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TeCHniCal g n i S i w o l l l l i o w f d l o l i o g w d f o o o T g n g e m n i e R R u u S S a a e e m m f H o C S a y e a w w H o T H o d b n S a . , w w y e o R i v
IMPAIRMEN
RelevanT To aCCa qualifiCaTion papeRS f7 Following the revisions to IFRS 3, Business Combinations and Combinations and IAS 27, Consolidated and Separate Financial Statements in Statements in January 2008, there are now two ways of measuring the goodwill that arises on the acquisition of a subsidiary and each has a slightly different impairment process. This article discusses and shows both ways of measuring goodwill following the acquisition of a subsidiary, subsidiary, and how each measurement of goodwill is subject to an impairment review. review.
H t cct The traditional measurement measurement of goodwill on the acquisition of a subsidiary is the excess of the fair value of the consideration given by the parent over the parent’s parent’s share share of the fair value of the net assets acquired. This method can be referred to as the proportionate method. It determines only the goodwill that is attributable to the parent company c ompany.. The new method of measuring goodwill goodwill on the acquisition of the subsidiary is to compare the fair value of the whole of the t he subsidiary (as represented represented by the fair value of the consideration given by the
Rr 1 Calculate the goodwill arising arising on the of High on a proportionate basis. 2 Calculate the gross goodwill arisin acquisition of High, ie using the fair v the NCI.
St 1 The proportionate goodwill arising is ca by matching the consideration that the given, with the interest that the parent the net assets of the subsidiary, subsidiary, to give of the subsidiary that is attributable attributable to Parent’s Parent’s cost of investment investment at the fair value of consideration given Less the parent’s parent’s share of the fair value value of the net assets of the subsidiary acquired (80% Goodwill attributable to Sign up to vote on this title the parent
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2 The gross goodwill arising is c alculate matching the fair value of the whole b
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STudenT aCCounTanT 08/2009 Studying Papers F7 or P2? prrc ojcts 10 11 r
OF GOODWILL asset in the group accounts, and as we shall see be subject to an annual impairment review. In the event that there is a bargain purchase, ie negative goodwill arises, then this is regarded as a profit and immediately recognised in income.
bsc rcs rt An asset is impaired when its carrying value exceeds the recoverable amount. The recoverable amount is, in turn, defined as the higher of the fair value less cost to sell and the value in use; where the value in use is the present value value of the future cash flows. An impairment review calculation looks like this. This is the net book value, ie the figure that the asset is currently recorded at in the accounts.
Impairment review Carrying value of the asset X > Recoverable amount (X)
This is the estimate of how much cash
e l b a Csr rt r R A company has an asset that has a c e v of $800. The asset has not been r asset is subject to an impairment re o e C H asset was sold then it would sell for e T there would be associated associated selling co R f (The fair fair value less costs to sell of e o therefore $600.) The estimate of H of the future cash flows to be genera T R e asset if it were kept kept is $750. (This is S d H use of the asset.) e g . e i e Rr H C S x e u Determine the outcome of the impair e H i e T n St u S e i l T u An asset is impaired when its carryin a l exceeds the recoverable amount, whe v n a recoverable recoverable amount is the higher of u v less costs to sell and the value in use g o e with value lesstitle cost to sell of n upatofair vote on this i m H Sign value in use of $750 it both follows y a T aUseful usefulto minimise lo Notsense R makes common R e d recoverable recoverable amount will be the higher a l n ie $750. C b a
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STudenT aCCounTanT 08/2009 Studying Papers F7 or P2? prrc ojcts 10 11 r
OF GOODWILL asset in the group accounts, and as we shall see be subject to an annual impairment review. In the event that there is a bargain purchase, ie negative goodwill arises, then this is regarded as a profit and immediately recognised in income.
bsc rcs rt An asset is impaired when its carrying value exceeds the recoverable amount. The recoverable amount is, in turn, defined as the higher of the fair value less cost to sell and the value in use; where the value in use is the present value value of the future cash flows. An impairment review calculation looks like this. This is the net book value, ie the figure that the asset is currently recorded at in the accounts.
Impairment review Carrying value of the asset X > Recoverable amount (X)
This is the estimate of how much cash
e l b a Csr rt r R A company has an asset that has a c e v of $800. The asset has not been r asset is subject to an impairment re o e C H asset was sold then it would sell for e T there would be associated associated selling co R f (The fair fair value less costs to sell of e o therefore $600.) The estimate of H of the future cash flows to be genera T R e asset if it were kept kept is $750. (This is S d H use of the asset.) e g . e i e Rr H C S x e u Determine the outcome of the impair e H i e T n St u S e i l T u An asset is impaired when its carryin a l exceeds the recoverable amount, whe v n a recoverable recoverable amount is the higher of u v less costs to sell and the value in use g o e with value lesstitle cost to sell of n upatofair vote on this i m H Sign value in use of $750 it both follows y a T aUseful usefulto minimise lo Notsense R makes common R e d recoverable recoverable amount will be the higher a l n ie $750. C b a
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TeCHniCal
As the asset has never been revalued, the loss has to be charged to income. Impairment losses are non-cash expenses, like depreciation, so in the cash flow statement they will be added back when reconciling operating profit to cash generated from operating activities, just like depreciation again. Assets are generally subject to an impairment review only if there are indicators indicators of impairment. IAS 36, Impairment of Assets lists examples of circumstances that would trigger trigger an impairment review. External sources ¤ market value declines ¤ negative changes in technology, markets, economy, or laws ¤ increases in market interest rates ¤ company share price is below book value Internal sources ¤ obsolescence or physical damage ¤ asset is part of a restructuring or held held for disposal ¤ worse economic performance than expected
e R a S e e R l When looking to assign the impairme e p particular assets within the cash genera H m unless there is an asset that is specifica T a it is goodwill that is written off first, wit f i x . e w balance being assigned on a pro rata ba y The goodwill goodwill arising on the acquisitio l S e i subsidiary is subject to an annual impa n T v i e review. This requirement ensures that th o S l R of goodwill is not being overstated overstated in th S T accounts. Goodwill is a peculiar w asset in e n cannot be revalued so any impairment i T l e v S e automatically be charged against incom e S m R a R is not deemed to be systematically con T f i or worn out thus there is no requiremen n o a p systematic amortisation. e m m T i prrtt prrt t th r R n i n When goodwill has been calculated on a e a a m p R proportionate basis then for the purpos R e conducting the impairment review it is m i i uptogoodwill so that a g gross Sign up vote on this titlein the impairm n p g goodwill will include an unrecognised n Usefulattributab Notleuseful a m to the NCI. i i R goodwill attributable , Any impairment loss that arises is fir T o 6 T 3 d against the total of recognised and unr
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STudenT aCCounTanT 08/2009
g n i T T e a n R e e H n T e f g o H S Csr rt r Only the parent’s share of the good a . w rrtt impairment loss will actually be recor e C T i At the year-end, an impairment review is being v a n $50 = $30. e u conducted on a 60%-owned subsidiary. At the date The impairment loss will be applied R m o the goodwill, so that the intangible as of the impairment review the carrying value of the T R m that will appear on the group stateme subsidiary’s net assets were $250 and the goodwill n o a position will be $270 ($300 - $30). attributable to the parent $300 and the recoverable e f amount of the subsidiary $700. In the group statement of financial m y e l accumulated profits will be reduced $ R e b i Rr a no impact on the NCI. a H Determine the outcome of the impairment review. In the group income statement, the p T R e loss of $30 will be charged as an extr R v m i You're Reading a Preview e expense. There is no impact on the N St e H o In conducting the impairment review of H T C Unlock full access with a free trial. proportionate goodwill, it is first necessary to gross grss th rt r T e e it up. R Where goodwill has been calculated g y l g a the ingredients in the impairment rev l oFree Trial With Proportionate Grossed up Goodwill Download T n are already consistently recorded in f a e goodwill including the impairment loss (whether it relates to S i R notional a a T goodwill or the other assets)will be a S unrecognised between the parent and the NCI in th i l R Sign up to vote on this title e NCI proportion that they share profits and l l i C Useful l Not useful i w $300 x 100/60 = $500 S w d a Csr rt r rss Now, for the purposes of the impairment review, d o o At the year-end, an impairment review o
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TeCHniCal d 0 4 e $ T e a H e l i , u T e m n R u o a C S H C S S ’ a o S i e l C H T n T n e n e H m T o i R i y T i a b S p d o m i p e l e C u a i H T d C f e n o R a e i C n i R n f a e f H H o S T ’ d T S n T n e n e a m R ) e a 0 T p 0 2 a e $
you may wiSH To noTe a appaRenT anomaly wiTH Carrying value Net assets $400 RegaRdS To THe aCCoun Goodwill $300 TReaTmenT of gRoSS $700 Recoverable amount ($500) goodwill and THe Impairment loss $200 impaiRmenT loSSeS The impairment loss will be applied to write down aTTRibuTable To THe nC the goodwill, so that the intangible asset of goodwill THe goodwill aTTRibuT that will appear on the group statement of financial You're Reading a Preview position, will be $100 ($300 - $200). To THe nCi in THiS examp In the equity of the group statement of financial STaTed aS $40. THiS me Unlock with a freeiS trial. position, the accumulated profits will full be access reduced by the parent’s share of the impairment loss on the THaT goodwill iS $40 gR gross goodwill, ie $160 (80% x $200) and the NCI Download With Free Trial THan iT would Have bee reduced by the NCI’s share, ie $40 (20% x $200). In the income statement, the impairment loss of iT Had been meaSuRed o $200 will be charged as an extra operating expense. pRopoRTionaTe As the impairment loss relates to the gross goodwill Sign up to vote on this title baSiS; li of the subsidiary, so it will reduce the NCI in the THe nCi iS alSo $40 gReaT subsidiary’s profit for the year by $40 (20% x $200). Useful Not useful Having been meaSuRed osrt value aT aCquiSiTion. Impairment review
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01tchnIcal
ifrs busines
Rlvant to acca qualIFIcatIon pa
IFRS 3, Business Combinations was issued in January 2008 contIngnt conSIdRatIon as the second phase of a joint project with the Financial IFRS 3 defines contingent consideration as: ‘Usu Accounting Standards Board (FASB), the US standards obligation of the acquirer to transfer additional a setter, and is designed to improve financial reporting and equity interests to the former owners of an acqu international convergence in this area. The s tandard has of the exchange for control of the acquiree if You're Reading a Preview also led to minor changes in IAS 27, Consolidated and events occur or conditions are met. However, con consideration also may give the acquirer the righ Separate Financial Statements . The requirements of the Unlock 2008. full accessreturn with a free trial. revised IFRS 3 have been examinable since December of previously transferred consideration if This article relates to the relevance of IFRS 3 to Paper F7, conditions are met’ (this would be an asset). Financial Reporting . IFRS 3 requires the acquirer to recognise any c Download With Free Trial as part of the consideration for th This article is also of interest to candidates studying consideration UK-based papers, as under UK regulation consolidated It must be recognised at its fair value which is ‘th goodwill is calculated using the non-controlling interest’s for which an asset could be exchanged, or a liabili (NCI) proportionate share of the subsidiary’s identifiable net between knowledgeable, willing parties in an arm Sign up to vote on this title assets (referred to as method (ii) below). transaction’. This ‘fair value’ approach is consist Usefulother Not useful which forms The revised IFRS 3 introduces: the way in of consideration ar ¤ Restrictions on the expenses that can form part of the Applying this definition to contingent considerati acquisition costs be easy as the definition is largely hypothetical; i
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Studnt accountant issue14/2010 Studying Paper F7? perfre jeies 10 11 re ree is ex
combinations
If there is a change to the fair value of contingent (ii) at the non-controlling interest’s proportion consideration due to additional information obtained after the acquiree’s (subsidiary’s) identifiable ne the acquisition date that affects the facts or circumstances is the UK method). as they existed at the acquisition date, it is treated as a ‘measurement period adjustment’ and the contingent The differential effect of the two methods is th You're Reading a Previewthe whole of the goodwill attribu liability (and goodwill) are remeasured. This is effectively recognises a retrospective adjustment and is rather similar to an acquired subsidiary, whereas (ii) only recognis Unlock full access with a free adjusting event under IAS 10, Events After the Reporting share oftrial. the goodwill. Period . Changes in the fair value of contingent consideratio n Xampl 1 due to events after the acquisition date (for example, Download Free Trial meeting an earnings target which triggers a higher paymentWithParent pays $100m for 80% of Subsidiary whi than was provided for at acquisition) are treated as follows: assets with a fair value of $75m. The directors ¤ Contingent consideration classified as equity shall not have determined the fair value of the NCI at th be remeasured, and its subsequent settlement shall be acquisition Signwas up to$25m. vote on this title accounted for within equity (eg Cr share capital/share (i)Useful Not useful premium Dr retained earnings). Method Consideration ¤ Contingent consideration classified as an asset or a Parent liability that: NCI
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03tchnIcal
The two methods are an extension of the methodology used in IAS 36, Impairment of Assets when calculating the impairment of goodwill of a cash generating unit (CGU) where there is a non-controlling interest.
