dividend: ordinary (2,000)
48,890
8 Income tax
$’000 $’000
Provision for year 23,400
Increase in deferred tax provision 2,200
Less charged to revaluation surplus (1,000)
1,200
24,600
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9 Finance costs
$’000
8% Preference shares 960
6% Loan notes 600
1,560
(c) TELENORTH CO
EARNINGS PER SHARE FOR THE YEAR TO 30 SEPTEMBER 20X1
Bonus Weighted
Date Narrative Shares Time fraction average
‘000
1.10.X0 Share b/f 20,000
1.10.X0 Options exercised 4,000
24,000 9/12 4/3.80 (W) 18,947
1.7.X1 Rights issue (1/4) 6,000
30,000 3/12 7,500
26,447
Working
Calculation of theoretical ex rights price:
$
4 shares @ $4 16
1 share @ $3 3
19
EPS =
36,730
26,447 = $1.39
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Depreciation on the Right of Use asset will be calculated as $54,000 – $4,000/4 years = $12,500
per annum. The depreciation is calculated over 4 years (useful life) not 3 years (lease term)
because the company obtains ownership of the asset at the end of the lease term.
STATEMENTS OF FINANCIAL POSITION AT 31 DECEMBER (EXTRACTS)
*(24,000 – 8,063)
Working
$
Lease
Original measurement of right-of-use asset 54,000
Deposit (9,000)
Balance 1.1.20X1 (lease liability) 45,000
Interest 25% 11,250
Payment 31.12.20X1 (24,000)
Balance 31.12.20X1 32,250
Interest 25% 8,063
Payment 31.12.20X2 (24,000)
Balance 31.12.20X2 16,313
Interest 25% 4,078
Payment 31.12.20X3 (20,391)
–
TT2021
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Financial statement extracts
Workings
1 Carrying amount of right-of-use asset
$
PVFLP 66,404
Non-refundable deposit paid on 1 January 20X3 17,596
84,000
Depreciation of asset: $84,000 / 5 years useful life (16,800)
Carrying amount at year end ($84,000 – $16,800) 67,200
The asset is depreciated over the shorter of its useful life (five years) and lease term (six years).
2 Lease liability
$
1.1.X3 PVFLP 66,404
Interest at 12% ($66,404 ×
1.1.X3 – 31.12.X3 12%) 7,968
The interest element ($7,968) of the current liability can also be shown separately as interest
payable.
20X6
$’000
Accelerated tax depreciation (W1) 186
Revaluation (W2)* 252
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20X6
$’000
438
*The deferred tax on the revaluation gain will be charged to the revaluation surplus as IAS 12
requires deferred tax on gains recognised in other comprehensive income to be charged or
credited to other comprehensive income.
Workings
1 Tax depreciation
$’000 $’000
At 30 September 20X6:
Carrying amount 1,185
Tax base:
At 1 October 20X5 405
Expenditure in year 290
695
Less tax depreciation (25%) (174)
(521)
Cumulative temporary difference 664
@ 28% = 186
2 Revaluation surplus
Temporary difference ($1,500,000 – $600,000) @ 28% = $252,000
Tutorial note. IAS 12 requires the deferred tax liability on revaluations to be recognised even if
the entity does not intend to dispose of the asset since the value of the asset is recovered
through use which generates taxable income in excess of tax depreciation allowable.
$
Profit before tax 2,530,000
Less income tax expense (1,127,000)
Profit for the year 1,403,000
Less preference dividends (276,000)
Earnings 1,127,000
Earnings per share = 1,127,000 / 4,120,000
(b) The first step is to calculate the theoretical ex-rights price. Consider the holder of 5 shares.
No. $
Before rights issue 5 8.90
TT2021
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No. $
Rights issue 1 1.20
After rights issue 6 10.10
EPS =
$1,127,000
4,509,929
=$0.25
(c) The maximum number of shares into which the loan stock could be converted is 90% ×
1,500,000 = 1,350,000. The calculation of diluted EPS should be based on the assumption
that such a conversion actually took place on 1 January 20X4. Shares in issue during the
year would then have numbered (4,120,000 + 1,350,000) = 5,470,000 and revised earnings
would be:
$ $
Earnings from (1) above 1,127,000
Interest saved by conversion (1,500,000 × 10%) 150,000
Less attributable tax (150,000 × 30%) (45,000)
105,000
1,232,000
... Diluted EPS = 1,232,000 / 5,470,000 $0.23
Introduction
In accordance with your instructions, I set out below a review of the entity’s financial performance
over the last three years.
The main focus of this report is on the reasons for the increase in the level of bank loans.
Appropriate accounting ratios are included in the attached appendix.
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Bank lending
The main reason for the steep increase in bank lending is due to the entity not generating
sufficient cash from its operating activities over the past three years.
For the year ended 30 June 20X8, the entity had a net cash deficiency on operating activities of
$18 million.
