CPA-Financial Reporting

FINANCIAL REPORTING COURSE
OUTLINE
AIM OF Financial Reporting
To develop knowledge and skills in understanding and
applying accounting standards and the theoretical
framework in the preparation of financial statements
of entities, including groups and how to analyze and
interpret those financial statements.
Chapter 1: Conceptual Framework
It’s the framework for the preparation and presentation
of Financial Statements. It sets out the concepts that
underlie financial statements for external users.
Purpose of Conceptual framework
1. Assists IASB in the development of new standards
and reviewing of the existing standards.
2. Assists IASB in harmonizing accounting standards
and procedures.
Chapter 1: Conceptual Framework Con’t
3. Assists National Standard setting bodies in
developing national accounting standards
4. Assists preparers of financial statements in applying
standards to deal with topics which aren’t discussed in
the standards framework
5. Assists auditors in forming an opinion as to whether
financial statements conform with IASs or IFRSs
Scope of the Conceptual Framework
1. The objectives of the Financial Statements
2. The qualitative characteristics of financial
statements
3. Definition, Recognition and Measurement of the
Elements from which
Financial Statements are constructed
4. Concept of Capital and Capital Maintenance
Objectives of Financial Statements
Provide information on the financial position,
financial performance and changes in financial
position to a wide range of users of the financial
statements to enable them make informed decisions.
Assumptions of the Financial Statements
(Underlying)
There are two fundamental accounting assumptions
1) Accrual Basis Assumption
Simply means the matching concept. That is, match
income with expenses. This means transactions and
events will be recorded in the financial statements
when they occur but not when money is paid in or
received in the accounting records and in the correct
period.
(Underlying)
There are two fundamental accounting assumptions
2. Going Concern Assumption
It’s the assumption that the business will be in
operation for the foreseeable future.
That is, the business entity has no intention or
necessity to liquidate or curtail the major operations of
the business.
(Underlying)
If the business entity has that intention or necessity to
liquidate, the FS should be prepared on realization
method and the method should be disclosed in the
notes to financial statements.
NB. Accruals basis could be meaningless if the going
concern is not there.
2. THE QUALITATIVE CHARACTERISTICS OF FINANCIAL
INFORMATION
The Conceptual Framework states that qualitative
characteristics are the attributes that make the
information provided in financial statements useful to
users.
Qualitative characteristics Are divided into two
groups
• Fundamental Qualitative Characteristics
• Enhancing Qualitative characteristics
INFORMATION
a) Fundamental Qualitative Characteristics
1) Relevance
2) Faithful Representation
b) Enhancing Qualitative Characteristics
1) Verifiability
2) Timeliness
3) Understandability
4) Comparability
INFORMATION
Fundamental Qualitative Characteristics
1) Relevance
Information is relevant if it has the ability to influence
economic decisions of users and provided in time to
influence those decisions.
To give information of great value, accountants must
review the materiality of all transactions and events
which will be used to construct the financial
statements.
INFORMATION
Materiality
Information is material if its omission or misstatement
would influence the economic decisions of the users
of financial statements. Materiality is judged on the
size or amount of error under that circumstance.
INFORMATION
2) Faithful Representation
Business entities are going to disclose all the information that
could influence the economic decisions of the users of
financial statements. That is, they will not understate their
expenses and liabilities while also not overstate income and
assets of Financial Statement.
INFORMATION
• Enhancing Qualitative Characteristics
1) Verifiability
Verification can be direct or indirect. Direct verification means verifying
an amount or other representation through direct observation, for
example, by counting cash.
Indirect verification means checking the inputs to a model, formula or
other technique and recalculating the outputs using the same
methodology' e.g. recalculating inventory amounts using the same cost
flow assumption such as first-in, first-out method (Framework, para
QC27).
Chapter 1: Conceptual
Framework Con’t
2. THE QUALITATIVE CHARACTERISTICS OF
FINANCIAL INFORMATION
2) Timeliness
'Timeliness means having information available to
decision makers in time to be capable of influencing
their decisions. Generally, the older the information is
the less useful it becomes' (Framework, para QC29)
Framework Con’t
3) Understandability
Financial statements prepared by the business entity
must be readily understandable by the users. The users
are assumed to have a reasonable knowledge on the
nature of the business practice.
Framework Con’t
4) Comparability
The financial statements should be compared through time and should be
compared with different business entities within the same industry.
To enhance comparability, the business entity must adopt the same
accounting policies in each year they are reporting. This is in accordance
with IAS 8 Accounting Policies, which are the principles, conventions,
bases, rules and practices business entities use in the preparation and
presentation of financial statements.
Framework Con’t
Elements from which Financial Statements are
constructed.
Definition of the Elements of Financial Statements
1. Assets
An asset is a resource controlled by the business entity as a result of a
past event, from which future economic benefits are expected to flow to
the entity. Control is the ability to generate economic benefits from the
asset and also to restrict others from using the asset.
2. Liabilities
A Liability is a present obligation as a result of a past event, the
settlement of which will result into an outflow from the entity of
resources embodying economic benefits.
Framework Con’t
constructed.
3. Capital
Capital is the amount invested in a business by the owner. Equity is the
residual interest of the assets of the entity after deducting all its
liabilities.
4. Income
Income is the increase in economic benefits during the accounting period
in the form of inflows, enhancement of assets or reduction in liabilities
resulting to increase in equity other than those relating to the
contribution by the members.
Framework Con’t
constructed.
Income can be classified into two:
a) Revenue
Increase in economic benefits from the ordinary activities of the business
which qualify to be an income. E.g sales, fees, dividends, interests,
royalties etc.
b) Gains
Other items that meet the definition of an income but do not relate to the
ordinary activities of the business. E.g sales of NCA. Gains
Framework
5. Expenses
Con’t
Expenses are decrease in economic benefits during the accounting period
in form of outflows, depletion of assets or incurrence of liabilities
resulting to decrease in equity other than distribution made to the owners
of the entity.
Recognition of the Elements of the Financial Statements
Recognition means incorporating in the SOFP and IS an item that meets
the definition and satisfies the criteria for recognition.
• It’s probable that future economic benefits is going to flow to or
from the entity
• The cost or value can be measured reliably
Measurement of the Elements of Financial Statements
When preparing the financial statements, the following methods of
measurement should be used.
a. Historical Cost: original monetary value of an economic item
b. Current Cost: the market value (new asset)
c. Realizable Cost: the disposal value, if you assume you are liquidating
d. Present Cost: the discounted cost. Discounted value of the assets and
liabilities
4. Concept of Capital and Capital Maintenance
Capital is the amount invested in the business by the owners.
Capital maintenance is the accounting equation:
Capital = Assets
New Capital = Old Capital + Profits – Losses
Capital Maintenance is viewed in two dimensions
a. Financial Capital Maintenance
The value of the firm is seen in monetary terms. That is, the value at the
beginning of the year against the value at the end of the accounting
period. Financial capital maintenance must be in money terms.
b. Physical Capital Maintenance
Looking at the value of the firm by comparing the assets held by the
entity at the beginning and assets held at the end of the accounting
period
CHAPT 2: REGULATORY FRAMEWORK
The Regulatory System
Structure of the International Regulatory System
The IASC
Foundation
SAC
IASB
IFRIC
The International Accounting Standards Committee (IASC) Foundation
The IASC Foundation:
• Is a supervisory body for the new structure
• Has 22 trustees
• Is responsible for governance issues and ensuring each body is properly
funded
Objectives of IASC Foundation
1) Develop a set of global accounting standards which are of high quality, are
understandable and are enforceable;
2) Which require high quality, transparent and comparable information in
financial statements to help those in the world’s capital markets and other
users make economic decisions;
3) Promote using and applying of these standards.
International Accounting Standards Board (IASB)
The IASB:
• Is solely responsible for issuing International Accounting Standards (IASs),
Standards now called International Financial Reporting Standards (IFRSs)
• Is made up of 14 members
• Has the same objectives as the IASC Foundation
The IASB and National Standard Setters
The intentions of the IASB are
• To develop a single set of understandable and enforceable high quality
world wide accounting standards, however
• The IASB cannot enforce compliance with its standards, therefore
International Accounting Standards Board (IASB)
• It needs the co-operation of national standard setters, in order to achieve
this IASB works in partnership with the major national standard setting
bodies:
• All the most important national standard setters are represented on the
IASB and their views are taken into account so that a consensus can be
reached;
• All national standard setters can issue IASB discussion papers and exposure
drafts for comment in their own countries, so that the views of all preparers
and users of financial statements can be represented;
• Each major national standard setter ‘leads’ certain international standard
setting projects. The IASB intends to develop a single set of understandable
and enforceable high quality worldwide accounting standards.