Net assets (to be consolidated) Consolidated goodwill
Xampl 2 Parent owns 80% of Subsidiary (a CGU). Its identifiable net assets at 31 March 2010 are $500.
NCI (140 - (250 x 20%)) (see below))
Note: IFRS 3 requires that any impairment l be written of to the controlling and non-cont interests on the same basis as that in which p are allocated.
Seri 1
$ Net assets included in the consolidated statement You're 500 Reading Preview of financial position (ii) aWith a recoverable amount of $550, the impa Consolidated goodwill (calculated under method (i)) 200 will be $150 and applied to the goodwill redu Unlock full access with$50. a freeThe trial. 700 statement of financial position wou NCI
140
Download With Free Trial (to be consolidated) Net assets
Seri 2
Consolidated goodwill (under method (i)) $
Net assets included In the consolidated statement of financial position Consolidated goodwill (calculated under method (ii))
500 160 660
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NCI (140 - (150 x 20%))
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Seri 2 Where method (ii) has been used to calculate go
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In this case, because the fair value of the non-controlling interests in scenario 1 is proportional to the consideration paid by Parent, the notional adjustment leads to the same impairment losses of $450 for (i) and $550 for (ii) as under scenario 1 (see *). Applying these: (i) the impairment loss of $250 is again applied to eliminate goodwill and the remaining $50 is applied to reduce the other net assets. The non-controlling interest will be reduced by $10 being its share (20%) of the reduction of other net assets. This gives exactly the same statement of financial position as under scenario 1.
Net assets (to be consolidated) Consolidated goodwill
The problem with this methodology is that go what is subsumed within it) is a very complex ite to describe goodwill, traditional aspects such as reputation, skilled workforce, site location, mark so on, all spring to mind. These are perfectly val an acquisition, goodwill may contain other facto premium to acquire control, and the value of savings or higher profits) when the subsidiary is within the rest of the group. While non-controllin may legitimately lay claim to their share of the m aspects of goodwill, they are unlikely to benefit aspects, as they relate to the ability to control You're Reading a *Thus, Preview $ it may not be appropriate to value no 450 interests on the same basis (proportional to) Unlock full access with a free trial.interests (see method (i) below). controlling nil IFRS 3 illustrates the calculation of c onsolid 450 at the date of acquisition as:
Download With Free Trial
NCI (100 - 10 (50 x 20%))
90
(ii) the impairment loss of $150 would be applied to goodwill leaving the other net assets unaffected. As only Parent’s share of goodwill is recognised, only 80% of the loss is applied, giving:
Consideration paid by parent + non-controlling - fair value of the subsidiary’s net identifiab = consolidated goodwill. Sign up to vote on this title
Not useful Useful The non-controlling interest in the above formu valued at its fair value (method (i)) or its propo of the subsidiary’s net identifiable assets (met
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On 1 October 2006, Plateau acquired the following non-current investments: Three million equity shares in Savannah by an exchange of one share in Plateau for every two shares in Savannah, plus $1.25 per acquired Savannah share in cash. The market price of each Plateau share at the date of acquisition was $6, and the market price of each Savannah share at the date of acquisition was $3.25. Thirty per cent of the equity shares of Axle at a cost of $7.50 per share in cash.
The following information is relevant: (i) At the date of acquisition, Savannah had five remaining of an agreement to supply goods its major customers. Savannah believes it is h that the agreement will be renewed when it e The directors of Plateau estimate that the va customer based contract has a fair value of indefinite life, and has not suffered any impai (ii) On 1 October 2006, Plateau sold an item of Savannah at its agreed fair value of $2.5m. I amount prior to the sale was $2m. The estim Only the cash consideration of the above investments remaining life of the plant at the date of sale You're Reading a Preview has been recorded by Plateau. In addition, $500,000 of years (straight-line depreciation). professional costs relating to the acquisition of Savannah are (iii) During the year ended 30 September 2007, S Unlock full access withsold a free trial. to Plateau for $2.7m. Savannah h included in the cost of the investment. goods The summarised draft statements of financial position of up these goods by 50% on cost. Plateau had the three companies at 30 September 2007 are: the goods still in its inventory at 30 Septemb Download With Free ThereTrial were no intra-group payables/receivabl Plateau Savannah Axle September 2007. $’000 $’000 $’000 (iv) At the date of acquisition the non-controllin Assets in Savannah be on valued at its fair value. F Sign upistotovote this title Non-current assets: purpose Savannah’s share price at that date Useful of Property, plant to be indicative theNot fairuseful value of the share and equipment 18,400 10,400 18,000 of the non-controlling interest. Impairment te Investments in Savannah 30 September 2007 concluded that neither
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tri e Note (iv) may instead have said that the fair value of the NCI at the date of acquisition was $3,250,000. Alternatively, it may have said that the goodwill attributable to the NCI was $500,000. All these are different ways of giving the same information.
th conSIdRatIon gIvn by FoR th ShaRS oF Savanna woRkS out at $4.25 pR ShaR conSIdRatIon oF $12.75m Fo 3 mIllIon ShaRS.
aser Consolidated statement of financial position of Plateau as at 30 September 2007: (i) Property, plant and equipment $’000 $’000 The transfer of the plant creates an initial Assets profit (URP) of $500,000. This is reduced You're Reading a Preview Non-current assets: for each year (straight-line depreciation ov Property, plant and equipment of depreciation in the post-acquisition peri Unlock 28,400 full access with aat free (18,400 + 10,400 - 400 (w (i))) 30trial. September 2007, the net unrealised Goodwill (w (ii)) 5,000 $400,000. This should be eliminated from Customer-based intangible 1,000 retained profits and from the carrying amo Download With Free Investments theTrial plant. – associate (w (iii)) 10,500 (ii) Goodwill in Savannah – financial asset 9,000 $’0 53,900 Controlling interest: Sign up to vote on this title Current assets: Shares issued (3,000/2 x $6) Useful x $1.25) (3,000 Not useful Inventory (6,900 + 6,200 - 300 URP Cash (w (iv))) 12,800 Trade receivables (3,200 + 1,500) 4,700 17,500 Non-controlling interests
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(iii) Carrying amount of Axle at 30 September 2007 Cost (4,000 x 30% x $7.50) Share post-acquisition profit (5,000 x 30%)
$’000 9,000 1,500 10,500
(iv) The unrealised profit (URP) in in inventory Intra-group sales are $2.7m on which Savannah made a profit of $900,000 (2,700 x 50/150). 50/150). One third of these are still in the inventory inventory of Plateau, thus there is an unrealised profit profit of $300,000. (v) The 1.5 million shares shares issued by Plateau in the share exchange, exchange, at a value of $6 each, would be recorded as $1 per share as c apital and $5 per share as premium, giving an increase in share capital of $1.5m and a share premium of $7.5m. (vi) Consolidated retained earnings $’000 Plateau’s Plateau’s retained earnings 25,250 Professional costs of acquisition must be expensed (500) Savannah’s post-acquisition (2,900 - 300 URP) x 75% 1,950 Axle’s post-acquisition profits (5,000 x 30%) 1,500 URP in plant (see (i)) (400)
Note that subsequent to the date of acquisition, non-controlling interest is valued at its fair value acquisition plus its proportionate share of Savan (adjusted) post acquisition profits.
FuRthR ISSuS The original question contained an impairment o let’s say that this is $1m. IAS 36 (as amended by requires a goodwill goodwill impairment of a subsidiary (i cash generating unit) to be allocated between the and the non-controlling interests in on the same as the subsidiary’s profits and losses are allocate of the impairment of $1m, $750,000 $750,000 would be a to the parent (and debited to group retained earn reducing them to $29.55m ($30,300,000 - $750 $250,000 would be allocated to the non-controll writing it down to $3.65m ($3,900,000 - $250,0 It could be argued that this requirement repre an anomaly. It can be calculated (though not don this example) that of Savannah’s Savannah’s recognised goo (before the impairment) of this $5mtitle only $500,000 ( Sign up to vote on relates to the non-controlling interests, but the N Useful Not useful in Savannah shareholding 25% (its propor tionate the goodwill impairment.
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RELEVANT TO ACCA QUALIFICATION PAPER F7 AND P2
Studying Paper F7 or P2? Performance objectives 10 and 11 are relevant to this exam
The IASB’s Conceptual Framework for Financial Reporting
I am from England, and here in the UK, unlike most countries, our system o government has no comprehensive written constitution. Many countries do have such constitutions and in these circumstances the laws of the land are shaped and influenced by the constitution. Now while the International Accounting Standards Board (IASB) is not a country it does have a sort of constitution, in the form of the Conceptual Framework for Financial Reportin (the Framework), that proves the definitive reference document for the development of accounting standards. The Framework can also be describe as a theoretical base, a statement of principles, a philosophy and a map. B setting out the very basic theory of accounting the Framework points the wa for the development of new accounting standards. It should be noted that th Framework is not an accounting standard, and where there is perceived to b conflict between the Framework and the specific provisions of an accountin standard then the accounting standard prevails.
Before we look at the contents of the Framework, let us continue to put the Framework into context. It is true to say that the Framework: up toavote on this title approach seeks to ensure that accounting standardsSign have consistent Not useful Useful problem solving and do not represent a series of adhoc responses tha address accounting problems on a piece meal basis assists the IASB in the development of coherent and consistent
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be faithful in its presentation, ie be complete, neutral and free from error. T usefulness of information is enhanced if it is also comparable, verifiable, timely, and understandable.
The Framework also considers the nature of the reporting entity and, in wha reminds me of my school chemistry lessons, the basic elements from which financial statements are constructed. The Framework identifies three eleme relating to the statement of financial position, being assets, liabilities and equity, and two relating to the income statement, being income and expens The definitions and recognition criteria of these elements are very importan and these are considered in detail below. The five elements
An asset is defined as a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.
Assets are presented on the statement of financial position as being noncurrent or current. They can be intangible, ie without physical presence goodwill. Examples of assets include property plant and equipment, financia assets and inventory. Sign up to vote on this title Useful Not useful While most assets will be both controlled and legally owned by the entity it should be noted that legal ownership is not a prerequisite for recognition,
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Contingent Assets is consistent with the Framework's approach when considering whether there is a liability for the future costs to decommission rigs. As soon as a company has erected an oil rig that it is required to dismantle at the end of the oil rig's life, it will have a present obligation in respect of the decommissioning costs. This liability will be recognised in ful as a non-current liability and measured at present value to reflect the time value of money. The past event that creates the present obligation is the original erection of the oil rig as once it is erected the company is responsib to incur the costs of decommissioning. Equity is defined as the residual interest in the assets of the entity after deducting all its liabilities.
The effect of this definition is to acknowledge the supreme conceptual importance of indentifying, recognising and measuring assets and liabilities equity is conceptually regarded as a function of assets and liabilities, ie a balancing figure.
Equity includes the original capital introduced by the owners, ie share capit and share premium, the accumulated retained profits of the entity, ie retain You're Reading a Preview earnings, unrealised asset gains in the form of revaluation reserves Sign up to vote on this title and, in Unlock full access with a free trial. group accounts, the equity interest in the subsidiaries enjoyed useful by the Useful not Not parent company, ie the non-controlling interest (NCI). Slightly more exotical Download With Free Trial equity can also include the equity element of convertible loan stock, equity
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MARCH 2011 while this clearly increases the asset of cash, it is a transaction with equity participants and so does not represent income for the entity.
Again note how the definition of income is linked into assets and liabilities. This is often referred to as ‘the balance sheet approach’ (the former name f the statement of financial position).
Expenses are defined as decreases in economic benefits during the account period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.
The reference to ‘other than those relating to distributions to equity participants’ refers to the payment of dividends to equity shareholders. Suc dividends are not an expense and so are not recognised anywhere in the Statement of Comprehensive Income. Rather they represent an appropriatio of profit that is as reported as a deduction from Retained Earnings in the Statement of Changes in Equity.