In addition, for at least the past two years, the cash generated from operating activities has not
been sufficient to cover interest payable. Therefore, those payments, together with tax and
dividends, have had to be covered by borrowings.
As at 30 June 20X9, bank borrowings were $610 million out of a total facility of $630 million.
Payment of the proposed dividends alone would increase the borrowings to the limit.
Operating review
Although revenue has been rising steadily over the period, operating profit has remained almost
static.
Over this period the profit margin has risen, but not as much as would be expected. The cost of
sales have risen in almost the same proportion as sales. This may be due to increased costs of raw
materials, as inventories have risen steeply; but the turnover of inventory has been falling or static
over the same period.
There has also been a large increase in trade receivables. Both the increase in inventories and
trade receivables have had to be financed out of operating activities leading to the present
pressure on borrowings.
Although the number of days sales in trade receivables has fallen steadily over the period, the
trade receivables at the end of June 20X9 still represent nearly a year’s credit sales. This is
excessive and seems to imply a poor credit control policy, even taking into account the extended
credit terms being granted by the company.
Recommendations
The entity needs to undertake an urgent review of its credit terms in order to reduce the levels of
trade receivables.
Inventory levels are also extremely high (representing over four months’ sales) and should be
reviewed.
Operating costs also need to be kept under control in order to generate more cash from sales.
Please contact me if you need any further information.
Signed: An Accountant
TT2021
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20X7 20X8 20X9
Depreciation 60 70
Increase in inventory (140) (80)
Increase in trade receivables (58) (83)
Increase in trade payables – 10
(18) 57
120/(382+720) 140/(372+930)
95/(372+520)× ×100 = ×100 =
ROCE MATHTYPE 100 = 10.6% 10.9% 10.7%
Interest cover MATHTYPE 95/25 = 3.8 120/60 = 2.0 = 1.3
520/892 =
Gearing MATHTYPE 58.3% = 65.3% = 71.4%
1,850/892= 2.1 2,200/1,102=
Asset turnover MATHTYPE times 2.0 times = 1.9 times
Cole Co Darwin Co
$’000 $’000 $’000 $’000
Revenue (3,000 – 125) (Note 1) 2,875 4,400
Opening inventory 450 720
Purchases (Note 2) 2,055 3,080
Closing inventory (540) (850)
1,965 2,950
Gross profit 910 1,450
Operating expenses 480 964
Depreciation (Note 3) 40 (120)
Loan interest 80 –
Overdraft interest (W3) 15 –
(615) (844)
Profit for the year 295 606
Cole Co Darwin Co
$’000 $’000 $’000 $’000
Assets
Non-current assets
Property, plant, equipment (W1) 3,100 2,620
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Cole Co Darwin Co
$’000 $’000 $’000 $’000
Current assets
Inventories 540 850
Trade receivables (W2) 897 750
Cash and cash equivalents
(W3) – 60
1,437 1,660
4,537 4,280
Equity and liabilities
Equity shares ($1) 1,000 500
Revaluation surplus (800 – 40) 760 700
Retained earnings to 31 March
20X9
(684 + 295 + 40) / (1,912 + 606) 1,019 2,518
2,779 3,718
Non current liabilities
10% loan note 800 –
Current liabilities
Trade payables (W4) 163 562
Overdraft (W3) 795 –
4,537 4,280
Workings
1 Non-current assets
Carrying
Cost/valuation Depreciation amount
$’000 $’000 $’000
Cole Co: property 2,000 100 1,900
plant 6,000 4,800 1,200
3,100
2 Trade receivables
Cole Co: 522 + 375 (note (1)) = 897
TT2021
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3 Cash and cash equivalents
Cole Co Darwin Co
$’000 $’000
As stated 20 (550)
Reversal of sale (note (1)) (500)
Payment for purchases (note (2)) (300)
Payment for plant (note (3)) 600
Payment/saving of interest to statement of financial
position 15 10
(795) 60
4 Trade payables
Cole Co 438 – 275 (note (2)) = 163
(1) Sale to Brander Co is at gross margin 40%, therefore the cost of sale is $500 × 60% =
$300.
Had a normal margin of 20% applied, the cost of this sale would represent 80% of the selling
price. The normal selling price would be $300/0.80 = $375
Sales and receivables would reduce by $125 and the proceeds of $500 would not have been
received.
(2) Purchase of goods from Advent Co on normal terms would have increased purchases by
$25. Using the normal credit period would mean these goods would have been paid for
by the year end, increasing the overdraft and reducing trade payables.
(3) The plant bought in February 20X9 has not yet generated income for Darwin Co, so it is
sensible to ignore it in the acquisition comparison.