International Financial Reporting Interpretations Committee (IFRIC)
• Issues rapid guidance on accounting matters where divergent interpretations
of IFRSs have arisen
• Issues interpretations called IFRIC 1, IFRIC 2, etc
In 1997 the IASC formed the Standards Interpretation Committee (SIC) to
ensure proper compliance with IFRSs by considering points of contention
where divergent interpretations have emerged and issuing an authoritative
view; 33 interpretations (entitled SIC 1, SIC 2, etc) were issued by the SIC
before its change of name (see below).
SICs are important because IAS 1 (revised) states that financial statements
cannot be described as complying with IFRSs unless they comply with each
IAS/IFRS and each interpretation from the SIC/IFRIC. In 2002 the SIC
changed its name to the International Financial Reporting Interpretations
Committee (IFRIC). Interpretations are now designated IFRIC 1, IFRIC 2, etc.
Standards Advisory Council (SAC)
The SAC provides a forum for a range of experts from different countries and
different business sectors to offer advice to the IASB when drawing up new
standards. The procedure for the development of an IFRS is as follows:
1) The IASB identifies a subject and appoints an advisory committee
to advise on the issues;
2) The IASB publishes an exposure draft for public comment, being a
draft version of the intended standard;
3) Following the consideration of comments received on the draft, the
IASB publishes the final text of the IFRS;
4) At any stage the IASB may issue a discussion paper to encourage
Comment;
5) The publication of an IFRS, exposure draft or IFRIC interpretation requires
the votes of at least 8 of the 14 IASB members.
Status of IFRS’s
Neither the IASC Foundation, the IASB nor the accountancy profession has
the power to enforce compliance with IFRSs. Nevertheless, some countries
adopt IFRSs as their local standards, and others ensure that there is minimum
difference between their standards and IFRSs. In recent years, the status of the
IASB and its standards has increased, so IFRSs carry considerable persuasive
force worldwide.
Benchmark Treatment and Allowed Alternative Treatment
Some older IASs have two choices of treatment of items in the financial
statements:
• Benchmark treatment, Allowed alternative treatment In future IFRSs, If
different treatments are allowed they will be given equal status, No treatment
will be designated as the benchmark treatment.
This is the case in IFRS 3 (revised), issued in 2008, which provides a choice of
treatment with regard to goodwill.
The Regulatory Framework
The regulatory framework of accounting in each country which uses IFRS is
affected by a number of legislative and quasi-legislative influences as well as
IFRS:
• National Company Law
• EU directives
• Security Exchange Rules
Why a Regulatory Framework is Necessary
A regulatory framework for the preparation of financial statements is
necessary for the following reasons:
1) Financial Statements are used by a wide range of users – investors,
lenders, customers, etc.
2) They need to be useful to these users
3) They need to be comparable
4) They need to provide at the least some basic information
5) They increase users’ understanding of, and confidence in, financial
statements
6) They regulate the behavior of companies towards their investors
Accounting standards on their own would not be a complete regulatory
framework. In order to fully regulate the preparation of financial statements
and the obligations of companies and directors, legal and market regulations
are also required.
Principles Based and Rules Based Framework
Principles based Framework:
• Based upon a conceptual framework such as the IASB’s Framework
• Accounting standards are set on the basis of conceptual framework
Rules based framework
• Cookbook approach
• Accounting standards are a set of rules which companies must Follow For
Example: In the UK there is a principle based framework in terms of the
statement of principles and accounting standards and a rules based framework
in terms of the Companies Acts, EU directives and Stock Exchange Rules.
CHAPT 3: ACCOUNTING STANDARDS
IAS 1: PRESENTATION OF FINANCIAL STATEMENTS
Objective of IAS 1
The objective of IAS 1 is to prescribe the basis for presentation of general
purpose financial statements, to ensure comparability both with the entity's
financial statements of previous periods and with the financial statements of
other entities.
Scope of IAS 1
IAS 1 applies to all general purpose financial statements based on
International Financial Reporting Standards.
General purpose financial statements are those intended to serve users who are
not in a position to require financial reports tailored to their particular
information needs.
Objectives of Financial Statements
The objective of general purpose financial statements is to provide information
about the financial position, financial performance, and cash flows of an entity
that is useful to a wide range of users in making economic decisions. To meet
that objective, financial statements provide information about an entity's:
• Assets, Liabilities, Equity, Income and Expenses, including gains and losses;
• Contributions by and distributions to owners and;
• Cash flows.
That information, along with other information in the notes, assists users of
financial statements in predicting the entity's future cash flows and, in
particular, their timing and certainty.
Components of Financial Statements
A complete set of financial statements should include:
1. A statement of financial position (balance sheet) at the end of the period
2. A statement of comprehensive income for the period (or an income
statement and a statement of comprehensive income)
3. A statement of changes in equity for the period
4. A statement of cash flows for the period
5. Notes, comprising a summary of accounting policies and other explanatory
Notes.
NB: When an entity applies an accounting policy retrospectively or makes a
retrospective restatement of items in its financial statements, or when it
reclassifies items in its financial statements, it must also present a statement of
financial position (balance sheet) as at the beginning of the earliest
comparative period.
An entity may use titles for the statements other than those stated above.
Key Terms in IAS 1
1. Fair Presentation and Compliance with IFRSs
The financial statements must "present fairly" the financial position, financial
performance and cash flows of an entity.
Fair presentation requires the faithful representation of the effects of
transactions, other events, and conditions in accordance with the definitions
and recognition criteria for assets, liabilities, income and expenses set out in
the Framework.
The application of IFRSs, with additional disclosure when necessary, is
presumed to result in financial statements that achieve a fair presentation.
Key Terms in IAS 1
2. Going Concern
An entity preparing IFRS financial statements is presumed to be a going
concern. If management has significant concerns about the entity's ability to
continue as a going concern, the uncertainties must be disclosed.
If management concludes that the entity is not a going concern, the financial
statements should not be prepared on a going concern basis, in which case
IAS 1 requires a series of disclosures.
Key Terms in IAS 1
3. Accruals Basis of Accounting
IAS 1 requires that an entity prepare its financial statements, except for cash
flow information, using the accrual basis of accounting. That is, costs should
be recognized when incurred but not when money expense has been paid
while income should be recognized when it has been earned but not when
revenue has been received.
4. Consistency of Presentation
The presentation and classification of items in the financial statements shall be
retained from one period to the next unless a change is justified either by a
change in circumstances or a requirement of a new IFRS.
5. Materiality and Aggregation
Each material class of similar items must be presented separately in the
financial statements. Dissimilar items may be aggregated only if they are
individually immaterial.
6. Set – Offs (Offsetting)
Assets and liabilities, and income and expenses, may not be offset unless
required or permitted by an IFRS.
7. Comparative Information
IAS 1 requires that comparative information shall be disclosed in respect of
the
previous period for all amounts reported in the financial statements, both face
of financial statements and notes, unless another Standard requires otherwise.
If comparative amounts are changed or reclassified, various disclosures are
required.
Structure and content of financial statements in general
Clearly identify: the financial statements
1. The reporting enterprise;
2. Whether the statements are for the enterprise or for a group;
3. The date or period covered;
4. The presentation currency;
5. The level of precision (thousands, millions, etc.).
Reporting period
There is a presumption that financial statements will be prepared at least
annually. If the annual reporting period changes and financial statements are
prepared for a different period, the entity must disclose the reason for the
change and a warning about problems of comparability.
Notes to the Financial Statements
The notes must:
• Present information about the basis of preparation of the financial statements
and the specific accounting policies used;
• Disclose any information required by IFRSs that is not presented elsewhere
in the financial statements and;
• Provide additional information that is not presented elsewhere in the
financial
statements but is relevant to an understanding of any of them.
IAS 1 suggests that the notes should normally be presented in the following
order:
1. A statement of compliance with IFRSs
2. A summary of significant accounting policies applied, including:
• The measurement basis (or bases) used in preparing the financial
statements
• The other accounting policies used that are relevant to an understanding of
the financial statements
3. Supporting information for items presented on the face of the statement of
financial position (balance sheet), statement of comprehensive income (and
income statement, if presented), statement of changes in equity and
statement of cash flows, in the order in which each statement and each line
item is presented.
4. Other disclosures, including:
• Contingent liabilities (see IAS 37) and unrecognized contractual
commitments;
• Non-financial disclosures, such as the entity's financial risk management
objectives and policies (see IFRS 7).
Terminology
The 2007 comprehensive revision to IAS 1 introduced some new terminology.