Examples of expenses includeYou're depreciation, impairment of assets and Reading a Preview purchases. As with income most expenses are recognised inthis the Income Sign up to vote on title Unlock full access with a free trial. Statement section of the Statement of Comprehensive but in certai Useful Income, Not useful circumstances expenses (losses) are required by specific standards to be Download With in Free Trial recognised directly in equity and reported the Other Comprehensive Inco
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there are various measurement methods that can be used. The failure to be prescriptive at this basic level results in many accounting standards sitting the fence how they wish to measure assets. For example IAS 40, Investment Properties and IAS 16, Property, Plant and Equipment both allow the preparer choice to formulate their own accounting policy on measurement.
Applying the Framework A company is about to enter into a three-year lease to rent a building. The lease cannot be cancelled and there is no certainty of renewal. The landlord retains responsibility for maintaining the premises in good repair. The directors are aware that in accordance with IAS 17 that technically the lease classified as an operating lease, and that accordingly the correct accountin treatment is to simply expense the income statement with the rentals payab Required Explain how such a lease can be regarded as creating an asset and liability the Framework.
Solution – lease Given that it is reasonable to You're assume that athe expected life of the premises Reading Preview vastly exceed three years and that the landlord Sign (lessor) is on responsible for th up to vote this title Unlock full access with a free trial. maintenance, on the basis of the information given, the risks and rewards o Not useful Useful ownership have not passed. As such IAS 17 prescribes that the lessee charg Download With FreeNo Trial the rentals payable to the income statement. asset or liability is recogni
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There is, at present, a conflict between IAS 17 and the Framework. The IASB currently reviewing IAS 17 because the current accounting treatment of less not recognising the future operating lease rentals as liabilities arguably amounts to off balance sheet financing. The Framework’s definition of a liability is at the heart of proposals to revise IAS 17 to ensure that the statement of financial position faithfully and completely represents all an entity’s liabilities. Accordingly this conflict should soon be resolved.
Tom Clendon FCCA is a subject expert at Kaplan
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RELEVANT TO ACCA QUALIFICATION PAPER F7 AND PERFORMANCE OBJECTIVES 10 AND 11
The need for and an understanding of a conceptual framework
This topic forms most of Section A (and has an influence on Section B) of th syllabus for Paper F7, Financial Reporting. A conceptual framework is impor to the understanding of the many principles and concepts that underpin International Financial Reporting Standards (IFRS) and is an often-neglected part of candidates’ studies.
Questions from these areas regularly appear in Paper F7 exams – usually as Question 4 – and I often comment in my examiner’s report that they are the least well-answered question in the exam paper; the questions also have a h incidence of candidates not attempting them at all.
This article is intended to illustrate the relevance and importance of this top
What is a conceptual framework? In a broad sense a conceptual framework can be seen as an attempt to defi the nature and purpose of accounting. A conceptual framework must consid You're Reading a Preview the theoretical and conceptual issues surrounding financial reportingand fo Sign up to vote on this title Unlock full access with a free trial. a coherent and consistent foundation that will underpin the development of Useful Not useful accounting standards. It is not surprising that early writings on this subject were mainly from academics.Download With Free Trial
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THE NEED FOR AND AN UNDERSTANDING OF A CONCEPTUAL FRAMEWORK OCTOBER 2011 •
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standards were produced on a ‘fire fighting’ approach, often reacting a corporate scandal or failure, rather than being proactive in determin best policy. Some standard setting bodies were biased in their composition (ie no fairly representative of all user groups) and this influenced the quality and direction of standards the same theoretical issues were revisited many times in successive standards – for example, does a transaction give rise to an asset (research and development expenditure) or liability (environmental provisions)?
It could be argued that the lack of a conceptual framework led to a proliferation of ‘rules-based’ accounting systems whose main objective is th the treatment of all accounting transactions should be dealt with by detaile specific rules or requirements. Such a system is very prescriptive and inflexible, but has the attraction of financial statements being more comparable and consistent.
By contrast, the availability of a conceptual framework could lead to You're Reading a Preview ‘principles-based’ system whereby accounting standards are developed from Sign up to vote on this title an agreed conceptual basis with specific objectives. Unlock full access with a free trial. Useful Not useful This brings us to the International Accounting Standards Board’s (IASB) Th Download With Free Trial Conceptual Framework for Financial Reporting (the Framework), which is in
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THE NEED FOR AND AN UNDERSTANDING OF A CONCEPTUAL FRAMEWORK OCTOBER 2011
when they should be recognised and a discussion of measurement is (for example, historic cost, current cost) and the related concept of capital maintenance.
The development of the Framework over the years has led to the IASB producing a body of world-class standards that have the following advantag for those companies that adopt them: IFRS are widely accepted as a set of high-quality and transparent glo standards that are intended to achieve consistency and comparability across the world. They have been produced in cooperation with other internationally renowned standard setters, with the aspiration of achieving consensu and global convergence. Companies that use IFRS and have their financial statements audited accordance with International Standards on Auditing (ISA) will have a enhanced status and reputation. The International Organisation of Securities Commissions (IOSCO) recognise IFRS for listing purposes – thus companies that use IFRS n produce only one set of financial statements for any securities listing You're of Reading a Preview countries that are members IOSCO. This makes it easier and cheap to raise finance in international markets.Sign up to vote on this title Unlock full access with a free trial. Useful useful Companies that own foreign subsidiarieswill find theNotprocess of consolidation simplified if all their subsidiaries use IFRS. Download With Free Trial Companies that use IFRS will find their results are more easily compa •
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THE NEED FOR AND AN UNDERSTANDING OF A CONCEPTUAL FRAMEWORK OCTOBER 2011
Here are a few examples of past questions.
June 2008 exam (a) The IASB’s Framework for the Preparation and Presentation of Financial Statements requires financial statements to be prepared on the basis that th comply with certain accounting concepts, underlying assumptions and (qualitative) characteristics. Five of these are: Matching/accruals Substance over form Prudence Comparability Materiality • • • • •
Required Briefly explain the meaning of each of the above concepts/assumptions. (5 marks)
(b) For most entities, applying the appropriate concepts/assumptions in for inventories is an important element in preparing their financial statements. You're Reading a Preview
Sign up to vote on this title Required Unlock full access with a free trial. Useful Not useful in (a) ma Illustrate with an example how each of the concepts/assumptions applied to accounting for inventory. Download With Free Trial (10 marks)
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THE NEED FOR AND AN UNDERSTANDING OF A CONCEPTUAL FRAMEWORK OCTOBER 2011
indicate that the substance of a transaction may be different from its legal form.
Observations Part (a) is based on the important topic of substance over form. Note the question does not ask for a definition of the concept (this would be more fo Paper F3); instead it asks why the concept is important and what features m indicate that the substance of a transaction may be different to its legal for In other words, how do we identify such transactions?
Most answers to this question merely gave a definition of substance and an example (inevitably leasing) of its use in financial statements.
Part (b) consisted of a numerical example related to a sale and re-purchase agreement to illustrate the difference that the application of substance has financial statements (compared to the legal form).
June 2011 exam (a) Your assistant has been reading the IASB’s Framework for the Preparation You're Reading a Preview and, as part of the Presentation of Financial Statements (the Framework) Signunder up to vote on this title qualitative characteristics of financial statements the heading of Unlock full access with a free trial. Useful Not is useful information ‘relevance’, he notes that the predictive value of considered important. He is aware that financial statements are prepared historically (i Download With Free Trial after transactions have occurred) and offers the view that the predictive valu
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THE NEED FOR AND AN UNDERSTANDING OF A CONCEPTUAL FRAMEWORK OCTOBER 2011
From memory I would say that this (section) question had the highest numb of candidates that did not give any answer; and of those that did, very few scored more than half of the available marks.
Part (a) was followed by a section on continuing and discontinued operation and a calculation of diluted earnings per share. If these topics had been mentioned in Part (a) alone, it would have gained two of the six marks available.
Conclusion Simply look out for more of this type of question – it is an important area an should not be neglected. Steve Scott is examiner for Paper F7
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TeChniCal
not-for-profi relevanT To paperS 1, 5, 7, 8, p2, p3 S l n e o , v e i l T e l S v l e e a u l n Q S o i e l a r T S u n S T e e a f e m o f a r y d p a n e m u h f T n e T o i h a . T T 8 a T f C i a . d f i S n . l n a 5 a o p u i 7 T f d
Wt s t--ft st? Ts t--ft Several papers in the ACCA Qualification may feature It would be simplistic to assume Not-for-profit organis that any organisation that does in both the public sec questions on not-for-profit organisations. At the not pursue profit as an objective private sector. Most, is a not-for-profit organisation. public sector organis Fundamentals level, these include Papers F1, F5, F7 and This is an incorrect assumption, not have profit as the objective and were es F8. At the Professional level they as many such organisations do include Papers P2, P3 and P5. make a profit every year and order to provide wha overtly include this in their formal refer to as public goo Although many of the principles plans. Quite often, they will are mainly services t of management and organisation apply to most business models, describe their profit as a ‘surplus’ not be available at th rather than a profit, but as either price to those who ne not-for-profit organisations You're Reading a Preview have numerous features that term can be defined as an excess them (such as medic of income over expenditure, the museums, art galleri distinguish them from the Unlockdifference full access with freeconsidered trial. profit maximising organisations mayabe some forms of trans rather semantic. or could not be provi often assumed in conventional economic theor y. Not-for-profit organisations all through the marke With Free from Trialprofit This article explains some of Download are distinguished as defence and regul these features. The first part maximising organisations by markets and busines of the article broadly describes three characteristics. First, most sector examples inclu the generic characteristics of not-for-profit organisations do forms Sign up to vote on this titleof charity and not-for-profit organisations. not have external shareholders organisations, such a Useful Not useful The second part of the providing risk capital for the associations that pro article, to be published in the business. Second, and building for low income and m October 2009 digital issue on the first point, they do groups, sports assoc
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STudenT aCCounTanT 09/2009
organisations
. Ct t, csttt, If it is a company d ) n Not-for-profit organisations can cts Memorandum and T established as incorporated Not-for-profit organisations are Association, with t T i n e be or unincorporated bodies. The invariably set up with a purpose the latter entrench f e e d i common business forms include or set of purposes in mind, and that the objectives l o S v i a the organisation will be expected altered easily in th r n v d the following: p e i ¤ in the public sector, they may to pursue such objectives beyond Not-for-profit organ - u a r p be departments or agents the lifetime of the founders. that are not compa S i Q of government On establishment, the founders commonly have a s o d e g f ¤ some public sector bodies will decide on the type of which are broadly - e n T o i are established as private organisation and put in place Articles of Associa T o T g u companies limited by a constitution that will reflect As with any type a b guarantee, including n S You're Reading a Preview their goals. The constitutional organisation, the e u i f i g r the Financial Services base of the organisation will not-for-profit organ T Authority (the UK financial Unlock fullbeaccess with a free trial. o n dictated by its legal form. laid down by the fo a n S i their successors in S p a d services regulator) e ¤ in the private sector they may Unlike profit maxim i m l Download With Free Trial r o l r noT-or-proiT be established as cooperatives, however, the broad e o C a objectives of not-fo v industrial or provident societies organiSaTionS e g S C (a specific type of mutual organisations will t e a o n are invariably SeT organisation, owned by its l Sign up to vote on thischange title over time. T p The purposes of a u r o members), by trust, as limited up WiTh a purpoSe Useful Not useful T companies or simply as clubs are most often dicta C o T ( in mind, and The S or associations. underlying founding ’ T n i e Within these broad C i organiSaTion a S l m
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03 . W o S r n g d o i e T b n a o a S i T e n d v i a e v g T r r C u S o e p T i x o f e T o e r r r e d p - a r r y o o n f i - a n T m T o , i f n e v o h i T r g C p u e e j o b T h o a r T l y e a r n T a e a m g h i T r e r
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TeChniCal
It is important to recognise Many service-orientated mt that although not-for-profit organisations use ‘value for The management stru organisations do not maximise money’ indicators that can be of not-for-profit organ profit as a primary objective, used to assess performance resembles that of many are expected to be against objectives. Where maximisers, though t self-financing and, therefore, the organisation has public used to describe cert generate profit in order to survive accountability, performance bodies and officers m and grow. Even if their activities measures can also be published differ somewhat. rely to some extent on external to demonstrate that funds While limited com grants or subventions, the have been used in the most a board of directors providers of this finance invariably cost-effective manner. executive and non-ex expect the organisation to be as It is important within an directors, many not-f You're Reading a Preview financially self-reliant as possible. exam question to read the organisations are ma As the performance of clues given by the examiner Council or Board of Unlockregarding full access with trial. not-for-profit organisations whata free is important whose role is to ensu cannot be properly assessed to the organisation and adherence to the fou by conventional accounting what are its guiding principles, objectives. In recent Freewhen Trial ratios, such as ROCE, ROI, etc, Download and to With use these has been some conv it often has to be assessed with assessing the performance of between how compa reference to other measures. Most the organisation. not-for-profit organis not-for-profit organisations rely managed, Sign up to vote on this title including on measures that estimate the reliance on non-exec alThough many o Useful Not useful (notably in re performance of the organisation officers in relation to: the scrutiny or overs The prinCipleS ¤ effectiveness – the extent to and the employmen
o managemenT