The effects are:
• Cost of plant – $600, overdraft affected
• Depreciation reduced $600 × 20% = $120
The depreciation charged changes:
Cole Co Darwin Co
$’000 $’000
As stated for property (60)
Depreciation on revaluation 100
Reduction (above) (120)
40 increase (120) (decrease)
(b) Recalculations
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Ratios Cole Co Darwin Co
Receivables
collection (days) 897/2,875 × 365 = 114 (unchanged) = 62
Payables period
(days) 163/2,055 × 365 = 29 (unchanged) = 67
Using the unadjusted figures, Cole Co would be preferred, as its key ratios given are better
than those of Darwin Co. Cole Co achieves better profitability due to greater unit margins.
Both companies have poor asset turnover implying under-utilisation or inefficient methods.
Both companies manage working capital in a similar fashion. Webster Co should examine
liquidity ratios:
Cole Co: 1,082/438 = 2.5
Darwin Co: 1,600/1,112 = 1.4
The acid test ratio of Cole Co is 1.23 whereas Darwin Co’s is 0.67.
Using the adjusted accounts, the above position is reversed showing Darwin Co to be more
profitable and to manage its assets more efficiently. Cole Co’s true liquidity position is not so
healthy – Cole Co controls receivables poorly and appears to pay suppliers earlier.
Darwin Co’s poor liquidity position is probably due to financing non-current assets from its
overdraft. Alternative refinancing would be beneficial.
Cole Co’s parent company has produced an initially favourable set of ratios by creating
favourable payment terms and trading conditions, and Darwin Co’s original ratios were
distorted by revaluations and the timing of new plant purchases.
Other factors to consider include:
(1) The asking price
(2) The future prospects, profits and cash flow forecasts
(3) The state of forward order books
(4) The quality of the management and labour force
(5) Other possible acquisitions
Tutorial note. This question is at the upper end of the scale of difficulty which you are
likely to encounter, particularly part 1. Study the answer carefully.
$’000
Revenue 70,000
Cost of sales (45,000/0.9 (1)) (50,000)
Gross profit 20,000
Operating costs (7,000)
Directors salaries (2) (2,500)
Loan interest (10% × 10,000 (3)) (1,000)
Profit before tax 9,500
Income tax expense (3,000)
Profit for the year 6,500
TT2021
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The adjusted ratios, based on the statement of profit or loss as above, the equity of $30m
and the replacement of the directors’ loan accounts by a commercial loan are as follows:
(b) The ratios based on the original summarised financial statements of Hydan Co show a very
healthy picture, well above the sector average. Hydan Co has high gross and net profit
margins and an impressive net asset turnover, giving a return on equity of more than twice
the sector average. On the face of it, Hydan Co is trading very profitably and efficiently,
keeping costs well under control.
However, when the financial statements are adjusted to show the likely picture post-
acquisition, it becomes clear that Hydan Co has been to quite a large degree cushioned by
the family and by the other family-owned companies. Removing the 10% discount Hydan
enjoys on its purchases reduces the gross profit margin from 35.7% to 28.6%, slightly under
the sector average.
If Xpand Co purchases Hydan Co, it will need to appoint a new board of directors and
replace the directors’ loan accounts with a commercial loan. Both of these expenses have up
to now been subsidised by the family.
Adjusting further for the increased directors’ remuneration and interest on the loan takes the
net profit margin down from 20% to 9.3%, significantly below the sector average of 12%. The
value of equity would not change significantly as a result of the acquisition, as the increase
to $30m is compensated for by the reclassification of the loan as debt. The fall in the return
on equity from 47.1% to 21.7% is therefore driven by the fall in net profit. However, it is worth
noting that 21.7% return on equity is not much below the sector average of 22%.
Xpand Co should take the view that if it acquires Hydan Co it will be acquiring a business
that is performing slightly below the average for its sector. The impressive profitability
pictured in the summarised financial statements is obviously not going to survive the
acquisition. But Hydan Co will still be trading quite profitably and it could be that there are
cost savings which were not considered necessary by the previous management but which
could now be made, which will bring its performance into line with the average for its sector.
Tutorial note. This is a recent question and looks at the financial statements from the
viewpoint of an acquirer. There are 6 marks for the adjustments and ratios and 9 for the
analysis.