Consequential amendments were made at that time to all of the other existing
IFRSs, and the new terminology has been used in subsequent IFRSs including
amendments.
Statement of Comprehensive Income
The recommended pro-forma layout is as follows:
PQR ltd,
Statement of Comprehensive Income for the Year Ended 31st December 2010
RWF000
Revenue X
Cost of sales (X)
Gross profit X
Other income X
Administrative expenses (X)
Distribution costs (X)
Profit from operations X
Statement of Comprehensive Income
The recommended pro-forma layout is as follows:
PQR ltd,
Statement of Comprehensive Income for the Year Ended 31st December 2010
RWF000
Finance costs (X)
Profit/(Loss) before tax (PBT) X
Income tax expense (X)
Profit/Loss for the year X
Other Comprehensive Income
Revaluation surplus/(Deficit) X/(X)
Total comprehensive income for the year X
Statement of Comprehensive Income Con’t
RWF000
Investment income X
Profit before tax X
Income tax expense (X)
Profit for the year X
Other Comprehensive Income
Gain/Loss on revaluation of PPE X
Gain/Loss on available for sale investments X/(X)
Total comprehensive income for the year X
Statement of Changes in Equity
Essentially the statement of changes in equity presents in a columnar format
all the changes which have affected the various equity balances of share
capital and reserves.
DISCLOSURE OF SIGNIFICANT ACCOUNTING POLICIES
An entity shall disclose the significant accounting policies used in preparing
the financial statements.
Question
XYZ ltd,
The following items have been extracted from the trial balance of XYZ ltd, a
limited liability company, as at 30th September 2010.
RWF RWF
Opening Inventory 186,400
Purchases 1,748,200
Carriage Inwards 38,100
Carriage Outwards 47,250
Sales Revenue 3,210,000
Trade Receivables 318,000
Wages & Salaries 694,200
Question
XYZ,
The following items have been extracted from the trial balance of XYZ, a
RWF RWF
Sundry Administrative Expenses 381,000
Allowance for doubtful debts, as at 1st October 2009 18,200
Bad Debts written off during the year 14,680
Question
XYZ,
The following items have been extracted from the trial balance of XYZ, a
RWF RWF
Office Equipment as at 1st October 2009:
Cost 214,000
Accumulated Depreciation 88,700
Office Equipment: Additions during the year 48,000

Proceeds of sale of items during the year 12,600
Interest paid 30,000
Question Con’t
Notes:
1. Closing inventory amounted to RWF219,600
2. Prepayments and accruals:
Prepayments Accruals
RWF RWF
Carriage Outwards 1,250
Wages & Salaries 5,800
Sundry Administrative Expenses 4,900 13,600
Interest Payable 30,000
Question Con’t
Notes:
3. Wages and salaries cost is to be allocated:
Cost of Sales 10%
Distribution Costs 20%
Administrative Expenses 70%
4. Further bad debts totaling RWF8,000 are to be written off, and the closing
allowance for doubtful debts is to be equal to 5% of the final trade receivables
figure. The bad and doubtful debt expense is to be included in administrative
expenses.
Question Con’t
Notes:
5. Office equipment:
Depreciation is to be provided at 20% per annum on the straight-line basis,
with a full year’s charge in the year of purchase and none in the year of sale.
During the year office equipment, which had cost RWF40,000 with
accumulated depreciation of RWF26,800 was sold for RWF12,600. All office
equipment is used for administrative purposes.
6. Income Tax of RWF22,000 is to be provided for.
REQUIREMENT:
Prepare the company’s Income Statement for the year ended 30th September
2010 in accordance with IAS 1
IAS 2: INVENTORIES
Objectives of IAS 2
The objective of IAS 2 is to prescribe the accounting treatment for inventories.
It provides guidance for determining the cost of inventories and for
subsequently recognizing an expense, including any write-down to net
realizable value.
Scope of Inventories
Inventories include;
1. Assets held for sale in the ordinary course of business (finished goods),
2. Assets in the production process for sale in the ordinary course of business
(work in process), and
3. Materials and supplies that are consumed in production (raw materials).
IAS 2: INVENTORIES
ie. Types of Inventores are;
1.Raw material;
2. Work in progress (WIP);
3. Finished Goods
NB: IAS 2 excludes certain inventories from its scope:
1. Work in process arising under construction contracts (IAS 11Construction
Contracts)
2. Financial instruments (IAS 39Financial Instruments: Recognition and
Measurement)
3. Biological assets related to agricultural activity and agricultural produce at
the point of harvest (IAS 41 Agriculture).
IAS 2: INVENTORIES
Valuation of Inventory (Measurement)
They are valued at the lower of Costs and Net Realizable Value
Cost
It’s the cost to bring an asset to its present location and condition including
cost of purchase and cost of conversion. That is: Cost should include all:
1. Costs of purchase (including taxes, transport, and handling) net of trade
discounts received
2. Costs of conversion (including fixed and variable manufacturing overheads)
3. Other costs incurred in bringing the inventories to their present location and
Condition.
IAS 2: INVENTORIES
Net Realizable Value (NRV)
NRV is the estimated selling price in the ordinary course of business, less the
estimated cost of completion and the estimated costs necessary to make the
sale.
Valuation Methods
1. First In First Out (FIFO)
2. Last in First Out (LIFO)
3. Average Cost Method (AVCO)
NB: FIFO and AVCO are used where the items of inventory are ordinarily
interchangeable. That is, prices keep on changing/fluctuating.
IAS 2: INVENTORIES
Disclosure
1. Accounting policies adopted for inventories;
2. Total carrying amount;
3. Amount of inventories carried out at NRV;
4. Amount of inventories recognized as expenses during the period;
5. Details of any circumstances that have led to the Wright off inventories to
NRV.
IAS 2: INVENTORIES
Example 2
The following relates to product A and B
Item Costs Notes
A 2000 • Items to be sold for $3500. No other costs are
anticipated
B 500 • Items to be sold for $600. Selling costs will be
$50 and a trade discount of 10% is offered on
selling price
Required
Determine the value of closing inventory.
IAS 2: INVENTORIES
Example 3
ABC ltd had the following transactions for the month of November:
1st Nov: Opening Inventory 600 units @ $2 each
5th Nov: Produced 800 units @ $3 each
10th Nov: Produced 1200 units @ $4 each
15th Nov: Sold 2200 units
20th Nov: Purchased 1800 units @ $5 each
25th Nov: Purchased 1600 units @ $6 each
30th Nov: Sold 3500 units
IAS 2: INVENTORIES
Example 3
Required
1. Calculate the value of closing inventory using FIFO, LIFO and Weighted
average method (Prepare a stock ledger card)
2. Find the gross profit if the selling price of stock was $12 each (Using FIFO
for closing inventory).
Example 4
XYZ ltd had the following transactions for the month of January 20X1:
1st Jan: Opening Inventory 600 units @ $3 each
5th Jan: Purchased 1800 units @ $4 each
IAS 2: INVENTORIES
Example 4
15th Jan: Sold 4200 units @ $6 each
21st Jan: Purchased 2100 units @ $6.5 each
30th Jan: Sold 5400 units @ $8 each
Required
1. Calculate the value of closing inventory using FIFO LIFO and weighted
average method (Prepare a stock
ledger card)
2. Find the gross profit (Using weighted average method for closing inventory)
IAS 16: PROPERTY PLANT AND EQUIPTMENT
Objective of IAS 16 PPE
To show the accounting treatment for property, plant and equipment
Introduction
IAS 16 PPE are tangible items that are:
1) Held for use in the production or supply of goods, for rental to others or for
administrative purposes;
2) Are expected to be used in more than one period. The principle issues in
accounting for PPE are:
• Recognition of assets
• Determination of carrying amount
• Depreciation charges and • Impairment losses
Definitions
1) Carrying Amount
It’s the amount at which an asset is recognized after deducting accumulated
depreciation and any impairment losses.
2) Costs
This is the purchase price of any asset ie the consideration given to acquire an
asset.
3) Depreciable Amount
This is the cost of an asset less its residual amount.
4) Depreciation
It is the systematic allocation of the depreciable amount of an asset over its
expected useful life or pattern of use.
Definitions
5) Residual Value
It’s the amount at which an asset can be obtained when there are no longer any
expected future returns from the asset.
6) Fair Value
This is the amount by which an asset can be exchanged for between two
knowledgeable and willing parties at an arm’s length transaction.