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TECHnICAL
not-for-profi PART 2: CHARITIES RELEVAnT TO PAPERS F1, F5, F7, F8, P2, P3 S L n E O , V E I L T E L S V L E E A u L n Q S O I E L A R T S u n S T E E A F E M O F A R y d P A n E M u H F T n E T O I H A . T T 8 A T F C I A . d F I S n . L n A 5 A O P u I 7 T F d
¤ the advancement of the arts, activities. For exampl The term ‘charity’ refers to the practice of benevolent giving. culture, heritage or science is a federal internatio ¤ the advancement of organisation compris Charities are established for general or specific amateur sport 13 different bodies a ¤ the advancement of human all continents, while m philanthropic purposes. They are one type of rights, conflict resolution or thousands of charitie not‑for‑profit organisation, reconciliation or the promotion organisations manag but with several additional of religious or racial harmony staffed entirely by vo distinguishing features: or equality and diversity Unsurprisingly, most ¤ they exist entirely to benefit ¤ the advancement of constituent organisat defined groups in society environmental protection within Oxfam operate ¤ as their purposes are or improvement limited companies, w You're Reading a Preview ¤ the relief of those in need, by philanthropic, they can usually charities would find t avail themselves of favourable reason of youth, age, ill‑health, inappropriate and pr access with a free trial. tax treatment, and for this Unlock full disability, financial hardship or established as assoc reason have to be registered other disadvantage A charity is not for ¤ the advancement of with a regulator from engaging in com Download With Free Trial ¤ their activities are restricted or animal welfare activities provided th ¤ the promotion of the efficiency limited by a regulator activities fully serve ¤ they rely on the financial of the armed forces of the objectives of the cha support of the public or Crown or of the police, example, Sign up to vote on this title charities su businesses (or both) in order to fire and rescue services or British Heart Founda Useful Not useful Red Cross, an achieve their objectives ambulance services British ¤ in order to be financially ¤ other purposes currently Concern all raise fun viable, they rely heavily on recognised as charitable and operating chains of
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STudEnT ACCOunTAnT 10/2009
organisations FORMATIOn, COnSTITuTIOn And OBJECTIVES
Charities are always formed with specific philanthropic purposes in mind. These purposes may be expanded or varied over time, provided the underlying purpose remains. For example, Oxfam was originally formed as the Oxford Committee for Famine Relief in 1942, and its original purpose was to relieve the famine in Greece brought about by the Allied blockade. Oxfam now provides famine relief on a worldwide basis. The governing constitution of a charity is normally set down in its rules, which expand on the purposes of the business. Quite often, the constitution dictates what the organisation cannot do, as well as what it can do. Charities plan and control their activities with reference
. , Objectives may change over may, of course, be y time E due to changes in the unstable politically T E T I Operational risk A R R external environment in which T A A the charity operates. Barnardos arises from the hig S on volunteer worke E T S H is a childrens’ charity that was C originally founded as Doctor L n T the extent to which A E E Barnado’s Homes, to provide for on continued supp E S E S H orphans who could not rely on as problems of inte R d A T family support. For example, many S n E F E The development of welfare staff their shops w A P H O services after World War II and unpaid retired peop H E T S the increasing willingness of some debate as to C d T E You're Reading a Preview families to adopt and foster generations of retir u n V S I A I children resulted in less be as willing to do t H , T reliance Unlock full access with a free trial. on the provision of As many charitie S O T T T E C residential homes for children contain operating e E S R E but greater reliance on other in order to ensure S T u J B support Download Withservices. Free Trial S E S As a result, objectives can be m A S n O the Barnardos charity had to often difficult or im T S E E change the way in which it looked for them to employ paid staf n A O H at maximising theSign welfare up to of vote on thispart‑time title E H T T orphaned children. volunteer workers. R C Useful Not useful g R u S Local charities are dependent Risks also arise u S I n on the support of a more limited social environment I E C - F L T population and therefore have to in times of recessi n O O C
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ACCA F9 Class Notes June 2011
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TECHnICAL
E C n T A A F M H O R T S O S E F E R R S u E u S P A C A R I E E d M H O O T O T H g . E S I E S C L H E I T B T n I E u T V R P A I E n H T F T C E E A R T C F I E H O L L B T I y B u A w E P T I S H g R E A I T . n I H T I y V I V I C g C T n M C E I E O H R A C I T R I F E F E F C T I H E n F
CHECK yOuR undERSTAndIng
Test your knowledge by answering these self-test questions – the questions are based on both thi Part 1, published in the September 2009 issue. Qestio 1
Qestio 2
Qestio 3
What performance measures might be used by a famine relief charity?
Why do individuals give to charities?
XYZ Charity provides community facilities fo persons participating management commit outsource the operati premises and land to organisation. What co might be imposed by council of XYZ Charity
You're Reading a Preview e l i f o r p r i e h t s e s i a r r o , d o o g l e e f
. s r e h t o h t i w
. n d n a t i f a e b d l u d e t c i r t s e b d l u o w g n r o , e s a e l ‑ b u y n a o t d l u o w e l b a c i l p p a s
e l p o e p e m o s s e k a m t i t a h t y l p m i s Unlock full access with a free trial. s i g n i v i g r o f e v i t o m r e h t o n A . d e d i v o r p n e e b s a h . s d n e i r f d n a y l i m a f f o f e i l e r e r e h w s a e r a n i s s e n k c i s e l p m a x e e h t w o l l o f y e h t e s u a c e b Download With Free Trial d n a y t i l a t r o m n i s e g n a h c ¤ r o , y t e i c o s f o n o i t a t c e p x e n a s a t i d e t c a r t t a s r e e t n u l o v d r a g e r y e h t e s u a c e b e v i g e m o S f o s r e b m u n ¤ . s e i t i l i b a i l x a t Sign up to i t a vote on this title s e i t i v i t c a l a i c r e m m o c t s n i a g a t e s e b n a c s n o n o d f o s e v i t c e j b o d n a m o r f e m o c n i ¤ e l b a t i r a h c t s o m , s k a e r b x a tNot useful t n e t s i s n o c n i r Useful s a ) e m o c n i f o f o f l e s e n o l i a v a o t s i g n i v i g d e s u e b t o n d l u n o i t r o p o r p h g i h a b r o s b a s t s o c r o f e v i t o m l a i c n a n i f y l e r u p A o t g n i g n o l e b y
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ACCA F9 Class Notes June 2011
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property, plant and equipment, and tangible fixed assets relevant to CAT Papers 3 and 6, and new ACCA Qualification Papers F3 and F7
measurement and depreciation You're Reading a Preview
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because demand has not yet built up, does Employment costs (Note 1) not justify further capitalisation of costs in Production overheads directly this period. Any abnormal costs (for example, related to the construction (Note wasted material) cannot be included in the Allocated general administrative cost of PPE. overheads IAS 16 does not specifically address the Architects’ and consultants’ fees issue of whether borrowing costs associated directly related to the constructi with the financing of a constructed asset can Costs of relocating staff who are be regarded as a directly attributable cost of to work at the new factory construction. This issue is addressed in IAS 23, Costs relating to the formal open of the factory Borrowing Costs. IAS 23 requires the inclusion of borrowing costs as part of the cost of Interest on loan to partly finance constructing the asset. In order to be consistent construction of the factory (Note with the treatment of ‘other costs’, only those You're Reading a Preview finance costs that would have been avoided if Note 1 the asset had not been constructed are eligible The factory was constructed in t Unlock full access a free trial. for inclusion. If the entity with has borrowed funds months ended 31 May 20X7. It specifically to finance the construction of an into use on 30 June 20X7. The asset, then the amount to be capitalised is costs are for the nine months to Download With FreeWhere Trial Signthe up to vote on this title the actual finance costs incurred. borrowings form part of the general borrowing Not2useful Useful Note of the entity, then a capitalisation rate that The production overheads were represents the weighted average borrowing rate the eight months ended 31 May of the entity should be used. included an abnormal cost of
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ACCA F9 Class Notes June 2011
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or other amount (for more on the revaluation of the asset, see the second article in the August 2007 issue of student accountant). Depreciation is not providing for loss of value of an asset, but is an accrual technique that allocates the depreciable amount to the periods expected to benefit from the asset. Therefore assets that are increasing in value still need to be depreciated. IAS 16 requires that depreciation should be recognised as an expense in the income statement, unless it is permitted to be included in the carrying amount of another asset. An example of this practice would be the possible inclusion of depreciation in the costs incurred on a construction contract that are carried forward and matched against future income from the contract, under the provisions of IAS 11. A number of methods can be used to allocate depreciation to specific accounting periods. Two of the more common methods, specifically mentioned in IAS 16, are the straight line method, and the reducing (or
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have been $180,000 at the end of 20X6. Given the reassessment of the UL and RV, the depreciable amount at the end of 20X6 is $168,000 ($180,000 - $12,000) over three years. Therefore, the depreciation charges in 20X7, 20X8 and 20X9 will be $56,000 ($168,000/3) unless there are future changes in estimates. Where an asset comprises two or more major components with substantially different economic lives, each component should be accounted for separately for depreciation purposes, and each depreciated over its UL.
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Requirement Compute the annual depreciatio the furnace for each year of its l
Solution 20X2–20X6 inclusive The asset has two depreciable c the lining element (allocated co – UL five years); and the balanc (allocated cost $150,000 – UL Therefore, the annual depreciati ($50,000 x 1/5 + $150,000 x 31 December 20X6, the ‘lining has a written down value of zero
EXAMPLE 3 On 1 January 20X2, an entity purchased a 20X7–20Y1 inclusive Unlock full accessThe with a free trial. furnace for $200,000. estimated UL of The $70,000 spent on the new the furnace was 10 years, but its lining needed treated as the replacement of a replacing after five years. On 1 January 20X2 component of an asset and add Download With Sign up to voteThe onannual this title the entity estimated that theFree cost ofTrial relining depreciation is now the furnace (at 1 January 20X2 prices) x 1/5 + $150,000 x Not useful Useful ($70,000 was $50,000. The lining was replaced on 1 January 20X7 at a cost of $70,000. Paul Robins is a lecturer at FTC
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ACCA F9 Class Notes June 2011
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property, plant and equipment, and tangible fixed assets – part 2 relevant to ACCA Qualification Papers F3 and F7
revaluation and derecognition You're Reading a Preview
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is $10,000 ($30,000 - $20,000). IAS 16 allows (but does not require) entities to make a transfer of this ‘excess depreciation’ from the revaluation reserve directly to retained earnings. Revaluation losses
Revaluation losses are recognised in the income statement. The only exception to this rule is where a revaluation surplus exists relating to a previous revaluation of that asset. To that extent, a revaluation loss can be recognised in equity. EXAMPLE 2
The property referred to in Example 1 was revalued on 31 December 20X6. Its fair value had fallen to $1.5m. Compute the revaluation loss and state how it should be treated in the financial statements. Solution
The carrying value of the property at 31 December 20X6 would have been $2.74m
Under FRS 15 the amount to which a x $20,000). The actual carrying fixed asset is revalued is different than property at 31 December 20X6 under IAS 16. As far as properties are (see Example 2). Therefore, of th concerned (these probably being the class loss of $1.24m (see Example 2 of fixed asset most likely to be carried at ($2.74m - $1.86m) is charged t valuation) the basic valuation principle of total recognised gains and loss is value for existing use – not reflecting balance of $360,000 ($1.24m any development potential. Notional, charged to the profit and loss acc directly attributable acquisition costs should also be included where material. DERECOGNITION OF PPE – TH However, specialised properties may need POSITION to be valued on the basis of depreciated PPE should be derecognised (re replacement cost, since there may be no PPE) either on disposal or when data on which to base an ‘existing use’ economic benefits are expected You're Reading a Preview valuation. If properties are surplus to the (in other words, it is effectively s entity’s requirements, then they should gain or loss on disposal is recog Unlock access with value a freenet trial. be valuedfull at open market of difference between the disposal expected directly attributable selling costs. the carrying value of the asset (u Revaluation losses that are caused by a or revaluation model) at the dat Download With Free Trial Sign up to voteThis on net thisgain titleis included in the clear consumption of economic benefits, for example physical damage to an asset, – the sales proceeds Not useful Useful statement should be recognised in the profit and loss recognised as revenue. account. Such losses are recognised as an Where assets are measured operating cost similar to depreciation. revaluation model, any remainin
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This is the second of two articles, and considers revaluation of property, plant and equipment (PPE) and its derecognition. The first article, published in the June/July 2007 issue
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an appropriate level of management must to sell of $550,000 and an be committed to a plan to sell the asset, and loss of $50,000 recognised an active programme to locate a buyer and removed from non-current a complete the plan must have been initiated. presented in ‘non-current as The asset needs to be actively marketed at a sale’. On 30 November 20X reasonable price, and a successful sale should sale of $5,000 would be re normally be expected within one year of the 2 On 30 September 20X6 date of classification. be transferred to non-curren The types of asset that would typically for sale at its existing carryi satisfy the above criteria would be property, $500,000. When the asset and very substantial items of plant and 30 November 20X6, a prof equipment. The normal disposal or scrapping $55,000 would be recognis of plant and equipment towards the end of its useful life would be subject to the provisions Where an asset is measured un You're Reading a Preview of IAS 16. When an asset is classified as held revaluation model then IFRS 5 r for sale, IFRS 5 requires that it be moved revaluation must be updated im fullbalance access sheet with apresentation free trial. from Unlock its existing to being classified as held for sa (non-current assets) to a new category of the of this treatment is that the selli balance sheet – ‘non-current assets held for always be charged to the incom With Free Trial Signasup to votethe ondate thisthe title sale’. Download No further depreciation is charged asset is classified a its carrying value will be recovered principally Not useful Useful EXAMPLE through sale rather than continuing use. 5 The existing carrying value of the asset is An asset being classified as held compared with its ‘fair value less costs to sell’ currently carried under the reval
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accounting for property, plant and equipment rlvAt to AccA AlIFIcAtIo PAPr F7
The accounting for IAS 16, Property, Plant and Equipment is a particularly important area of the Paper F7 syllabus. You can almost guarantee that in every exam you will be required to account for property, plant and equipment at least once. This article is designed to outline the key areas of IAS 16, Property, Plant and Equipment that you may be required to attempt in the F7 exam.