$m $m
Cash flows from operating activities
Profit before taxation 1,050
Adjustments for:
Depreciation 970
Interest expense 250
2,270
Decrease in inventories (W4) 100
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$m $m
Increase in trade receivables (W4) (400)
Increase in trade payables (W4) 160
Cash generated from operations 2,130
Interest paid (250)
Income taxes paid (W3) (210)
Net cash from operating activities 1,670
Cash flow from investing activities
Purchase of property, plant and equipment (W1) (870)
Cash flows from financing activities
Payment of lease liabilities (W3) (450)
Dividends paid (300)
Net cash used in financing activities (750)
Net increase in cash and cash equivalents 50
Cash and cash equivalents at beginning of year (205)
Cash and cash equivalents at end of year (155)
Workings
1 Assets – Property, plant and equipment
$’000
B/d 3,700
Depreciation (970)
Right-of-use assets 600
Acquired for cash (β) 870
C/d 4,200
2 Equity
3 Liabilities
Lease Taxation
$m $m
B/d – (1,200 + 450) / (850 + 205) 1,650 1,055
Addition 600
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Lease Taxation
$m $m
Charge for year 450
Cash paid (β) (450) (210)
C/d – (500 + 1,300) / (225 + 1,070) 1,800 1,295
$m
$m
Cash flows from operating activities
Profit before taxation 109
Adjustments for
Loss on disposal 6
Depreciation 43
Interest income (6)
Interest expense 17
169
Decrease in inventories (W4) 53
Increase in trade receivables (W4) (8)
Increase in trade payables (W4) 56
Cash generated from operations 270
Interest paid (W3) (13)
Income taxes paid (W3) (62)
Net cash from operating activities 195
Cash flows from investing activities
Purchase of property, plant and equipment (W1) (165)
Proceeds from sale of property, plant and equipment (28 – 6) 22
Interest received 6
(137)
Net cash used in investing activities
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$m
$m
Cash flows from financing activities
Proceeds from issuance of share capital (W2) 60
Dividend paid (32)
Net cash from financing activities 28
Net increase in cash and cash equivalents 86
Cash and cash equivalents at beginning of the period 8
Cash and cash equivalents at end of the period 94
Workings
1 Assets – Property, plant and equipment
$m
B/d 264
Depreciation (43)
Disposal (28)
Revaluation surplus (31)
Cash additions (β) 165
C/d 327
2 Equity
IAS 7 requires that investing and financing activities that do not require the use of cash,
such as converting debt to equity, should be excluded from the statement of cash flows.
3 Liabilities
TT2021
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Interest Income tax
$m $m
C/f 7 39
(b) REPORT
TT2021
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Because assets are understated, depreciation will also be understated. While the purpose of
depreciation is not to set aside funds for replacement of assets, if an asset has to be replaced
at twice the price that was paid for its predecessor, the company may decide that it may
have been prudent to make some allowance for this in earlier years.
When inventory prices are rising, and when the company is operating a FIFO system, the
cheapest inventories are being charged to cost of sales and the most expensive are being
designated as closing inventory in the statement of financial position. This leads to
understatement of cost of sales.
(c) The Conceptual Framework does not explicitly specify which measurement basis is required
in each case rather that management take into account the fundamental qualitative
characteristics of relevance and faithful representation.
The information provided should always be useful to the users of the financial statements,
Therefore, if an asset has a fluctuating value based on active market conditions, such as a
retail outlet, then fair value is likely to be the most suitable basis for measurement. A bespoke
piece of machinery, designed for that particular business is likely to have a minimal value on
the open market, however, the business will gain significant financial benefit from it, so a
value in use measurement is potentially the most suitable.
55 Not-for-profit (9 mins)
There are two main areas in which the Department would be expected to monitor the performance
of the school.
Although the school is a not-for-profit organisation, it still has to account for the funding it
receives. It is spending taxpayers money so the government has a duty to ensure that it is
delivering value for money. This is particularly important in the light of the criticisms that have
been made.
The accounts kept by the school should be regularly audited to ensure that no financial
mismanagement has occurred and it will be expected to prepare and implement budgets. The
school should be expected to show some excess of income over expenditure, which will give it a
surplus for emergencies, even if this will be lower than in a profit-making entity, and a number of
accounting ratios can be used to monitor its performance.
Investor ratios such as ROCE will not be particularly appropriate but working capital ratios, such
as payables days, will be important, as will liquidity ratios. The school may not be expected to
make a profit, but it will be expected to remain solvent. Additional ratios, such as expenditure per
pupil, can be calculated and compared to the same ratio for other schools in the area.
Value for money is composed of three elements – economy, efficiency and effectiveness.
Financial performance can be monitored to assess economy and efficiency but in the case of a
school the government will be most interested in effectiveness. This requires looking at the non-
financial indicators.
The mission of the school, however it is worded, will be to maximise the educational attainment of
its pupils and it will need to demonstrate that it is making progress in this direction. The basic
measure of this is the external exam scores of its pupils and this can be directly compared to the
performance of other schools, such as percentage of pupils achieving grade A–C in maths, etc.
However, these scores need to be weighted to take account of the number of pupils from deprived
backgrounds, such as those eligible for free school meals, and the number of pupils with English
as a second language. More subjective measures could also be used, such as feedback from
pupils and parents.