7) Recoverable Amount
This is the amount that is higher of:
a) Fair value of an asset less selling expenses
b) Value in use
Definitions
8) Impairment Loss
It’s a fall in the value of an asset so that its recoverable amount is less than its
carrying amount in the statement of financial position
Recognition of PPE
An item of PPE should be recognized when the following conditions are met:
1. It is probable that future economic benefits associated with the item will
flow to the entity;
2. The cost of the PPE can be measured reliably
NB: PPE can be recognized in the following ways:
1. Initial recognition (measurement);
2. Subsequent recognition (measurement
Recognition of PPE
Initial Recognition
PPE should be recognized at cost. The costs include the following:
1. The purchase price including import duties and non refundable purchase
taxes after deducting trade discounts;
2. Directly attributable costs of bringing an asset to its present location and
condition and necessary for it to be capable of operating.
These include:
• Cost of site preparation
• Initial delivery and handling costs
• Installation and assembly costs
• Costs of testing whether the asset is functioning properly
Recognition of PPE
Initial Recognition
• Professional fees
• Employee benefit costs
3. Estimated costs of dismantling and removing the item, and restoration of the
site on which the asset was located due to obligation incurred when the item
was acquired.
4. Borrowing costs (IAS 23): Only the part to be capitalized
Recognition of PPE
Initial Recognition
NOTE:
Once the initial cost of the asset has been established (to be Capitalized), then
any subsequent expenditure incurred on PPE should be expensed unless it
improves the condition of the asset beyond its previous performance.
IAS 16 gives the following examples of improvement to PPE:
a) Modification of an item of PPE to extend its useful economic life
b) Upgrading of machine parts to improve quality of output
c) Adoption of a new production process leading to large reduction in
operating costs
d) Extensions to a building.
Recognition of PPE
Subsequent Recognition
In attributing the value of PPE, a firm has a choice to make between keeping
an asset at its initial cost or at a carrying amount based on its revalued
amount. IAS 16 gives the following two alternatives;
1. Benchmark treatment/ cost model
2. Allowed alternative method/ Revaluation model
Recognition of PPE
1. Benchmark Treatment/ Cost Method
• In this method, an asset is carried at cost less accumulated depreciation less
any impairment losses.
• The adoption of the cost model does not mean that an asset is not revalued.
• Depreciation is charged from the time an asset is made available for use.
• IAS 16 does not prescribe the depreciation method to be adopted but
recommends 3 methods
1) Straight line method
2) Reducing Balance method
3) Sum of digits method/ machine hours method
2. Allowed Alternative Method/ Revaluation Method
In this method, PPE is carried at a revalued amount. The revalued amount is always
equivalent to the Fair Value at the date of revaluation.
Requirements for Revaluation of Assets
1) When an asset is revalued from a certain class, then all the assets in that class should
be revalued;
2) Revaluation should be carried out consistently over time eg after every 3- 5 years.
3) The revaluation surplus is included in equity and is shown as part of the shareholders
funds;
Recognition of PPE
4) A transfer from revaluation surplus account to the Retained Earnings should
be made in relation to excess depreciation (excess depreciation transferred to
RE in the SOCE)
Accounting for Revaluation
The following steps are used in the revaluation of assets:
1) Charge depreciation for the year if the asset is being revalued at the end of
the year. If the asset is being revalued at the beginning of the year, then move
to step two.
2) Transfer the accumulated depreciation to the cost account by;
Recognition of PPE
Dr. Accumulated Depreciation a/c xx
Cr. Asset a/c xx
3) Recognize the revaluation amount by putting it as a balance carried down in
the cost a/c on the credit side.
4) Balancing figure in the cost a/c is transferred to the revaluation a/c
Recognition of Excess Depreciation
This involves transferring the amount of revaluation surplus over the expected
remaining life of the asset by two ways:
1) By the difference in depreciation charged. Since the asset has been revalued
then depreciation charged is higher than if the asset was not revalued
2) Divide the revaluation surplus over the expected remaining life of the asset
De-recognition of PPE
The carrying amount of an item of PPE shall be derecognized when:
1) It is disposed.
2) There are no future economic benefits expected from its use or disposal.
NB:
• The gain or loss arising from de-recognition of an item of PPE shall be
included in the income statement in the year that it occurs.
• Depreciation is charged on the revalued amount
Gain/Loss = Disposal Proceeds – C.V of Asset (Rev Model). Goes to IS
Balance on RR relating to disposed off taken to RE
Disclosure requirements of IAS 16
1) The measurement basis used for determining the gross carrying amount
(Cost or Revaluation)
2) The depreciation method used (straight line, reducing balance or machine
hour methods)
3) The useful life or depreciation rate used
4) If revaluation was done, the method that was used for revaluation
5) A reconciliation of the movement of items of the PPE (Fixed Asset
movement schedule)
NB: In any question on IAS 16 always find the following
1) Carrying Amount
2) Recoverable amount (higher of FV and Value in use)
3) Impairment loss: when CA> RA. Which leads to revaluation downwards
4) No impairment = revaluation upwards
5) Cost of asset calculation
Example 1
Smart Ltd has recently purchased an item of plant from X Ltd the details of
which are as follows:
Basic list price of plant $240,000
Trade Discount 12.5%
Ancillary Costs:
• Shipping and Handling costs $2750
• Pre Production Testing $12500
3) Impairment loss: when CA> RA. Which leads to revaluation downwards
4) No impairment = revaluation upwards
5) Cost of asset calculation
Example 1 Con’t
• Maintenance contract for 3 years $24000
• Site Preparation costs:
o Electrical cable installation $14000
o Concrete Reinforcement $4500
o Own Labour costs $7500 $26000
Additional Information
Example 1 Con’t
1. Smart paid for the plant (excluding the ancillary costs) within 4 weeks of
order thereby obtaining an early settlement discount of 3%.
2. Smart had incorrectly specified the power loading of the original electrical
cable to be installed by the contractor and the cost of correcting this error was
$6,000 which was included in the above figure of $14,000.
3. The plant is expected to last for 10 years and at the end of this period, there
will be a compulsory cost of $15,000 to dismantle the plant and $3,000 to
restore the site to its original condition.
Required
Calculate the amount at which the plant will be measured at recognition (5
marks)
Example 2
ABC Ltd started construction on a building for its own use on 1st April 2007
and incurred the following costs.
$000
Purchase price of land 250,000
Stamp Duty 5,000
Legal fees 10,000
Site preparation and clearance 18,000
Materials 100,000
Labour (period 1st April 2007 – 1st July 2008 150,000
Architects fees 20,000
General overheads 30,000
Example 2 Con’t
The following information is also relevant:
• Materials costs were greater than anticipated. On investigation, it was found
that materials costing $10 million had been spoiled and therefore wasted and a
further $15 million was incurred as a result of faulty design work
• As a result of these problems, work on the building ceased for a fortnight
during October 2007 and it is estimated that approximately $9 million of the
labour costs relate to this period
• The building was completed on 1st July 2008 and occupied on 1st September
2008
Required: Calculate the cost of the building that will be included in tangible
NCA additions.
IAS 15: NON CURRENT ASSETS HELD FOR SALE AND
DISCONTINUED OPEERATIONS
OBJECTIVE
The objective of IFRS 5 is to enable accountants to disclose information about
discontinued operations and NCA held for sale
NON CURRENT ASSETS HELD FOR SALE
Definition: Are those assets which their carrying amount would be recovered
thru sale transaction rather than continuing in use.
The following conditions must be evident for the asset to be classified as held
for sale
1. The asset should be available for immediate sale
2. High level management should be committed to the plan and this is thru
communicating to the stakeholders eg they announce to employees about
retrenchment or redeployment; announce to suppliers of the discontinued
acquisition of raw materials
3. There must be an active programme to locate a buyer in which prices are
negotiated on an arm’s length principal.
4. The selling price must be almost or above the CA or FV of the asset
5. The plan should be completed within one year
6. It’s highly unlikely that the management are going to change the plan
NOTE:
1. Once the NCA are held for sale, they should be removed from IAS 16 and
be accounted for under IAS 2 (inventories). That is, they should now be
recognized at the lower of cost and NRV
2. When the NCA are classified as held for sale, we should stop depreciating
those assets.
3. All NCA should be disclosed separately in the face of the SOFP as follows:
Extract of SOFP
NCA A xx
B xx xx
CA C xx
D xx xx
xx
NCA Held for Sale:
E xx
F xx xx
Total Assets xx
Equity
Revaluation Reserve xx
NCA Held for Sale xx
DISCONTINUED OPERATION
Definition: it’s a component of business enterprise in the pursuant of a single
coordinated plan disposed off by whatever method entirely or thru a peace mill
basis or terminated through a bad omen.