How should the above information be accounted for i financial statements? (See page 5 for the solution to
xAmPl 2 Construction of Deb and Ham’s new store began on 1 The following costs were incurred on the construction
$000 IAS 16, ProPrty, PlAt Ad IPmt ovrvIw Freehold land 4,500 There are essentially four key areas when accounting for Architect fees 620 property, plant and equipment that you must ensure that you are Site preparation 1,650 You're Reading a Preview familiar with: Materials 7,800 Sign up to vote on this11,200 title Direct labour costs ¤ initial recognition Unlock full accessLegal with afees free trial. ¤ depreciation 2,400 Useful Not useful General overheads 940 ¤ revaluation ¤ derecognition (disposals). Download With TheFree store Trial was completed on 1 January 2010 and bro
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Stdt AccotAt issue19/2010
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Studying Paper F7? Pefane bjeies 10 an 11 ae eean his ea
A gAI o rvAlAtIo IS AlwAyS rcogISd I Ity, dr A rvAlAt rSrv (lSS t gAI rvrS’S rvAlAtIo loSSS o t SAm ASS wr PrvIoSly rcogISd I t Icom StAtmt – I tIS IStAc IS to Sow I t Icom StAtmt). t rvAlAtIo gAI IS kow rAlISd gAI wIc lAtr comS rAlISd w t ASSt IS dISPoS oF (drcogISd).
depeiain Depreciation is defined in IAS 16 as being the systematic allocation of the depreciable amount of an asset over its useful economic life. In other words, depreciation applies the accruals concept to the capitalised cost of a non-current asset and matches this cost to the period that it relates to.
xAmPl 6 A company purchased a property with an overall co 1 April 2009. The property elements are made up a $000 Land and buildings (Land element $20,000) Fixtures and fittings Lifts
65,000 24,000 depeiain ehs There are many methods of depreciating a non-current asset with 11,000 the most common being: 100,000 ¤ Straight line You're ReadingCalculate a Preview the annual depreciation chargefor the pr ¤ % on cost or up31 toMarch vote on this title the year Sign ended 2010. (See page 6 for the ¤ Cost – residual value Unlock full access with a free trial. Useful economic life Example 6.)Useful Not useful
¤
Reducing balance ¤ % on carrying value
rvAlAtIoS
Download WithThis Free Trial is an important topic in the exam and features
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reauain ains A gain on revaluation is always recognised in equity, under a revaluation reserve (unless the gain reverse’s revaluation losses on the same asset that were previously recognised in the income statement – in this instance the gain is to be shown in the income statement). The revaluation gain is known as an unrealised gain which later becomes realised when the asset is disposed of (derecognised). Double entry: Dr Non-current asset cost (difference between valuation and original cost/valuation) Dr Accumulated depreciation (with any historical cost accumulated depreciation) Cr Revaluation reserve (gain on revaluation)
Double entry: Dr Revaluation reserve Cr Retained earnings
Be careful, in the exam a reserves transfer is only req examiner indicates that it is company policy to make realised profits in respect of excess depreciation on r If this is not the case then a reserves transfer is not n This movement in reserves should also be disclose statement of changes in equity.
xAmPl 9 A company revalued its property on 1 April 2009 to $ for the land). The property originally cost $10m ($2m land) 10 years ago. The original useful economic life unchanged. The company’s policy is to make a transf You're Reading a Preview profits in respect of excess depreciation. up to vote this titlefor in the year e xAmPl 7 How willSign the property be on accounted Unlock fullThe access31 with a free2010? trial. (See page 6 for the solution to Exam A company purchased a building on 1 April 2007 for $100,000. March Useful Not useful asset had a useful economic life at that date of 40 years. On 1 April xAm FocS 2009 the company revalued the building to its current fair value of Download With Free Trial $120,000. In the exam make sure you pay attention to the date
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xAmPl 11 At 1 April 2009 HD Ltd carried its office block in its financial statements at its original cost of $2 million less depreciation of $400,000 (based on its original life of 50 years). HD Ltd decided to revalue the office block on 1 October 2009 to its current value of $2.2m. The useful economic life remaining was reassessed at the time of valuation and is considered to be 40 years at this date. It is the company’s policy to charge depreciation proportionally. How will the office block be accounted for in the year ended 31 March 2010? (See page 7 for the solution to Example 11.)
cArFl, I t xAm A rS trASFr IS oly rIrd IF t xAmIr IdIcAtS tAt It IS c PolIcy to mAk A trASFr to rAlISd ProFItS I rSPct o dPrcIAtIo o rvAld ASS tIS IS ot t cAS t A rSrvS trASFr IS ot c deeniin tIS movmt I rSrvS So Property, plant and equipment should be derecognised when it is no longer expected to generate future economic benefit or when it is dIScloSd I t StAtmt disposed of. You're ReadingcAgS a Preview I Ity. When property, plant and equipment is to be derecognised, a Sign up to vote on this title gain or loss on disposal is to be calculated. This can be found by Unlock full access with a free trial. comparing the difference between: Useful Not useful
Carrying value Disposal proceeds
X
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ias 16 solutions SoltIo 1 In accordance with IAS 16, all costs required to bring an asset to its present location and condition for its intended use should be capitalised. Therefore, the initial purchase price of the asset should be: List price Less: trade discount (10%) Import duty Delivery fees Electrical installation costs Pre-production testing Total amount to be capitalised at 1 March
$ 82,000 (8,200) 73,800 1,500 2,050 9,500 4,900 91,750
¤ Depreciation
of the store. Even though the asse yet been brought into use, IAS 16 states depreciati begins when it is available for use, ie when it is in t and condition necessary for it to be capable of the manner intended by management.
Note: depreciation cannot be calculated in this quest information surrounding useful economic life has not – this is for illustrative purposes only. Depreciation is in this article.
SoltIo 3 The $18,000 should be capitalised as part of the cos asset as the revenue earning capacity of the machine significantly increased, which could in turn lead to th The maintenance contract of $7,000 is an expense and therefore of additional economic benefit and the cost of the up You're Reading a Preview should be spread over a five-year period in accordance with the reliably measured. Sign up to vote on this title accruals concept and taken to the income statement. If the Unlock full accessSoltIo with a free 4trial. $7,000 has been paid in full, then some of this cost will represent Useful Not useful a prepayment. Income statement extract In addition the settlement discount received of $3,690 Depreciation expense ($73,800 x 5%) is to be shown as other income in the Download With Free Trial
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Stdt AccotAt issue19/2010
31 March 2010 As the residual value and useful economic life estimates have changed during the year ended 2010, the depreciation charge will need to be recalculated. The carrying value will now be spread according to the revised estimates.
SoltIo 9 Statement of comprehensive income extract for th 31 March 2010 Depreciation expense
Depreciation charge: 100,000 – 15,000 = $17,000 per annum 5 years Income statement extract 2010 Depreciation Statement of financial position extract 2010 Machine (100,000 – 17,000)
SoltIo 6 Land and buildings (65,000 – 20,000)/50 years)) Fixtures and fittings (24,000/10 years)
Other comprehensive income: Revaluation gain
12,0
Statement of financial position extract as at 31 $17,000
$83,000
Non-current assets Property (20,000 – 400)
19,6
You're Reading a Preview
Equity Sign up to vote on this title $000 Unlock full access with a free trial. Revaluation reserve 900
Download 2,400
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(12,000 – 200)
Not useful
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11,8
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07tcIcAl
SoltIo 10 Statement of comprehensive income extract 31 March 2010 Depreciation charge
2,500
Other comprehensive income: Revaluation gain 10,500 Statement of financial position extract 31 March 2010 Building at valuation 98,000 Statement of changes in equity extract Revaluation reserve Revaluation gain 10,500
Working paper: Note: Revaluation takes place part way through the ye therefore depreciation must first be charged for the p 09 – 30 September 09, then the revaluation can be re then depreciation needs to be charged for the period 2009 – 31 March 2010. (W1) Depreciation 1 April–30 September 2009 2,000,000 x 6/12 = $20,000 50 years
(W2) Revaluation The carrying value of the asset at 1 October 2009 ca and revalued.
Carrying value of non-current asset at revaluation da You're Reading a Preview (2,000,000 – (400,000 – 20,000)) Working paper: 1,580,00 Sign up to voteasset on this title Note: revaluation takes place at year end, therefore a full year of Valuation of non-current 2,200,00 Unlock full accessGain with on a free trial. depreciation must first be charged. revaluation 620,00 Useful Not useful
(W1) Depreciation year ended 31 March 2010 100,0000 = $2,500
Double entry:
Download With Trial(2,200,000 – 2,000,000) Dr Free NCA cost
200,00
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RELEVANT TO ACCA QUALIFICATION PAPERS F7 and P2
Studying Paper F7 or P2? Performance objectives 10 and 11 are relevant to these exams
How to account for property in Hong Kong This article is applicable to any candidate studying for F7, P2 or DipIFR
With very few exceptions, all land in Hong Kong is owned by the Governmen and leased out for a limited period. It does not matter if the properties are high-rise buildings, residential, offices or factories, they are built on land under a government lease.
Developers of these properties lease lots of land from the Government and develop the land according to the lease conditions, such as to construc buildings on the land according to the specifications within a specified period.
Individual units of these lots of land and buildings are usually sold a undivided shares in the lots. Interests of all parties, including future buyers o the units, are governed by the deeds of mutual covenant.
In substance and in form, ‘owners‘ of these units are a lessee of a lease of land and buildings. According toYou're IFRS,Reading the land and buildings elements of these a Preview leases should be considered separately for the Sign purposes ofonlease classification up to vote this title Unlock full access with a free trial. under IAS 17. Useful Not useful Allocation of the interests inDownload leases ofWith land and building Free Trial
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2 ACCOUNTING FOR PROPERTY
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Classification as property, plant and equipment or as an investment property The issue is complicated when the separate elements of the land and buildings are further classified in accordance with IAS 16, Property, Plant and Equipmen and IAS 40, Investment Properties.
IAS 16 According to IAS 16, land and buildings are separable assets and are accounted for separately, even when they are acquired together. Land has an unlimited useful life and, therefore, is not depreciated. Buildings have a limited useful life and, therefore, are depreciable assets. An increase in the value o the land on which a building stands does not affect the determination of the depreciable amount of the building.