TT2021
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$000
Investments (240,000 – 200,000 – 40,000) 0
Goodwill (W1) 69,600
629,600
Current assets (123,000 + 89,300 + 450 (W5)) 211,850
Equity
Share capital – $1 shares 210,000
Revaluation surplus Only Armstrong Co 82,000
Retained earnings (W4) 251,114
543,114
Non-controlling interest (W3) 31,000
Non-current liabilities
Deferred consideration (40,000 × 0.890) + (35,600 × 6%) 37,736
Current liabilities 229,600
267,336
Total equity and liabilities 841,450
Workings
1 Goodwill computation
$’000
Cash Per question 200,000
Deferred consideration (discounted) 40,000 × 0.890 35,500
NCI at acquisition Per question 30,000
Less net assets at acquisition (W2) (196,000)
69,600
2 Net assets
3 Non-controlling interest
$’000
NCI at acquisition Per question 30,000
TT2021
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$’000
NCI % of Miller Co post-acquisition 5,000 (W2) × 20% 1,000
31,000
4 Retained earnings
$’000
Armstrong Co retained earnings 249,700
Armstrong Co’s % of Miller Co post-acquisition
profit (5,000 (W1) × 80%) 4,000
Unwinding of discount for deferred consideration (35,600 × 6%) (2,136)
Unrealised profit on the I/G inventory (450)
251,114
$’000
Armstrong Co sold widgets to Miller Co Per question 7,500
Profit margin on the widgets sold to Miller Co is
20%, therefore:
Cost of inventory sold 7,500 × 80% 6,000
Profit on the sale 1,500
30% of items still in inventory at year end 1,500 × 30% 450
Unrealised profit on the inventory held 450
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Glossary
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Chapter 1: The Conceptual Framework
Asset: A present economic resource controlled by the entity as a result of past events
(Conceptual Framework: para. 4.2).
Comparability: The qualitative characteristic that enables users to identify and understand
similarities in, and differences among, items (Conceptual Framework: para. 2.25).
Current cost of an asset: 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 (Conceptual Framework: para.
6.21).
Current cost of a liability: 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 (Conceptual Framework: para. 6.21).
Equity: The residual interest in the assets of an entity after deducting all its liabilities (Conceptual
Framework: para. 4.2).
Fair value: 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 (Conceptual
Framework: para. 6.12 and IFRS 13: Appendix A).
Historical cost: Historical cost for an asset is the cost that was incurred when the asset was
acquired or created and, for a liability, is the value of the consideration received when the liability
was incurred.
Income: Increases in assets, or decreases in liabilities, that result in increases in equity, other than
those relating to contributions from equity participants (Conceptual Framework: para. 4.2).
Expenses: Decreases in assets, or increases in liabilities, that result in decreases in equity, other
than those relating to distributions to equity participants (Conceptual Framework: para. 4.2).
Liability: A present obligation of the entity to transfer an economic resource as a result of past
events (Conceptual Framework: para. 4.2).
Timeliness: This means having information available to decision-makers in time to be capable of
influencing their decisions. Generally, the older information is the less useful it is (Conceptual
Framework: para. 2.33).
Understandability: Classifying, characterising and presenting information clearly and concisely
makes it understandable (Conceptual Framework: para. 2.34).
Value in use: The present value of the cash flows, or other economic benefits, that an entity
expects to derive from the use of an asset and from its ultimate disposal (Conceptual Framework:
para. 6.17).
Verifiability: This 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 (Conceptual Framework: para. 2.30).
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• The number of production or similar units expected to be obtained from the asset by the entity.
Depreciable amount: The depreciable amount of an asset is the historical cost or other amount
substituted for cost in the financial statements, less its estimated residual value (IAS 16: paras. 50–
54).
Fair value model: After initial recognition, an entity that chooses the fair value model should
measure all of its investment property at fair value, except in the extremely rare cases where this
cannot be measured reliably. In such cases, it should apply the IAS 16 cost model.A gain or loss
arising from a change in the fair value of an investment property should be recognised in net
profit or loss for the period in which it arises.The fair value of investment property should reflect
market conditions at the end of the reporting period (IAS 40: paras. 33, 35, 40).
Investment property: Property (land or a building – or part of a building – or both) held (by the
owner or by the lessee as a right-of-use asset) to earn rentals or for capital appreciation or both,
rather than for:
(a) Use in the production or supply of goods or services or for administrative purposes, or
(b) Sale in the ordinary course of business.
Owner-occupied property: Property held by the owner for use in the production or supply of
goods or services or for administrative purposes.
Fair value: 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.
Cost: The amount of cash or cash equivalents paid or the fair value of other consideration given
to acquire an asset at the time of its acquisition or construction.
Carrying amount: The amount at which an asset is recognised in the statement of financial
position.
Property, plant and equipment: Tangible assets that:
• Are held for use in the production or supply of goods or services, for rental to others, or for
administrative purposes
• Are expected to be used during more than one period
Cost: The amount of cash or cash equivalents paid or the fair value of the other consideration
given to acquire an asset at the time of its acquisition or construction.
Residual value: The net amount which the entity expects to obtain for an asset at the end of its
useful life after deducting the expected costs of disposal.