Examples include:
1. Sale of a business line or a geographical area like a branch
2. Those subsidiaries that are acquired with the intention of selling them in the
near future.
NOTE:
1. The plan to dispose of the operation should be formal, detailed and
announced to the stakeholders
2. The comparative figures for discontinued operations should be prepared by
reinstating the figures regarding discontinued operations
DISCONTINUED OPERATION
ACCOUNTING FOR DISCONTINUED OPERATIONS
There are 2 methods that are used to account for discontinued operations in the
income statement
Method 1
Details Continuing Discontinued Total
$000 $000 $000
sales xx xx xx
Cost of Sales (xx) (xx) (xx)
Gross Profit xx xx xx
Income Tax (xx) (xx) (xx)
Profit After Tax xx xx xx
Method 2
Under this method, the discontinued operations are computed separately in the
notes to the FS and the results are combined to the continued operations after
the tax.
Example 1
On 1st January 2007, EAU Ltd. acquired a building for Frw 600,000. The
building had an expected useful life of 50 years.
On 31st December 2010, EAU Ltd. put the building up for sale. The criteria
necessary for classification as “Held-For-Sale” are deemed to be met.
On 31st December 2010, the building has an estimated market value of Frw
660,000 and selling costs of Frw 45,000 will be payable on disposal (including
Frw 15,000 tax charge).
Required
How should this building be accounted for?
DISCLOSURE REQUIREMENTS UNDER IFRS 5
• Description regarding the discontinuing operations eg declare whether it’s a
geographical area of business segment etc
• The date and nature of initial disclosure event
• The earliest date of completion
• The results of the discontinued operation either profits or loss after tax
• The cash flow statements regarding discontinued operation
IFRS 16: LEASES
Objective of IFRS 16 Leases
To prescribe for lessees and lessors the appropriate accounting policies and
disclosures to apply in relation to finance and operating leases.
Introduction
IFRS 16 was introduced to discourage business entities from off balance sheet
financing ie IFRS 16 was introduced to emphasize substance over form.
Off balance sheet financing: is the funding or refinancing of a company’s
operations in such a way that under legal requirements and traditional
accounting conventions some or all of the finance may not be shown in the
SOFP.
Substance over form: means transactions or events would be recorded in the
F.S son their financial or economic reality but not on their legal form.
Under the finance lease, the asset should charge depreciation and record the
asset in his books of account.
IFRS 16: LEASES
Types of Leases
Under IFRS 16, there are two types of Leases
1) Finance Lease
2) Operating Lease
Finance Lease: Occurs when the owner (lessor) transfers the risks and rewards incidental to
ownership to the lessee. The legal title may or may not be transferred.
The risks incidental to ownership include:
• Events that lead to loss of value of the asset eg depreciation, impairment losses etc.
• Maintenance costs incidental to the asset eg payment of insurance premiums, repairs,
• Renovations/restructuring mostly on buildings
Rewards incidental to ownership include:
• Use of the asset either individually or in combination with other assets to generate
economic benefits.
IFRS 16: LEASES
Qualification of Finance Lease
For an asset to qualify to be under finance lease, one of the following must be evident:
1) The lessor will transfer the ownership of the asset at the end of the lease period or lease
term;
2) The lessee has an option to purchase the asset at the end of the lease period and the amount
of payment is expected to be sufficiently lower than fair value of the assets at the end of the
lease term;
3) The lease term is for the major part of the economic useful life of the asset even if the title
isn’t transferred;
4) The discounted minimum lease payment (MLP) is greater than or equal to the FV of the
asset;
5) In the case of cancellation of the lease agreement, the party which cancels the agreement
bares the losses;
IFRS 16: LEASES
Qualification of Finance Lease
For an asset to qualify to be under finance lease, one of the following must be evident:
6) The asset is of a specialized nature and only the lessee who can use the asset without major
modifications;
7) Gains or losses from fluctuations of the FV are borne by the lessee;
8) Lessee has ability to continue the lease for a secondary period at a rent below the market
rate.
Operating Lease
If an asset does not qualify to be a financial lease, then it’s an operating lease ie if it
does not meet the above mentioned requirements.
NB: in case of land, even if it qualifies for the above conditions, it will be treated as
an operating lease unless the title is expected to be passed at the end of the lease term.
IFRS 16: LEASES
Accounting Treatment for Leases
Finance Lease
When accounting for finance lease, we use substance over form concept ie the business entity
which is using the asset should charge depreciation even if the legal title has not passed to it.
Under finance lease in the initial recognition, we recognize the assets in our books and the
amount we are going to pay.
The principle amount is recognized as a financial obligation (NCL).
When accounting for leases, that are finance lease it’s important to first get the financial
charge which is calculated as follows:
Minimum Lease payments (MLP) xx
Less: Cost of the asset (xx)
Finance charge xx
IFRS 16: LEASES
The finance charge computed is either charged or recognized in the IS under 3 methods as
follows;
1) Actuarial Method
2) Sum of the year Digits Method
3) Straight Line Method
Finance lease is accounted for in both the books of the lessor and also in the books of
the lessee as follows:
Books of the Lessee (Receiver of the Asset)
The lessee is going to recognize the asset in the books of accounts and the principle
amount of the lease payment as a financial obligation.
IFRS 16: LEASES
Dr. Leased Asset a/c xx

Cr. Financial Obligation xx
The finance charge paid is expensed in the IS computed using one of the three methods.
In the IS of the lessee, depreciation is charged on the asset in accordance with IAS 16.
Books of the Lessor
Lessor is going to derecognize the asset from his books and recognize the principal amount
receivable under finance lease in the current assets (accounts receivables).
Dr. Accounts Receivable xx
Cr. Assets xx
The rental income received is recognized as income after the gross profit in the IS.
IFRS 16: LEASES
NB: it is important to know when the rental income of the finance charge is paid since it can
either be paid in arrears or in advance.
Payment in Arrears
In this method, the lessee derives the benefits to the asset and pays the rent at the end of the
financial year.
Payment in Advance
In this method the lessee pays for the rent at the beginning of the period
Example 1;
Company X Limited acquires an asset under a finance lease. The asset, with an expected
useful life of 5 years, has a cash price of RWF10,900. The lease is for five years, with an
annual payment of RWF3,000 in arrears. The implicit rate of interest in the lease is 12%.
Calculate the value at which the asset will be initially recorded in the accounts.
IFRS 16: LEASES
Example 2;
Company Z Limited acquired a machine by way of a lease agreement. The fair value of the
machine was RWF15,850. Estimated life of the machine is 4 years.
The terms of the lease are:
Annual lease rental of RWF5,000 payable in arrears each year for 4 years. The implicit
interest rate is 10%.
Required
Calculate the finance charge and the closing balance of the liability (using the actuarial
method)
IFRS 16: LEASES
Example 3
Company Y Limited acquires a machine under a finance lease agreement. The machine has a
cash price of RWF6,000.
The terms of the lease are:
Deposit RWF900 followed by three annual payments of RWF2,100 per annum in arrears. The
implicit rate of interest is 11.35%.
Required:
Calculate the finance charge and the closing balance of the liability using
a) Actuarial method
b) Sum of digits method
c) Show the records in extract financial statements
IFRS 16: LEASES
Straight Line Method
The finance charge is divided equally over the useful life of the asset.
SALE AND LEASE BACK TRANSACTIONS
The sale and lease back transactions should be accounted for under substance over
form.
Business entities can sell their assets and lease them back as either:
1) Operating Lease
2) Finance Lease
Operating Lease
Under the operating lease, the money received from the buyer is recognized as revenue and
the finance charge paid in each year is recognized as a financial cost ie charged to the IS.
IFRS 16: LEASES
Finance Lease
The money received from the sale of the asset should not be recognized as revenue
(substance over form) but should be recognized as secured loans, security (collateral) being
the asset.
The finance charge of the lease should be recognized as finance interest on the loan
The business entity should not de-recognize the asset but should continue showing the
asset in the SOFP and continue charging depreciation over the useful life of the asset.
NB: introduction of IFRS 16 under sale and lease back was to stop the habit that the
business entities had of financing their business outside the balance sheet (off balance
sheet financing).
IFRS 16: LEASES
Disclosures under IFRS 16
Finance Lease (lessees)
1) Carrying amount of the asset
2) Reconciliation between total MLP and their present values
3) Contingent rent recognized as an expense
4) General description of the significant leasing agreement including contingent rent
provisions, renewal or purchase options and restrictions imposed on dividends, borrowings
etc.