IAS 40 A property interest that is held by a lessee under an operating lease may be classified and accounted for as investment property provided that: the rest of the definition of investment property is met the operating lease is accounted for as if it were a finance lease in accordance with IAS 17, Leases, and the lessee uses the fair value model for investment property • •
•
The choice between the cost and fair value models is not available to a lessee You're Reading a Preview accounting for a property interest held under an operating lease that it has Sign up toproperty. vote on this title elected to classify and account for as investment The standard Unlock full access with a free trial. requires such investment property to be measured using theNot fair value model. useful Useful
Download With Free IAS 40 depends on IAS 17 for requirements forTrial the classification of leases, the
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3 ACCOUNTING FOR PROPERTY
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position. No depreciation is required for the land element but it is required for the buildings element.
Option 2: Both land and buildings elements are measured at fair value with changes being posted to equity and presented under Property, Plant and Equipment in the statement of financial position. No depreciation is required for the land element but it is required for the buildings element.
Option 3: Both land and buildings elements are measured at cost and presented under investment property in the statement of financial position. No depreciation is required for the land element but is required for the buildings element.
Option 4: Both land and buildings elements are measured at fair value and presented under investment property in the statement of financial position. No depreciation is required for either the land element or buildings element. Scenario 2: Short-term lease of land
Land Buildings
Option 1 IAS 17 IAS 16 (Cost model)
Option 2 Option 3 IAS 17 IAS 17 IAS 16 IAS 40 (Revaluation (Cost You're Readingmodel) a Preview model)
Option 4 IAS 40 (Fair Value model) - for both land and building
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Land element is classified as an operating lease under IASNot 17useful because it has Useful indefinite economic life. Download With Free Trial
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4 ACCOUNTING FOR PROPERTY
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Option 4: Both land and buildings elements are measured at fair value and presented under Investment property in the statement of financial position. No depreciation is required for the land element and buildings element. Scenario 3: Land element is immaterial
Land Buildings
Option 1 Option 2 Option 3 All the purchase price will be treated element IAS 16 IAS 16 IAS 40 (Cost (Revaluation (Cost model) model) model)
Option 4 as buildings IAS 40 (Fair model)
As the land element is immaterial, the land and buildings elements are treated as a single unit for the purpose of lease classification. The economic life of the buildings is regarded as the economic life of the entire leased property.
Option 1: Property is measured at cost and presented under Property, Plant and Equipment in the statement of financial position. Depreciation is required.
Option 2: Property is measured at fair value with change being posted to equity and presented under Property, Plant and Equipment in the statement o financial position. Depreciation is required. You're Reading a Preview
up to vote onunder this title Investmen Option 3: Property is measured at cost andSign presented Unlock full access with a free trial. Useful Not useful property in the statement of financial position. Depreciation is required.
Download With Freeand Trialpresented under Investment Option 4: Property is measured at fair value
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research and development
relevant to CAT Paper 6 and ACCA Qualifcation Papers F7, and P2
fresh beginnings
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This article explains the accounting
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impossible to predict whether or not a project
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new scientific or technical know
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t e c h n i c a l
– SSAP 13, Accounting for Research and Development.
should be written off to the profit and loss account immediately.
Recognition Research
Problems with SSAP 13
development must be capitalise can demonstrate all of the follow the technical feasibility of c intangible asset (so that it w for use or sale) intention to complete and u the asset ability to use or sell the asse existence of a market or, if t internally, the usefulness of availability of adequate tech financial, and other resourc the asset the cost of the asset can be reliably.
SSAP 13 states that expenditure on research does not directly lead to future economic benefits, and capitalising such costs does not comply with the accruals concept. Therefore, the accounting treatment for all research expenditure is to write it off to the profit and loss account as incurred.
SSAP 13 is not in line with the newer International Accounting Standard covering this area. As seen previously, the UK allows a choice over capitalisation; this can lead to inconsistencies between companies and, as some of the criteria are subjective, this ‘choice’ can be manipulated by companies wishing to capitalise development costs.
Development
INTERNATIONAL TREATMENT OF R&D
As a basic rule, expenditure on development costs should be written off to the profit and loss account as incurred, as with the expenditure on research. However, under SSAP 13, there is an option to defer the development expenditure and carry it forward as an intangible asset if the following criteria are met: there is a clearly defined project expenditure is separately identifiable the project is commercially viable
One notable difference between the UK and international treatment is that the UK has a Unlock full access a freeoftrial. separate standard for thewith treatment R&D If any of the recognition criteria (SSAP 13), whereas under International then the expenditure must be ch Accounting Standards the accounting for R&D the income statement as incurre Download With Free Trial Sign up .to voteifon title criteria have b is dealt with under IAS 38, Intangible thethis recognition Assets capitalisation must take place.
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Recognition
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IAS 38 states that an intangible asset is to be recognised if, and only if, the following criteria
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Treatment of capitalised develo
Once development costs have b
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Example: Answer UK Option 1: expense all costs Profit and loss account extract
Balance sheet extract
Expenses: R&D
615,000
Option 2: Expense research as required and capitalise development costs Profit and loss account extract
Expenses: Research
Balance sheet extract
You're Reading a Preview 125,000
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Intangible asset: Development costs
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International Income statement extract
Balance sheet extract
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IAS 1, presentation of nancial statements relevant to all CAT and ACCA Qualication papers
presentation and terminology You're Reading a Preview
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Download Trial Sign up to votewill onbethis title of cash flows’ The International Accounting Standards Board (IASB) reissued IAS 1, With Free ‘Cash flow statement’ ‘statement Presentation of Financial Statements, in September 2007. The main 2008 exam sitting onwards. Useful Not useful changes are amendments to presentation and terminology. Although the revised IAS 1 does not become effective until annual periods beginning Another amendment resulting from the reissue of IAS 1 is on or after 1 January 2009, earlier adoption is permitted. ACCA operates requirement to present ‘other comprehensive income’ item
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EXAMPLE 1: ‘STATEMENT OF COMPREHENSIVE INCOME’ (IN ONE STATEMENT) GIVEN IN IAS 1
Revenue Cost of sales Gross profit Other income Distribution costs Administrative expenses Other expenses Finance costs Share of profit of associates Profit before tax Income tax expense Profit for the year from continuing operations Loss for the year from discontinued operations PROFIT FOR THE YEAR [a: income statement] Other comprehensive income:
20X7 20X8 390,000 355,000 (245,000) (230,000) 145,000 125,000 20,667 11,300 (9,000) (8,700) (20,000) (21,000) (2,100) (1,200) (8,000) (7,500) 35,100 30,100 161,667 128,000 You're Reading (40,417) (32,000)
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full access with a free trial. 121,250Unlock96,000 (30,500) 121,250Download 65,500 With
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by Neil Stein 16 May 2003
This article looks at the other elements of financial statements required by FRS 3, Reporting Financial Performance and IAS 1, Presentation of Financial Statements other than the income statement/profit and loss account.
UK requirements We'll look first at the UK requirements: 1. statement of total recognised gains and losses 2. note of historical cost profits and losses 3. reconciliation of movements in shareholders' funds.
Statement of total recognised gains and losses
FRS 3 argues that the profit and loss account is not sufficient on its own as a report of a company's financial performance. The statement of total recognised gains and losses (STRGL an attempt to present details of the other elements making up a company's total performance. The STRGL presents:
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profit for the financial year before dividends unrealised gains and losses on revaluation of assetsSign up to vote on this title Download With Free Trial currency translation differences Useful Not useful prior year adjustments.
The profit for the year is, of course, the figure in the profit and loss account. This will alread
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Figure 1: Statement of total recognised gains and losses
Total recognised gains and losses relating to the year
£m 29 4 (5) 28
Prior year adjustment
(10)
Profit for the financial year Unrealised surplus on revaluation of properties Unrealised loss on trade investment
Total gains and lossed recognised since last annual report 18
Note of historical cost profits and losses (no International equivalent)
Financial statements in the UK are usually prepared on the historical cost basis, but with the proviso that fixed assets - especially land and buildings - are often revalued to keep balance s values more in line with reality.
FRS 3 requires this note to state what the profit would have been if the financial statements h been prepared on a strict historical cost basis, with no asset revaluations. The note is only You're Reading Preview required if the difference between the reported profitaand the historical cost profit is material. There are two main possible causes Unlock of difference: full access with a free trial. 1. If assets are revalued, depreciation is based on the revalued amount. Using strict Sign up to vote on this title Download With Free Trial historical cost accounting, the depreciation would be based on original cost.
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2. If a revalued asset is sold, the profit coming through in the profit and loss account i difference between the proceeds of sale and the carrying amount in the records allowi
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charge of the year calculated on the revalued amount Historical cost profit for the year after taxation and dividends (retained profit)
Why have the note? FRS 3 cites two reasons:
1. Companies have discretion as to when to make revaluations - and to what extent historical cost figures may make profits and losses of different reporting entities more comparable. 2. Some users may wish to know the historical cost based profit on the sale of an asset.
Reconciliation of movements in shareholders' funds
This statement overlaps somewhat with the STRGL, because naturally everything in the STR affects shareholders' funds and therefore has to appear in this reconciliation. However, it also includes issues or redemptions of shares during the year. The information in the reconciliatio could be picked up from the company's balance sheet, but it is convenient to have a separate statement summarising the movements. Refer to Figure 3.
Figure 3: Reconciliation of movements in shareholders' funds You're Reading a Preview Profit for the financial year Dividends
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Other recognised gains and losses relating to the year (net)
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previously stated Prior year adjustment Premium on issue of shares (nominal value £7m)
-
-
(10)
44
200
110
13
Transfer from profit and loss account of the year
21
Transfer of realised profit
(14)
Decrease in value of trade investment
(5)
Surplus on property revaluations -
4
-
At end of year
185
145
57
14
That is the end of the coverage of the UK position.
International requirements
The main supplementary statement required by IAS 1, Presentation of Financial Statements i statement of changes in equity. This is similar to the UK reconciliation of movements in You're a Preview shareholders' funds, and it also includes theReading statement of movements in reserves. It shows, in columnar form, the equity share capital and reserves, with details of all the movements that h Unlock full access with a free trial. taken place during the period.
Sign up to vote on this title Download With Free Trial IAS 1 also illustrates a statement of recognised gains and losses that may be used as an Useful Not useful and alternative to the statement of changes in equity. Figures 5 6 show the statements, broadl presented as in IAS 1 (slightly abridged to exclude matters outside the scope of Paper F3).
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Net profit for the period
X
Dividends paid
(X)
Issue of share capital
X
X
-
-
Balance at end of period
X
X
X
X
* The change in accounting policy is treated as a prior year adjustment. This is the treatment required in IAS 8 if the change is to be applied retrospectively - in other words, as if the new policy had always been in use. A change can also be applied prospectively - applied only to transactions after the change, with no adjustment to the opening balance of retained earnings. fundamental error affecting prior periods would also normally be treated as a prior period adjustment as shown here.
Figure 6: Statement of recognised gains and losses $m Surplus/deficit on revaluation of properties X Surplus/deficit on revaluation of investments X Net gains not recognised in the income statement X Net profit for the period X You're Reading a Preview Total recognised gains and losses X Unlock full access with a free trial.
If this second presentation is adopted, the reconciliation of opening and closing balances of s capital, reserves and accumulated profit included in the changes in equity would Sign up toof vote on this title Download With Freestatement Trial shown in the notes to the financial statements. Useful Not useful
Neil Stein is former examiner for Paper 1.1
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RELEVANT TO ACCA QUALIFICATION PAPERS F7 AND P2
Bin the clutter
It is unusual to think about the effects of ‘clutter’ but, increasingly, this phenomenon is being discussed. One prominent website describes clutter a follows: ‘Clutter invades your space and takes over your life. Clutter makes disorganised, stressed, out of control. Clutter distracts you from your priorities. Clutter can stop you achieving your goals.’ This definition of clutt may not be completely applicable to annual reports, but it is possible to see certain aspects, which are applicable.
The UK’s Financial Reporting Council (FRC), among other organizations, ha called for reduced ’clutter’ in annual reports. Additionally, the Institute of Chartered Accountants In Scotland (ICAS) and the New Zealand Institute of Chartered Accountants (NZICA) were commissioned by the IASB to make cu to the disclosures within a certain group of IFRSs, and produce a report.