Entity specific value: The present value of the cash flows an entity expects to arise from the
continuing use of an asset and from its disposal at the end of its useful life or expects to incur
when settling a liability.
Fair value: 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.
Carrying amount: The amount at which an asset is recognised in the statement of financial
position after deducting any accumulated depreciation and accumulated impairment losses.
Impairment loss: An impairment loss is the amount by which the carrying amount of an asset
exceeds its recoverable amount.
Bearer plant: A bearer plant is a living plant that:
• Is used in the production or supply of agricultural produce;
• Is expected to bear produce for more than one period; and
• Has a remote likelihood of being sold as agricultural produce, except for incidental scrap
sales(IAS 16: para. 6)
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Business combination: ‘A transaction or other event in which an acquirer obtains control of one or
more businesses.’ (IFRS 3: Appendix A)
Intangible asset: ‘An identifiable non-monetary asset without physical substance.’ (IAS 38: para.
8)
Monetary assets: ‘Money held and assets to be received in fixed or determinable amounts of
money.’ (IAS 38: para. 8)
Research: ‘Original and planned investigation undertaken with the prospect of gaining new
scientific or technical knowledge and understanding.’ (IAS 38: para. 8)
Development: ‘Application of research findings to a plan or design for the production of new or
substantially improved materials, products, processes, systems or services before the start of
commercial production or use.’ (IAS 38: para. 8)
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Grants related to assets: Government grants whose primary condition is that an entity qualifying
for them should purchase, construct or otherwise acquire non-current assets. Subsidiary
conditions may also be attached restricting the type or location of the assets or the periods
during which they are to be acquired or held (IFRS 15: para. 3).
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(c) A contractual right to receive cash or another financial asset from another entity; or to
exchange financial instruments with another entity under conditions that are potentially
favourable to the entity.
Financial liability: Any liability that is:
(a) A contractual obligation:
(i) To deliver cash or another financial asset to another entity, or
(ii) To exchange financial instruments with another entity under conditions that are
potentially unfavourable.
Equity instrument: Any contract that evidences a residual interest in the assets of an entity after
deducting all of its liabilities. (IAS 32: para. 11)
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Restructuring: A programme that is planned and is controlled by management and materially
changes one of two things.
• The scope of a business undertaken by an entity
• The manner in which that business is conducted (IAS 37: para. 10)
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Chapter 16: Presentation of published financial statements
Current asset: An asset should be classified as a current asset when it:
• Is expected to be realised in, or is held for sale or consumption in, the normal course of the
entity’s operating cycle; or
• Is held primarily for trading purposes or for the short-term and expected to be realised within
12 months of the end of the reporting period; or
• Is cash or a cash equivalent asset which is not restricted in its use.All other assets should be
classified as non-current assets. (IAS 1: para. 66)
Current liabilities: A liability should be classified as a current liability when it:
• Is expected to be settled in the normal course of the entity’s operating cycle; or
• Is held primarily for the purpose of trading; or
• Is due to be settled within 12 months after the end of the reporting period; or when
• The entity does not have the right at the end of the reporting period to defer settlement of the
liability for at least 12 months after the end of the reporting period. All other liabilities should be
classified as non-current liabilities.(IAS 1: para. 69)
Operating cycle: The time between the acquisition of assets for processing and their realisation in
cash or cash equivalents. (IAS 1: para. 68)
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Presentational currency: Presentation currency is the currency in which the financial statements
are presented (IAS 21, para. 8).An entity can present its financial statements in any currency (or
currencies) it chooses.Its presentation currency will normally be the same as its functional
currency (the currency of the country in which it operates).
Prior period errors: Omissions from, and misstatements in, the entity’s financial statements for
one or more prior periods arising from a failure to use, or misuse of, reliable information that:
(a) Was available when the financial statements for those periods were authorised for issue; and
(b) Could reasonably be expected to have been obtained and taken into account in the
preparation and presentation of those financial statements.(IAS 8: para. 5)
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(iii) Is a member of the key management personnel of the reporting entity or of a parent of
the reporting entity
(b) An entity is related to a reporting entity if any of the following conditions apply:
(i) The entity and the reporting entity are members of the same group (which means that
each parent, subsidiary and fellow subsidiary is related to the others).
(ii) One entity is an associate* or joint venture* of the other entity (or an associate or joint
venture of a member of a group of which the other entity is a member).
(iii) Both entities are joint ventures* of the same third party.
(iv) One entity is a joint venture* of a third entity and the other entity is an associate of the
third entity.
(v) The entity is a post-employment benefit plan for the benefit of employees of either the
reporting entity or an entity related to the reporting entity.
(vi) The entity is controlled or jointly controlled by a person identified in (a).
(vii) A person identified in (a)(i) has significant influence over the entity or is a member of the
key management personnel of the entity (or of a parent of the entity).