Operating Leases (lessees)
1) Amount of MLP
2) Total minimum sub-lease income under non cancellable sub leases
3) Lease and sub lease payments recognized in income for the period
4) Contigent rent recognized as an expense
IAS 23: BORROWING COSTS
Objective of IAS 23
To prescribe the accounting treatment for borrowing costs.
Introduction
Borrowing costs include the following
1) Interests on bank overdrafts and borrowing
2) Amortization of discounts or premiums on borrowings
3) Finance charges on finance lease
4) Exchange differences on foreign currency borrowings where the
differences
are regarded as an adjustment on interest costs
Recognition of Borrowing Costs
• Borrowing costs must be capitalized as part of cost of an asset for only qualifying
assets.
• Qualifying Asset: Is an asset which takes a substantial period of time to get ready for its
intended use or sale e.g. investment property, manufacturing plant, power generating facility
etc.
• Other borrowing costs (not qualifying) are recognized as an expense
Commencement of Capitalization (Start)
Capitalization of borrowing costs should commence when the following conditions are met.
1) Expenditure for the asset is being incurred
2) Borrowing costs are being incurred
3) Activities that are necessary to prepare asset for its intended use or sale are in progress
Cessation of Capitalization (Stop)
Capitalization of borrowing costs should stop when;
1) Substantially all the activities necessary to prepare the qualifying asset for its intended use
or sale are complete (anything after that is treated as an expense).
2) Construction is suspended. For example due to industrial dispute
Disclosure of IAS 23 Borrowing Costs
1) Amount of Borrowing costs capitalized during the period
2) Capitalization rate used
NOTE
• If the borrowed funds are used in other investments before being capitalized, we have to
reduce the interest payable by the returns from those investments. The net amount is what is
capitalized.
Example1
On 1 June 2010, SH ltd commenced construction of new factory that is expected to take 3
years to complete. It is being financed by a three year term loan of frw 6million (taken out at
the start of constriction) the loan carries a fixed interest rate of 9% pa, and issue cost of 1.5%
of the loan were incurred on the loan. During the year frw 57,000 can be earned from the
temporary investment of this borrowing. The company’s year end is 31st Dec 2010
Required:
How much interest must have capitalized under IAS 23 for the year ended 2010 (You may
use straight line method to amortize the issue costs)
CHAPT 4: IAS 7: STATEMENT OF CASH FLOWS
Objective of IAS 7
The objective of IAS 7 is to require the presentation of information about the historical
changes in cash and cash equivalents of an entity by means of a statement of cash flows,
which classifies cash flows during the period according to operating, investing, and financing
activities.
Introduction
As much as it is important for a company to make profits, it must also generate cash in order
to facilitate continuity of its operations. The statement of cash flow therefore helps to show
the cash generated and issued.
Accounting concepts of accruals and matching are normally used to compute a figure
which shows additional wealth created for the business owners during the accounting
period (profits). Profits represent an increase in net assets in the statement of financial
position during the accounting period.
Presentation of the statement of Cash Flow
Cash flows must be analyzed into operating, investing and financing activities.
Key principles specified by IAS 7 for the preparation of a statement of cash flows are
as follows:
1. Operating activities are the main revenue-producing activities of the entity that are not
investing or financing activities, so operating cash flows include cash received from
customers and cash paid to suppliers and employees.
2. Investing activities are the acquisition and disposal of long-term assets and other
investments that are not considered to be cash equivalents.
3. Financing activities are activities that alter the equity capital and borrowing structure of
the entity.
4. Cash means the cash in hand and deposits available on demand e.g current a/c.
5. Cash Equivalent these are short term highly liquid investments that are readily
convertible to known amounts and subject to insignificant risk of changes in value e.g
treasury bills.
NOTE:
1. Interest and dividends received and paid may be classified as operating, investing, or
financing cash flows, provided that they are classified consistently from period to period
2. Cash flows arising from taxes on income are normally classified as operating, unless they
can be specifically identified with financing or investing activities.
3. For operating cash flows, the direct method of presentation is encouraged, but the indirect
method is acceptable.
Proforma of the Statement of Cash Flow:
ABC Ltd Statement of Cash Flow for the year ended XXXX
Cash Flow from Operating Activities: $ $
Cash generated from Operations xx
Less: Interest Paid (xx)
Less: Dividends Paid (xx)
Less: Income Tax Paid (xx)
Net Cash from/used in Operating Activities xx/(xx)
Cash Flow from Investing Activities:
Purchase of PPE (xx)
Proceeds from sale of NCA xx
Interest Received xx
Dividends Received xx
Proceeds on issue of shares xx
Repayment of loans (xx)
Net Cash from/ used in Investing Activities xx/(xx)
Cash Flow from Financing Activities:
Net Increase/ Decrease in Cash and Cash Equivalent xx/(xx)
Add: Cash and Cash Equivalent at the Beginning of the Period xx
Cash and Cash Equivalent at the end of the Period xx
Cash Flow from Operating Activities
There are two methods of calculation the cash generated from operations:
• Direct Method
• Indirect Method
1. Direct Method
The direct method shows each major class of gross cash receipts and gross cash payments.
The operating cash flows section of the statement of cash flows under the direct method
would appear something like this:
Cash receipts from customers xx
Less: Cash paid to suppliers xx
Less: Cash paid to employees xx
2. Indirect Method
The indirect method adjusts accrual basis net profit or loss for the effects of non-cash
transactions. Reconciles the profit before tax (as reported in the income statement).
The operating cash flows section of the statement of cash flows under the indirect
method would appear something like this:
Profit Before Tax xx
Add: Finance Costs xx
Less: Investment Income (xx)
Add: Depreciation charge xx
Add: Amortization of Goodwill (if any) xx
Loss/Profit on Disposal of NCA xx/(xx)
Increase/Decrease in Inventories (xx)/xx
Increase/ Decrease in Receivables (xx)/xx
Increase/ Decrease in Payables xx/(xx)
Cash Generated from Operations xx
NB: Interest expense/ finance cost is added back because it is not part of the cash generated
from operations while Depreciation is a non cash expense.
Example 1: Indirect Method
XYZ Ltd has the following SOFP and IS.
Statement of Financial Position
2006 2005
$000 $000
Non Current Assets 1048 750
Accumulated Depreciation (190) (120)
Net Book Value 858 630
Current Assets
Inventories 98 105
Trade Receivables 102 86
Dividends Receivable 57 50
Cash 42 18
Total Current Assets 299 259
Total Assets 1157 889
Capital and reserves
Share Capital 200 120
Share Premium 106 80
Revaluation Reserve 212 12
Accumulated Profits 283 226
Total C and R 801 438
Non Current Liabilities
Loan 200 300
Current Liabilities
Trade Payables 47 52
Dividends Payable 30 27
Interest Accrued 3 5
Tax 76 67
Total C. L 156 151
Total Capital and Liabilities 1157 889
Income statement for the year ended 31st December, 2006.
$000 $000
Sales 1,100
Cost of sales (678)
Gross Profit 422
Less: Operating Expenses (309)
Operating Profit 113
Add: Investment Income
- Interest 15
- Dividends 57 72
Less: Finance Charges (22)
Less: Income Tax (71)
Net Profit for the year 92
Additional Information:
1. Operating expenses include a loss on disposal of Non Current Assets of $5,000.
2. During the year, plant which had originally cost $80,000 and depreciation of $15,000 was
disposed off.
Required:
1. Calculate the cash generated from operations using indirect method
2. Prepare XYZ Statement of Cash Flow for the year ended 31st December, 2006.
IAS 8: ACCOUNTING POLICIES, CHANGES IN
ACCOUNTING ESTIMATES AND ERRORS
ACCOUNTING POLICIES
Accounting policies are the specific principles, bases, conventions, rules and practices
applied by an entity in preparing and presenting financial statements. IAS 8 requires an entity
to select and apply appropriate accounting policies, complying with IFRSs and interpretations
to ensure that the financial statements provide information that is:
1. Relevant
2. Reliable
• In that they represent faithfully the results of financial position of an entity
• Reflect the economic substance of events and transactions and not merely
there legal form
• Are neutral. That is free from bias
• Are prudent
• Are complete in all material aspects.