Reading a Previewrelevant information and Clutter in annual reports is a You're problem, obscuring up to vote on thisthe title performan making it more difficult for users to find the keySign points about Unlock full access with a free trial. Useful Not useful of the business and its prospects for long-termsuccess. The main observat of the discussion paper published by the FRC were: Download With Free Trial there is substantial scope for segregating standing data, either to a •
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ANNUAL REPORTS
AUGUST 2012
imposition of unnecessary new disclosures. A listed company may have to comply with listing rules, company law, international financial reporting standards, the corporate governance codes, and if it has an overseas listing any local requirements, such as those of the Securities and Exchange Commission (SEC) in the US. Thus, a major source of clutter is the fact that different parties require differing disclosures for the same matter. For example, an international bank in the UK may have to disclose credit risk under IFRS 7, Financial Instruments: Disclosures, the Companies Acts and th Disclosure and Transparency Rules, the SEC rules and Industry Guide 3, as well as the requirements of Basel II Pillar 3. A problem is that different regulators have different audiences in mind for the requirements they impo on annual reports. Regulators attempt to reach wider ranges of actual or potential users and this can lead to a loss of focus and structure in reports.
There may a need for a proportionate approach to the disclosure requireme for small and mid-cap quoted companies that take account of the needs of their investors, as distinct from those of larger companies. This may be achieved by different means. For example, a principles-based approach to disclosures in IFRS, specific derogations from requirements in individual IFR You're adapted Reading a Preview or the creation of an appropriately local version of the IFRS for SME up to on this titlereporting Pressures of time and cost can understandablySign lead tovote defensive Unlock full access with a free trial. Useful Not usefulmaterial fr smaller entities and to choosing easy options, such as repeating a previous year, cutting and pasting from the reports of other companies an Download With Free Trial including disclosures of marginal importance.
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ANNUAL REPORTS
AUGUST 2012
reader may be disadvantaged by having to hunt in the small print for what remains key to a full understanding of the report.
Preparers wish to present balanced and sufficiently informative disclosures and may be unwilling to separate out relevant information in an arbitrary manner. The suggestion of relegating all information to a website assumes all users of annual reports have access to the internet, which may not be th case. A single report may best serve the investor, by having one reference document rather than having the information scattered across a number of delivery points.
Shareholders are increasingly unhappy with the substantial increase in the length of reports that has occurred in recent years. This has not resulted in more or better information, but more confusion as to the reason for the disclosure. A review of companies’ published accounts will show that large sections such as ‘Statement of Directors Responsibilities’ and ‘Audit Committee report’ are almost identical.
Materiality should be seen as the driving force of disclosure, as its very Reading a or Preview definition is based on whetherYou're an omission misstatement could influence Sign up toThe vote assessment on this title decisions made by users of the financial statements. of wh Unlock full access with a free trial. Notto useful Useful is material can be highly judgmental and can vary from user user. A prob that seems to exist is that disclosures are being made because a disclosure Download With Free Trial checklist suggests it may need to be made, without assessing whether the
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ANNUAL REPORTS
AUGUST 2012
can be obscured in a long note running over several pages. A further proble is that accounting policy disclosure is often ‘boilerplate’, providing little specific detail of how companies apply their general policies to particular transactions.
IFRS requires disclosure of ‘significant accounting policies’. In other words, IFRS does not require disclosure of insignificant or immaterial accounting policies. Omissions in financial statements are material only if they could, individually or collectively, influence the economic decisions that users mak In many cases, it would not. Of far greater importance is the disclosure of t judgments made in selecting the accounting policies, especially where a ch is available.
A reassessment of the whole model will take time and may necessitate chan to law and other requirements. For example, unnecessary clutter could be removed by not requiring the disclosure of IFRS in issue but not yet effectiv The disclosure seems to involve listing each new standard in existence and each amendment to a standard, including separately all those included in th annual improvements project, regardless of whether there is any impact on You're Reading entity. The note becomes a list without anya Preview apparent relevance. Sign up to vote on this title
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Useful Not The IASB has recently issued a request for views regarding itsuseful forward agen in which it acknowledges that stakeholders have said that disclosure Download With Free Trial requirements are too voluminous and not always focused in the right areas.
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RELEVANT TO ACCA QUALIFICATION PAPERS F7 AND P2
What is a financial instrument?
Let us start by looking at the definition of a financial instrument, which is that a financial instrument is a contract that gives rise to a financial asset of one entity a financial liability or equity instrument of another entity.
With references to assets, liabilities and equity instruments, the statement of finan position immediately comes to mind. Further, the definition describes financial instruments as contracts, and therefore in essence financial assets, financial liabil and equity instruments are going to be pieces of paper.
For example, when an invoice is issued on the sale of goods on credit, the entity th has sold the goods has a financial asset – the receivable – while the buyer has to account for a financial liability – the payable. Another example is when an entity ra finance by issuing equity shares. The entity that subscribes to the shares has a financial asset – an investment – while the issuer of the shares who raised finance to account for an equity instrument – equity share capital. A third example is when entity raises finance by issuing bonds (debentures). The entity that subscribes to t You're Reading a Preview bonds – ie lends the money – has a financial asset – an investment – while the issu Sign up to vote on this title of the bonds – ie the borrower who has raised the finance – has to account for the Unlock full access with a free trial. Useful Not useful bonds as a financial liability. Download With Free Trial So when we talk about accounting for financial instruments, in simple terms what
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ACCOUNTING FOR FINANCIAL INSTRUMENTS JULY 2012
statement, thus reducing the reported profit of the entity, while the dividends paid equity shares are an appropriation of profit rather than an expense.
When raising finance the instrument issued will be a financial liability, as opposed being an equity instrument, where it contains an obligation to repay. Thus, the issu of a bond (debenture) creates a financial liability as the monies received will have be repaid, while the issue of ordinary shares will create an equity instrument. In a formal sense an equity instrument is any contract that evidences a residual interes the assets of an entity after deducting all of its liabilities.
It is possible that a single instrument is issued that contains both debt and equity elements. An example of this is a convertible bond – ie where the bond contains an embedded derivative in the form of an option to convert to shares rather than be repaid in cash. The accounting for this compound financial instrument will be considered in a subsequent article.
Equity instruments Equity instruments are initially measured at fair value less any issue costs. In man legal jurisdictions when equity shares are issued they are recorded at a nominal va with the excess consideration received recorded in a share premium account and t issue costs being written off against the share premium. You're Reading a Preview
Sign up to vote on this title Example 1: Accounting for the issue of equity Unlock full access with a free trial. Useful Not Dravid issues 10,000 $1 ordinary shares for cash consideration of useful $2.50 each. Iss costs are $1,000. Download With Free Trial
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ACCOUNTING FOR FINANCIAL INSTRUMENTS JULY 2012
Equity instruments are not remeasured. Any change in the fair value of the shares not recognised by the entity, as the gain or loss is experienced by the investor, the owner of the shares. Equity dividends are paid at the discretion of the entity and a accounted for as reduction in the retained earnings, so have no effect on the carry value of the equity instruments.
As an aside, if the shares being issued were redeemable, then the shares would be classified as financial liabilities (debt) as the issuer would be obliged to repay back the monies at some stage in the future.
Financial liabilities A financial instrument will be a financial liability, as opposed to being an equity instrument, where it contains an obligation to repay. Financial liabilities are then classified and accounted for as either fair value through profit or loss (FVTPL) or a amortised cost. Financial liabilities at amortised cost The default position is, and the majority of financial liabilities are, classified and accounted for at amortised cost.
Financial liabilities that are classified as amortised cost are initially measured at fa You're Reading a Preview value minus any transaction costs. Sign up to vote on this title
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Useful that means Not Accounting for a financial liability at amortised cost theuseful liability's effec rate of interest is charged as a finance cost to the income statement (not the inter Download With Free Trial paid in cash) and changes in market rates of interest are ignored – ie the l iability i
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ACCOUNTING FOR FINANCIAL INSTRUMENTS JULY 2012
In applying amortised cost, the finance cost to be charged to the income statemen calculated by applying the effective rate of interest (in this example 7%) to the opening balance of the liability each year. The finance cost will increase the liabilit The bond is a zero coupon bond meaning that no actual interest is paid during the period of the bond. Even though no interest is paid there will still be a finance cost borrowing this money. The premium paid on redemption of $1,449 represents the finance cost. The finance cost is recognised as an expense in the income statemen over the period of the loan. It would be inappropriate to spread the cost evenly as would be ignoring the compound nature of finance costs, thus the effective rate of interest is given. In the final year there is a single cash payment that wholly discharges the obligation. The workings for the liability being accounted for at amortised cost can be summarised and presented as follows. Opening balance
Year 1 Year 2
$10,000 $10,700
Plus income statement finance charge @7% on the opening balance $700 $749
Less the cash paid
(Nil) ($11,449)
Closing balance, being liability on the statement of finan position $10,700 Nil
Accounting for financial liabilities is regularly examined in both Paper F7 and Pape You're Reading a Preview P2 so let's have a look at another, slightly more complex example. Sign up to vote on this title
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Not useful Useful Example 3: Accounting for a financial liability at amortised cost Broad raises finance by issuing $20,000 6% four-year loan notes on the first day o Download With Free Trial the current accounting period. The loan notes are issued at a discount of 10%, and
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ACCOUNTING FOR FINANCIAL INSTRUMENTS JULY 2012
opening balance of the liability each year. The finance cost will increase the liabilit The actual cash is paid at the end of the reporting period and is calculated by applying the coupon rate (in this example 6%) to the nominal value of the liability this example $20,000). The annual cash payment of $1,200 (6% x $20,000 = $1, will reduce the liability. In the final year there is an additional cash payment of $21,015 (the nominal value of $20,000 plus the premium of $1,015), which extinguishes the remaining balance of the liability. The workings for the liability be accounted for at amortised cost can be summarised and presented as follows. Opening balance
Year Year Year Year
1 2 3 4
Total finance costs
$17,000 $17,840 $18,781 $19,835
Plus income statement finance charge @ 12% on the opening balance $2,040 $2,141 $2,254 $2,380
Less the cash paid (6% x 20,000)
($1,200) ($1,200) ($1,200) ($1,200) ($21,015)
$8,815 You're Reading a Preview
Closing balance, be the liability the statem of financi position $17,840 $18,781 $19,835
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Nil
Because the cash paid each year is less thanwith thea free finance Unlock full access trial. cost, each year the Useful Not useful outstanding liability grows and for this reason the finance cost increases year on y as well. The total finance cost charged to income Download With Freeover Trialthe period of the loan comprises not only the interest paid, but also the discount on the issue, the premi
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ACCOUNTING FOR FINANCIAL INSTRUMENTS JULY 2012
By accounting for a financial liability at FVTPL, the financial liability is also increas by a finance cost and reduced by cash repaid but is then revalued at each reportin date with any gains and losses immediately recognised in the income statement. T measurement of the new fair value at the year end will be its market value or, if no known, the present value of the future cash flows, using the current market interes rates. The interest rate used subsequently to calculate the finance cost will be this new current rate until the next revaluation.
Example 4: Accounting for a financial liability at FVTPL On 1 January 2011 Swann issued three year 5% $30,000 loans notes at nominal v when the effective rate of interest is also 5%. The loan notes will be redeemed at p The liability is classified at FVTPL. At the end of the first accounting period market interest rates have risen to 6%. Required Explain and illustrate how the loan is accounted for in the financial statements of Swann in the year ended 31 December 2011.
Solution Swann is receiving cash that is obliged to repay so this financial instrument is classified as a financial liability. The liability is classified at FVTPL so, presumably You're Reading a Preview is being held for trading purposes or the option to have it classified as FVTPL has Sign up to vote on this title been made. Unlock full access with a free trial.
Useful
Not useful
Initial measurement is at the fair value of $30,000 received and, although there ar Download With Free Trial transaction costs in this example, these would be expensed rather than taken into
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ACCOUNTING FOR FINANCIAL INSTRUMENTS JULY 2012
As Swann has classified this liability as FVTPL, it is revalued to $29,450. The reduction of $550 in the carrying value of the liability from $30,000 is regarded as profit, and this is recognised in the income statement. If, however, the higher disco rate used was not because general interest rates have risen, rather the credit risk o the entity has risen, then the gain is recognised in other comprehensive income. T can all be summarised in the following presentation. Opening balance
1/1/2011
$30,000
Plus income statement finance charge @ 5% on the opening balance $1,500
Less the cash paid (5% x 30,000)
Carrying value of the liability at the year end
Fair value of the liability at the year end
($1,500)
$30,000
$29,450
Gain incom statem
$55
We can briefly consider the accounting in the remaining two years. The finance cha in the income statement for the year end 31 December 2012 will be the 6% x $29 = $1,767, and with the cash payment of $1,500 being made, the carrying value of liability will be $29,717 ($29,450 plus $1,767 less $1,500) at the year end.