(viii) The entity, or any member of a group of which it is a part, provides key management
personnel services to the reporting entity or the parent of the reporting entity.*including
subsidiaries of the associate or joint venture (IAS 24: para. 9)
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Index
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Current asset, 375 Entity specific value, 534
Current cost of a liability, 12 Environmental and sustainability policies, 495
Current cost of an asset, 12 Environmental costs, 320
Current liabilities, 375 Equity, 8
Current ratio, 460 Equity instrument, 271, 437
Current tax, 351, 352 Equity method, 238
Current value, 10, 11 Events after the reporting period, 327, 630
Exclusion of a subsidiary from the consolidated
D financial statements, 568
Debt ratio, 684 Exemption from preparing consolidated
Decommissioning costs, 319 financial statements, 568
Deductible temporary differences, 351 Expenditure incurred in replacing or renewing a
Deferred tax, 353 component, 536
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Gearing, 464 IFRS 15, Revenue from Contracts with
General purpose financial statements, 4 Customers, 319
Goodwill, 65, 148, 568 IFRS 5 Non-Current Assets Held for Sale and
Discontinued Operations, 534, 404
Goodwill calculation, 169
IFRS 7 Financial Instruments: Disclosures, 611,
Government grants, 121 375
Grants for non-depreciable assets, 122 IFRS 9 Financial Instruments, 144, 596
Grants related to assets, 122 IFRS Interpretations, 31
Grants relating to income, 121 IFRS Interpretations Committee, 31
Gross profit margin, 459 Impairment indicators, 83
Group, 144 Impairment loss, 534, 213, 239
Group financial statements, 147 Impairment losses and inventory losses, 358
H Impairment of carrying amounts of non-current
assets, 538
Historical cost, 10, 11
Impairment loss, 81
I Income, 8
IAS 1 Presentation of Financial Statements, 14, Indirect method, 506
296, 373 Inflation, 494
IAS 10 Events After the Reporting Period, 315, Intangible asset, 63
327
Interest cover, 465
IAS 12 Income Taxes, 351
Internally generated intangible assets, 64, 65
IAS 16 Property, Plant and Equipment, 41, 296,
639 International Accounting Standards (IAS), 27
IAS 2 Inventories, 339 International Accounting Standards Committee
(IASC), 27
IAS 20 Accounting for Government Grants, 121
International Public Sector Accounting
IAS 24 Related Party Disclosures, 492 Standards (IPSAS), 525
IAS 27 Separate Financial Statements, 146, 238 Interpreting asset turnover ratio, 495
IAS 28 Investments in Associates and Joint Intragroup dividends, 213
Ventures, 238
Inventories, 339
IAS 36 Impairment of Assets, 81, 296
Inventory holding period, 462
IAS 37 Provisions, Contingent Liabilities and
Contingent Assets, 315 Investing activities, 506
IAS 38 Intangible Assets, 357 Investment property, 47
IAS 40 Investment Property, 296 Investment property (IAS 40), 47, 544
IAS 41 Agriculture, 342 J
IAS 7 Statement of Cash Flows, 505 Judgement, 401
IAS 8 Accounting Policies, Changes in
Accounting Estimates and Errors, 122, 401 K
IASB Conference, 31 Key Performance Indicators (KPIs), 526
Identifiable non-monetary asset, 63
L
Identify the performance obligations, 110
Lease, 291
IFRS 13 Fair Value Measurement, 11, 343
Leases of assets with a , 298
IFRS 15 Revenue from Contracts with
Customers, 299 Legal and constructive obligations, 317
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Liability, 8 Performance obligations satisfied over time, 113
Limitations of eps, 445 Physical capital maintenance, 14
Limitations of financial statements, 692 Potential ordinary share, 437, 442
Limitations of ratio analysis, 494 Power, 144
Limitations of the historical cost basis for Present obligation, 317
measurement, 11 Present obligations and obligating events, 317
Limitations of using current value, 12 Price/earnings (P/E) ratio, 466
Liquidity, 682 Primary users, 5
M Principle of revenue recognition, 108
Management’s stewardship, 5 Principles-based versus rules-based, 27
Matching, 5 Prior period errors, 403
Measurement, 10 Probable that an outflow of resources, 317
Measurement of financial assets, 276 Probable transfer of economic benefits, 625
Measurement of financial liabilities, 279 Problems of historical financial information, 491
Mid‑year acquisitions, 212 Procedure for rights issue, 674
Mission statement, 495 Profitability ratios, 456
Monetary assets, 63 Property, plant and equipment, 534
Provision, 317, 358
N
Provisions for restructuring, 322
Negative goodwill, 173
Ps as a performance indicator, 445
Net (operating) profit margin, 457
Public sector, 525
Net realisable value, 340, 638
Purchased goodwill, 568
Non-cash consideration, 112
Non-current assets, 375 Q
Not-for-profit, 525 Qualitative characteristics, 5
Quick (acid-test) ratio, 461
O
Objective of general purpose financial R
reporting, 5 Ratio analysis, 455
Objectives of the IASB, 28 Receivables collection period, 462