Changing Accounting Policy
The general rule is that accounting policies are normally kept the same from period
to period to ensure comparability of the financial statements overtime. IAS 8 requires
accounting policies to be changed only if the change:
1. Is required by IFRS
2. Will result in a reliable and more relevant presentation of events or transactions
A change in accounting policies occurs if there is a change in:
1. Recognition: Example: an expense is now recognized rather than an asset
2. Presentation: Example: depreciation is now included in cost of sales rather
than administrative expenses
3. Measurement: Example: stating assets at replacement costs rather than
historical cost
Accounting for a change in Accounting Policies
The required accounting treatment is that:
1. The change should be applied retrospectively with an adjustment to the opening balance of
the retained earnings of SOCE
2. Comparative information should be restated unless it is impracticable to do so
3. If the adjustments to opening RE can’t be reasonably determined, the change should be
adjusted prospectively
ACCOUNTING ESTIMATES
An accounting estimate is a method adopted by an entity to arrive at estimated amounts for
financial statements. Most figures in the financial statements require some estimation:
• The exercise of judgment based on the latest information available at the time
• At a later date, estimates may have to be revised as a result of the availability of new
information, more experience or subsequent developments
Changes in Accounting Estimates
The requirements of IAS 8 are:
1. The effects of a change in accounting estimates should be included in the income
statement in the period of the change and if subsequent periods are affected, in those
subsequent periods
2. The effects of the change should be included in the same income or expense
classification as was used for the original estimates
3. If the effect of the change is material, its nature and amount must be disclosed
Examples of Changes in Accounting Estimates
These include changes in:
1. The useful life of Non Current Assets (NCA)
2. The residual value of NCA, 3. The method of depreciation of NCA, 4. Warranty
provisions based on more up to date information
NOTE.
• If NCA has a depreciable amount of $5000 to be written off over 5 years, different
depreciation methods such as straight line method, reducing balance, machine hours
method, sum of digits method all represent different estimation techniques
• The choice of the method of depreciation would be the estimation technique, where as the
policy of writing off the cost of NCA over their useful life would be the accounting policy
• That is, the estimation technique therefore implements measurement aspect of accounting
policies
ERRORS
Errors are the omissions or misstatements in the financial statements
Prior Period Errors
Are omissions and misstatements in the financial statements for one or more prior periods
(past) arising from a failure to use the information that:
1. Was available when the financial statements for those periods were authorized for issue
2. Could reasonably be expected to have been taken into account in preparing those
financial statements.
Such errors include:
• Mathematical mistakes, mistakes in applying accounting policies, over sights and fraud
• Current period errors that are discovered in that period should be corrected before the
financial statement are authorized for issue
ERRORS
NOTE
1. Changes in accounting policies should be corrected retrospectively
2. Changes in accounting estimates should be corrected prospectively
3. Errors should be corrected retrospectively
Example 1
During 2001, a company discovered that certain items had been included in inventory
at 31st December, 2000 at a value of $ 2.5 million but they had in fact been sold
before the year end. The original figures reported for the year ending 31st December
2000 and the figures for the current year 2001 are as shown below:
2001 2000
$000 $000
Sales 52,100 48,300
Cost of Sales (33,500) (30,200)
Gross Profit 18,600 18,100
Tax (4,600) (4,300)
Net Profit 14,000 13,800
Example 1
The cost of goods sold in 2001 includes the $2.5 million error in opening inventory.
The Retained Earnings at 1st January 2000 were $ 11.2 million. (Assume that the
adjustments will not have an effect on tax charge).
Required
Show the 2001 income statement with comparative figures and retained earnings for each
year
Example 2
During 2007 ABC Ltd discovered that certain items had been included in inventory at 31st
December, 2006 valued at $4.2 million which had in fact been sold before the year end.
The following figures are available for the 2 years.
2006 2007
$000 $000
Sales 47,400 67,200
Cost of Sales (34570) (55,800)
Profit before Tax 12,830 11,400
Income Tax (3880) (3,400)
Profit for the Year 8950 8000
Retained earnings at 1st January 2006 were $13 million. Cost of sales for 2007 includes
$4.2 million in opening inventory error. The income tax rate was 30% for 2006 and 2007.
No dividends have been declared or paid.
Required
Show statement of profit or loss for 2007 with 2006 comparative and Retained Earnings
IAS 10: EVENTS AFTER THE REPORTING PERIOD
When the business entity prepares the financial statements, before they are presented to the
users of the financial statements, they must be audited by an independent body ie certified
public accountants known as auditors.
Their work is to ascertain or form an opinion that the financial statements presented to them
are prepared in all material aspect in accordance with IFRSs and show the true and fair
view.
The period when the auditors are performing their work, business transactions are occurring
which may affect the financial statements already prepared.
Under IAS 10 there are two important dates which marks the events after the reporting
period:
1. The date of the approval which is ordinarily the balance sheet date.
2. The date when the financial statements are authorized ordinarily this is the date of the
auditor’s report
The events which are happening during this period can be classified as either
1. Adjusting events
2. Non adjusting events
Adjusting events
Are those events which happen during the period and affect the financial statements which
have already been prepared. Examples include:
• Decision of a court case
• One of the customers being declared bankrupt
• Nature of our inventory
• Impairment of our assets
• Fraud and errors discovered by the auditors etc
Accounting Treatment
These amounts are adjusted to the financial statements before they are authorized.
Non Adjusting Events
Are the events which occur during the period but do not affect the financial statements
already prepared but will have great impact on the financial statements for the current
period and future periods. Examples include:
• Destruction of company building by fire, earthquakes etc
• Purchase of a significant noncurrent asset
• Announcement of discontinued operations during the period
• Announcement of the sale of some of the noncurrent assets
• Announcement of restructured and the organization of the business entity during the
period etc.
This must be disclosed in the notes accompanying the financial statements. Managers must
ensure that the users of the financial statements understand the effect they have in the
current year and future periods.
Example 1
Shortly after the reporting date a major credit customer of a company went into liquidation
because of heavy trading losses and it is expected that little or none of the $12,500 debt will
be recoverable. $10,000 of the debts relates to sales made prior to the year end; $2,500
relates to sales made in the first two days of the new financial year.
In the 20X1 financial statements the whole debt has been written off, but one of the
directors has pointed out that, as the liquidation is an event after the reporting date, the debt
should not in fact be written off but disclosure should be made by note to this year’s
financial statements, and the debt written off in the 20X2 financial statements.
Required: Advise whether the director is correct.
IAS 12: INCOME TAX
OBJECTIVE OF IAS 12
The objective is to prescribe the accounting treatment for the income taxes
INTRODUCTION
In almost all countries, business entities are taxed on trading income. The principle of
charging/determining the income tax under IAS 12 is to determine the current tax and
future tax.
Income Tax is a component of three elements which include the following:
1. Estimate for the Year xx
2. Under/Over Provision (Last Year) xx/(xx)
3. Transfer to/from Deferred Tax a/c xx/(xx)
Income Tax Expense xx
IAS 12: INCOME TAX
1) ESTIMATE FOR THE YEAR
In many countries, the exact tax expense is not known until after the end of the year when
the financial statements have been audited and authorized for use. Therefore, business
entities have to make estimates for Income Tax expense to make the financial statements
complete. These estimates are made by the management based on the tax paid last year plus
other adjustments regarding the company’s performance in the current year.
2) UNDER OR OVER PROVISION
Due to the estimates above, there could be a variance between the estimates and the actual
tax paid. If the amount which was charged in the income statement is higher than the actual
tax paid, it will result in over provision.
While if the amount that was charged in the income statement is less than the actual tax
paid, it results in under provision.
Adjustments to over or under provisions are in accordance with IAS 8: Accounting Policies,
Changes in Accounting Estimates and Errors (prospective application). Prospective
application is correction made this year and the year to come.
IAS 12: INCOME TAX
Example 1
The tax estimate for the year ending 2006 was $200,000. The estimate for the year ending
2007 was $250,000. Actual tax for last year (2006) was $235,000 which was paid in 2007.
Required
Show the extract of the Income Statement and the Statement of Financial Position for the
year ended 2006 and 2007.
Example 2
The estimate for the year ending 2006 was $200,000 and the estimate for the year ending
2007 was $250,000. Actual tax for last year (2006) which was paid in 2007 was $180,000.
Required
Show the extract of the IS and SOFP for year 2006 and 2007
IAS 12: INCOME TAX
3) DEFERRED TAX
Deferred tax simply means future tax. That is, the future tax payable or deductible.
Deferred tax normally results from the difference between accounting profit (Capital
Allowance) and Taxable profit (Depreciation).
NB:
• F7 only deals with deferred tax on Non Current Assets
• Under the Accounting Profit, we charge depreciation on PPE and on taxable profit we
receive allowances from the tax authority known as capital allowance or capital
deductions.
• Due to the difference between Capital Allowance and the Depreciation Charge, it results
to temporal difference when the balance sheet approach is used while under the
Income Statement Approach it results to timing difference (Depreciation on NCA –
Capital Allowance).
IAS 12: INCOME TAX
• This amount should be multiplied by the tax rate and accounted for in the deferred tax
account.
• The temporal difference can result to deferred tax asset or deferred tax liability.
Example 1
The following information relates to X Ltd
Cost of the Asset $40,000
Depreciation 20% on cost
Residual value: NIL
Capital Allowance: 1st Year 50%, 2nd -5th Year 12.5%
Tax Rate 30%
Profit before tax in each year $80,000
Required
Compute the deferred tax using; 1. Balance sheet approach and Income Statement approach
IAS 12: INCOME TAX
Example 2
Cost of Asset $500,000
Depreciation 25%
Residual value NIL
Capital Allowance: 1st Year 40% and 2nd – 4th Year 20%
Tax Rate 30%
Profit before tax each year $2,000,000
Required
Compute the deferred tax using
1. Balance sheet approach
2. Income Statement approach
IAS 12: INCOME TAX
Approach 1: Balance Sheet Approach
The important column in the balance sheet approach is the last column and any increase
means a charge in the income statement which is accounted for in the deferred tax account.
That is, transfer from the IS to the deferred tax account.
In case of an increase:
Dr. Income Statement xx
Cr. Deferred Tax xx
Any decrease in the column means a reduction in the charge in the IS regarding income
taxes. That is, transfer from deferred tax account to the IS.
Decrease:
Dr. DT xx
Cr. P&L xx
IAS 12: INCOME TAX
In the balance sheet, the amount in the last column indicates the balance carried forward.
Example 1 and 2 Above
Approach 2: Income Statement Approach
In this method we look at the timing difference. That is, difference between capital
allowance and depreciation charged in the IS each year. The difference is then multiplied by
the tax rate to get the deferred tax.
Example 1 and 2 above
The important row is the last row in this case (IS approach). If the amount is negative, it
means a charge in the IS which is accounted for in the deferred tax account. That is, transfer
from the IS to the deferred tax by:
Dr. Income Statement xx
Cr. Deferred Tax xx
If the amount is positive:
Dr. Deferred Tax xx and Cr. Income Statement xx
IAS 12: INCOME TAX
METHODS OF ACCOUNTING FOR DEFERRED TAX
1. Nil / Flow Through Provision
2. Full Provision
3. Partial Provision (Not Tested)
NIL/FLOW - THROUGH PROVISION
Under this method the tax liability recognized is expected to be tax liability payable for the
period. That is, we don’t make provisions for deferred tax.
Advantages of Nil Provision
1. It is straight forward to calculate as we account for only the real tax payable
2. It is the best method to apply where there is remoteness of the reversal of the deferred tax
3. The full provision method gives the wrong information about the gearing of the company
where as this method does not overstate the gearing of the company
IAS 12: INCOME TAX
METHODS OF ACCOUNTING FOR DEFERRED TAX
Disadvantages of Nil Provision
1. It leads to large fluctuations in the tax charge over the years and this makes it difficult for
the company to estimate the income tax expense
2. It breaches both accruals basis concept and prudence concept
3. Leads to overstatement of profits in the 1st year which can lead to wrong decision
making by management.
FULL PROVISION
Under this method, the provisions are made for effects of temporal difference. That is, the
method recognizes that the timing difference at the end of each balance sheet date will have
effect on future tax payments.
Advantages of Full Provision
1. It complies with both accruals and prudence concept
IAS 12: INCOME TAX
2. There is no room for manipulation of the financial statements regarding the deferred tax
3. Compared with the partial provision method, the method of calculating the deferred tax is
not subjective but its objective.
Disadvantages of Full Provision
1. In the case where deferred tax has remoteness of reversing, the provisions accumulate
year in year out
2. It gives wrong impression about the gearing of the company
3. By using the actual tax payable in the future, it enables the company to set aside the
actual amount payable in the future. In this case partial provision method is more
recommendable.
PARTIAL PROVISION
Under this method, deferred tax is provided to the extent that its expected to be paid in the
foreseeable future. That is, at its best it gives the actual amount payable in the future but its
computation is hardly subjective.
NB: the advantages of full provision are the disadvantages of partial provision and vice
IAS 12: INCOME TAX
OTHER METHODS OF ACCOUNTING FOR DEFERRED TAX
1. Deferred Method
In this method we use the balance sheet approach and we account for the deferred tax on all
temporal differences without making adjustments to the deferred tax. It is close to the full
provision method.
2. Liability Method
In this method we use the balance sheet approach but when computing the deferred tax we
only compute the temporal difference which will reverse for the foreseeable future.
CONCLUSION
IAS 12 recommends the full provision under the balance sheet approach using the liability
method when appropriate.
DISCLOSURE
1. Current Tax and Deferred Tax chargeable
2. An explanation of the relationship between taxable profit and accounting profit.
IAS 12: INCOME TAX
OTHER METHODS OF ACCOUNTING FOR DEFERRED TAX
3. Changes in tax rates
4. Tax relating to discontinued operations
IAS 20: ACCOUNTING FOR GOVT GRANTS AND
DISCLOSURE OF GOVT ASSISTANCE
Objective of IAS 20
The objective of IAS 20 is to prescribe the accounting for, and disclosure of, government
grants and other forms of government assistance.
Scope of IAS 20
IAS 20 applies to all government grants and other forms of government assistance.
However, it does not cover government assistance that is provided in the form of benefits in
determining taxable income. It does not cover government grants covered by IAS 41
Agriculture, either.
The benefit of a government loan at a below-market rate of interest is treated as a
government grant.
Recognition of Government Grants
A government grant is recognized at Fair Value only when the following conditions are
met;
1. The entity will comply with any conditions attached to the grant and
2. The grant will be received.
NB. The grant is recognized as income over the period necessary to match them with the
related costs, for which they are intended to compensate, on a systematic basis.
Accounting Treatment for Government Grant
There are two approaches for accounting for Government Grants
1. Capital Approach
2. Income Approach
a) Capital Approach
Under this approach the amount is credited immediately to the shareholders funds by:
Dr. Bank/Asset a/c xx
Cr. Equity a/c xx
That is, the amount or assistance from the government is recognized immediately.
Advocates of Capital Approach argue as follows:
1. The amount/assistance received from the government is a form of financial device with
no repayment requirement
2. The amount received from the government is not earned, but is a form of incentive to the
business entity. Since it is not earned, it should not be accounted for thru the income
statement.
b) Income Approach
Under this approach, the amount received from the government is accounted for in the FSs
thru the IS. That is, the amount received is deferred to the deferred income a/c and
amortized in the IS over the useful life of the asset or the period on which the assistance is
granted;
Initially:
Dr. Bank a/c xx
Cr. Deferred Income a/c xx
In the Subsequent period:
Dr. Deferred Income a/c xx
Cr. Income Statement a/c xx
In the Subsequent period:
Dr. Deferred Income a/c xx
Advocates of the Income Approach argue as follows:
1. The money received is not from shareholders and therefore should not be credited
directly to the shareholders funds
2. The amount received in form of government assistance is earned thru compliance with
the set of conditions by the government
3. Government grant is a form of a fiscal policy like income taxes and should be treated the
same way as the Income Tax. That is, thru the IS
Types of Government Grants
1. Those relating to Assets
2. Lump sum compensation of Operating Expenses
1. Those Relating to Assets
In this method, the govt grants are accounted for in two ways:
a) When the Grant is Deferred to Deferred Income a/c and amortised over the useful life of
the asset thru the IS (Deferred Income Approach)
b) When the carrying amount of the asset is reduced by the amount of Govt Grant Received
by:
Dr. Bank a/c xx
Cr. Asset a/c xx
That is, the impact of the Govt Grant is through reduction of the Depreciation charged.
NB. IAS 20 recommends creation of Deferred Income a/c. This is because when we reduce
the carrying amount of our assets, we will be giving wrong information about the asset in
the F.S (we will be unfaithful)
2. Lump Sum compensation of Operating Expenses
If the amount is received, to compensate the operating expenses which have already been
incurred or for financial assistance in the current period, they are recognized immediately in
the IS as income;
Dr. Bank a/c xx
If the lump sum is received to cater for future periods of operating expenses, we create
deferred income a/c in which the amount is amortized over the period in which the grant is
received
NB. IAS 20 recommends the Income Approach over Capital Approach
Example:
The Ministry of Infrastructure transfer title of a building to B. Limited, as part of an overall
package to encourage the development of a research and development facility to aid the
mining industry. The building has a fair value of RWF100,000.
Note that in circumstances where a non-monetary asset is transferred, an alternative
sometimes used is to record both the asset and the grant at a nominal amount.

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