Obligating event, 317 Recognition, 9
Obsolescence, 638 Recognition criteria, 64
Onerous contracts, 321 Recognition of an intangible asset, 550
Operating activities, 506 Recognition of impairment losses, 84
Operating cycle, 375 Recoverable amount, 81, 404
Options, warrants and their equivalents, 437 Regulatory framework, 27
Ordinary shares, 437 Related party (IAS 24), 492
Owner-occupied property, 47 Relevance, 5
Reliable estimate, 317
P
Repayment of grants, 122
Parent, 144
Replacements and Overhauls, 46
Payables payment period, 463
Reporting dates, 570
Performance measurement, 712
Research, 65
Performance obligation, 108
Research and development costs, 550
Performance obligation is satisfied, 109
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Residual value, 534, 542 The International Federation of Accountants
Restructuring, 322 (IFAC), 525
Restructuring and future operating losses, 175, The Three Es, 526
576 Theoretical ex-rights price (TERP), 441
Retirements and disposals, 538 Timeliness, 7
Return on capital employed, 456 Transaction is not a sale per IFRS 15, 300
Return on equity, 459 Transaction price, 108
Revaluation model, 68 Transfer of control, 108
Revaluation of depreciated assets, 42 Transfers to or from investment property, 49
Revaluation of non-current assets, 357
U
Revaluation surplus, 41
Underlying asset, 291
Reversal of an impairment loss, 87
Understandability, 7
Reversing a previous decrease in value, 41
Uniform accounting policies, 570
Review of the useful life, 542
US GAAP, 27
Right-of-use asset, 295
Useful life, 541
Rights issue, 440
V
S
Value in use, 12, 556, 404
Sale and leaseback transactions, 299
Value in use of an asset, 81
Seasonal trading, 692
Variable consideration, 111
Self-constructed assets, 536
Verifiability, 7
Short term liquidity and efficiency, 460
Short-term leases, 298 W
Significant influence, 145, 237 Warranties, 120, 319
Statement of cash flows, 505 Weighted average cost, 340
Statement of financial position, 373 Working capital cycle, 463
Statement of profit or loss and other World Bank, 28
comprehensive income, 377
Statement of Recommended Practice (SORP),
525
Subsequent measurement of the right-of-use
asset, 295
Subsidiary, 144
T
Tax base, 351
Tax expense (tax income), 351
Taxable profit (tax loss), 351
Taxable temporary differences, 351
Temporary difference, 351
The Conceptual Framework for General
Purpose Financial Reporting by Public Sector
Entities, 711
The existence of a significant financing
component, 111
The International Accounting Standards Board
(IASB), 27
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Bibliography
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Bibliography 839
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International Accounting Standards Board (2003) Accounting policies, Changes in Accounting
Estimates and Errors IAS 8 [Online] Available from http://eifrs.ifrs.org [Accessed October 2019]
International Accounting Standards Board (2003) Events after the Reporting Period IAS 10 [Online]
Available from http://eifrs.ifrs.org [Accessed October 2019]
International Accounting Standards Board (2004) Impairment of Assets IAS 36 [Online] Available
from http://eifrs.ifrs.org [Accessed October 2019]
International Accounting Standards Board (2004) Intangible Assets IAS 38 [Online] Available from
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International Accounting Standards Board (2004) Business Combinations IFRS 3 [Online] Available
from http://eifrs.ifrs.org [Accessed October 2019]
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Discontinued Operations IFRS 5 [Online] Available from http://eifrs.ifrs.org [Accessed October
2019]
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[Online] Available from http://eifrs.ifrs.org [Accessed October 2019]
International Accounting Standards Board (2007) Borrowing Costs IAS 23 [Online] Available from
http://eifrs.ifrs.org [Accessed October 2019]
International Accounting Standards Board (2010) Presentation of Financial Statements IAS 1
[Online] Available from http://eifrs.ifrs.org [Accessed October 2019]
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[Online] Available from: http://eifrs.ifrs.org [Accessed October 2019]
International Accounting Standards Board (2010) Consolidated Financial Statements IFRS 10
[Online] Available from http://eifrs.ifrs.org [Accessed October 2019]
International Accounting Standards Board (2014) Agriculture: Bearer Plants (Amendments to IAS 16
and IAS 41) [Online] Available from: http://eifrs.ifrs.org [Accessed October 2019]
International Accounting Standards Board (2014) Revenue from contracts with customers IFRS15
[Online] Available from: http://eifrs.ifrs.org [Accessed October 2019]
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from http://eifrs.ifrs.org [Accessed October 2019]
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05.html [Accessed February 2020]
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