You're Reading a Preview If at 31 December 2012 the market rate of interest has fallen to, say, 4%, then the Sign up to vote on this title value of the liability at the reporting willwith beathe present value of the last Unlockdate full access free trial. Usefulat 4% Not repayment due of $31,500 in one year's time discounted (ie useful $31,500 x 0.96 $30,288), which in turn means that as the fair value of the liability exceeds the Download With Free Trial carrying value, a loss of $571 (ie $30,288 less $29,717) arises which is recognise
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RELEVANT TO ACCA QUALIFICATION PAPERS F7 AND P2
What is a financial instrument? Part 2
My previous article covered the classification, initial measurement and subsequen measurement of financial liabilities (eg loans and bonds) and issued equity instruments (eg ordinary shares). It was established that when issuing financial instruments to raise finance, the issuer had to classify instrument as either financi fi nanci liabilities (and, in turn, financial liabilities were split into amortised cost and Fair Value Through Profit or Loss (FVTPL)) or equity e quity instruments. This can be summari in the following diagram. Issuing financial instruments (raising finance) Financial liabilities
Contain an obligation to repay
Equity instrumen
Evidence of an ownershipinteres Sign up to vote on this title the residual net useful Useful Not assets
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ACCOUNTING FOR FINANCIAL INSTRUMENTS AUGUST 2012
being repaid in cash. For accounting purposes it will be necessary on initial recognition to split out the debt and equity elements so that they can be separatel accounted for. The fair value of the option is highly subjective, but the fair value of debt element is more easily measured by discounting the future cash flows. The assumption is then made that the fair value of the option is the balancing figure.
Example 1 Graham Gooch issues a 3% $200,000 two-year convertible bond at par. The effect rate of interest of the instrument is 8%. The terms of the convertible bond is that t holder of the bond, on the redemption date, has the option to convert the bond to equity shares at the rate of 10 shares with a nominal value of $1 per $100 debt ra than being repaid in cash. Transaction costs can be ignored. Graham Gooch will account for the financial liability arising using amortised cost. Required Explain the accounting for the issue of the convertible bond.
Solution A convertible bond creates both an equity and a debt instrument. On initial recognition the debt element will be measured at fair value – ie the present value o the future cash flow, with the equity element representing the balancing figure. Transaction costs have been ignored, but would have to split proportionately betwe Sign up to vote on this title the debt and equity elements. The value ascribed to to the equity element is the Useful Not useful balancing figure. Cash flow
Discount factor
Present value
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ACCOUNTING FOR FINANCIAL INSTRUMENTS AUGUST 2012
Year 1 Year 2
Opening balance $182,098 $190,666
Income statement Less cash Closing balance finance cost@8% of the liability $14,568 ($6,000) $190,666 $15,334* ($6,000) $200,000
*includes rounding
At the end of Year 2 the liability can be extinguished by the payment of $200,000 cash, or if the option is exercised by the bond holder, then it is extinguished by the issue of 20,000 $1 ordinary shares at nominal value with a share premium of $180,000 also being recorded.
Financial assets Now let us turn our attention to the accounting for financial assets, as there have b some recent changes following the issue of IFRS 9, Financial Instruments which will supersede IAS 39, Financial Instruments: Recognition and Measurement . The new standard applies to all types of financial assets, except for investments in subsidiaries, associates and joint ventures and pension schemes, as these are all accounted for under various other accounting standards.
IFRS 9, Financial Instruments has simplified the way that financial assets are accounted. As with financial liabilities the standard retains a mixed measurement system for financial assets, allowing some to be stated at fair value while others at Sign up to vote on this title amortised cost. On the same basis that when an entity issues a financial instrumen Not useful Useful so when has to classify it as a financial liability liabili ty or equity instrument, an entity acquires a financial asset it will be acquiring a debt asset (eg an investment in bon trade receivables) or an equity asset (eg an investment in ordinary shares). Financ
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ACCOUNTING FOR FINANCIAL INSTRUMENTS AUGUST 2012
measuring assets or liabilities or recognising the gains and losses on them on different bases. An example of where it is appropriate to use the fair value option a thus, avoid an accounting mismatch is where an entity holds a financial asset that debt and that carries a fixed rate of interest, but is then hedged with an interest ra swap that swaps the fixed rates for floating rates. The interest swap is a financial instrument that would be held at FVTPL and so, accordingly, the financial asset classified as debt also needs to be at FVTPL to ensure that the gains and losses arising from both instruments are naturally paired in income and, thus, reflect the substance of the hedge. If the financial asset classified as debt was accounted for amortised cost, then this would create the accounting mismatch. All other financial assets that are debt instruments must be measured at FVTPL.
Accounting for financial assets that are equity instruments (eg investments in eq shares) Equity investments have to be measured at fair value in the statement of financial position. As with financial assets that are debt instruments, the default position fo equity investments is that the gains and losses arising are recognised in income (FVTPL). However, there is an election that equity investments can at inception be irrevocably classified and accounted as FVTOCI, so that gains and losses arising a recognised in other comprehensive income, thus creating an equity reserve, while You're Reading aSuch Preview dividend income is still recognised in income. an election cannot be made if Sign up to vote on this title equity investment is acquired for trading. On disposal of an equity investment Unlock full access with a free trial. Not useful Useful inincome accounted for as FVTOCI, the gain or loss to be recognised is the differe between the sale proceeds and the carrying value. Gains or losses previously Download With Free Trial recognised in other comprehensive income cannot be recycled to income as part o
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ACCOUNTING FOR FINANCIAL INSTRUMENTS AUGUST 2012
Financial assets
If classified as amortised cost: initial measurement is at fair value plus transaction costs and then subsequent
Debt instruments
Equity instruments
Contain an obligation to be repaid
Evidence of an ownership interest in the residual net assets
If classified as If classified a FVTPL: FVTOCI: initial initial measurement is measuremen at fair value, at fair value You're Reading a Preview and then so is transaction c Sign up to vote on this title subsequent and subsequ Unlock full access with a free trial. measurement Useful Not useful measuremen with gains and at fair value Download With Free Trial losses being gains and los
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ACCOUNTING FOR FINANCIAL INSTRUMENTS AUGUST 2012
determine and account for expected credit losses when the asset is originated or acquired rather than wait for an actual default. This is achieved by making an allowance for the initial expected losses over the life of the asset by considering a reduction in the interest revenue.
Example 2: accounting for impairment losses Imran Khan holds a portfolio of financial assets that are debt instruments (ie Imra Khan is a lender). These assets are initially recognised at $100,000 and accounted at amortised cost as they meet the business model and cash flow tests. Each loan a coupon rate of 8% as well as an effective rate of 8%. In the current period no loa have actually defaulted; however, it is felt that a proportion of loans will default ove the loan period and, thus, in the long run the rate of return from the portfolio will b approximately 3%. Required Discuss the impairment review of these assets in the first accounting period using expected loss model.
Solution The gross interest income that is initially recognised in income is $8,000 (as calculated using the effective rate of 8% on the initial carrying value of $100,000). Reading a Preview(as calculated using the coup With no defaults, cash of $8,000You're will also be received Sign up to vote onreview this titlethe carryin rate of 8% on the nominal value). Thus, prior to any impairment Unlock full access with a free trial. Useful Not useful value at the end of the first reporting period is $100,000.
Download With Free Trial However, to recognise the impairment loss on an expected loss basis the actual ne
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page 38
NOVeMBeR/DeCeMBeR 2008
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CONSTRUCTION CONTRACTS RELEVANT TO ACCA QUALIFICATION PAPER F7 The correct timing of revenue (and profit) is crucial in order to faithfully represent the results shown in the income statement. For many businesses, revenue and costs are easily divisible into a 12-month accounting period. For example, a retailer will recognise revenue when realised throughout the year, and match costs in accordance with the accruals concept. For some businesses, however, traditional revenue recognition methods (ie ‘show revenue when realised’) are not applicable. Many such organisations are in the construction industry and their business dealings involve contracts that are usually long-term in nature or span at least one accounting year end. For example, a contractor has just won the bid to build a stadium in the new Olympic village in London for the 2012 Olympic Games. Work will commence on 1 January 2009 and it is anticipated that the stadium will be completed on 31 December 2011. If this type of contract were treated as a normal sale of goods, then revenue and profit would
IAS 11 TREATMENT Where possible, IAS 11 applies the accruals concept to the revenue earned on a construction contract. If the outcome of a project can be reasonably foreseen, then the accruals concept is applied by recognising profit on uncompleted contracts in proportion to the percentage of completion, applied to the estimated total You're Reading a Preview contract profit. If, however, a loss is expected on the contract, then an application of Unlock full access with a free trial. prudence is necessary and the loss will be recognised immediately.
company commenced a contra to take more than one year to c contract summary at 31 Decem as follows:
Progress payments Contract price Work certified complete Contract costs incurred to 31 December 2008 Estimated total cost at 31 December 2008*
Download With Free Trial Sign up to vote on this title OUTCOME CAN BE RELIABLY MEASURED IAS 11 only allows revenue and contractUseful The examiner Not useful sometimes pre costs to *this be recognised when the outcome of the contract manner – ‘estimated total c can be predicted with reasonable certainty. incurred plus costs to complete This means that it should be probable that the
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Step 6: Depending on what approach was taken at step 5, you are now in a position to find the balancing figure to complete the income statement. Step 7: Calculate the asset or liability outstanding on the construction contract.
Income statement extract – 31 December 2008
Revenue (work certified) COS (ß) Gross profit (W2)
$000 1,824 1,680 144
Statement of financial position extract – 31 December 2008 Current assets Asset on a construction contract (W3) WORKING PAPER (W1) Expected outcome Contract price Total costs Expected profit
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linKed PeRFoRMance oBJectiVes studying paper F7? did you know that perForManCe oBJe 10 and 11 are linked?
page 39
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$000 2,736 2,520 216
(W2) Percentage of completion Accounting policy = Work certified complete Work certified to date Contract price 1,824 = 66.67% 2,736 (As a round percentage was not found, use the fraction to complete workings instead) Profit to be recognised = $216 (W1) x $1,824 /
Required: Calculate the effect of the above contract in the financial statements at 31 March 2008.
during the year amount to $700,00 had yet been received. What should entries be regarding the contract at
SOLUTION 1 Step 1: Set up extracts of the financial statements and a working paper. Step 2: Determine at W1 whether a profit or loss is expected on the contract. Step 3: A loss will be calculated in this example and should be recognised in the income statement immediately. Step 4: ‘Build’ up the income statement. If it is a work-certified accounting policy, then the work certified for the year should be taken to the revenue line. If it is a cost-basis accounting policy, then the costs incurred should be taken to the cost of sales line. Step 5: Depending on the approach taken at step 4, you are now in a position to find the balancing figure to complete the income statement. Step 6: Calculate the asset or liability outstanding on the construction contract.
Solution During the year, as costs have been natural double entries occurring wo Dr Purchases $700,00 Cr Bank/payables $700,000
As the outcome cannot be reliably m assuming all costs are recoverable, be taken as equal to the costs incur Dr Receivables $700,00 Cr Revenue $700,000
In processing the above journals, no taken on the contract during the fin
WHAT IS INCLUDED IN CONTRAC AND COSTS? Contract revenue will be the amoun initial contract, plus revenue from v original contract work, plus incentiv and claims that can be reliably mea Income statement extract – 31 March 2008 You're Reading a Preview contract revenue which can be valu $000 value of received or receivable reve Unlock full access with a free trial. Revenue (ß) 3,300 Contract costs are to include co COS (costs incurred) (3,600) directly to the initial contract plus c Gross loss (W1) (300) attributable to general contract Download With Free Trial Sign up to vote on this title that can be specifically charged to t the terms of the contract. Statement of financial position extract – Useful underNot useful 31 March 2008 Current liabilities EXAM ADVICE Liability on a construction contract 480 There are two common ‘technical a
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This article sets out the accounting treatment for the impairment of trade receivables/debtors. The provision for bad debts is now, in effect, governed by IAS 39, Financial Instruments: Recognition and Measurement for International stream students or FRS 26, Financial Instruments: Measurement for UK stream students. Adapted papers generally follow the cont of IAS 39.
This article covers the general accounting principles and then outlines its applicability to CAT Scheme Papers 1, 3 and 6, and Professional Scheme Paper F3.
General accounting principles (relevant to ACCA Qualification Papers F7 an P2)
Trade receivables are financial assets falling under 'loans and receivables' in IAS 39 and FRS According to these standards, loans and receivables are measured at amortised cost using the effective interest rate method. Initially, they will be carried at fair value at the time of recognition, which in the case of trade receivables/debtors will be the invoiced amount.
The effective interest rate method spreads the interest income or expense over the life of the financial asset or liability. Obviously, such a method does not seem to be relevant to trade receivables/debtors where normally there is no interest payment to spread. FRS 26 and IAS 3 therefore allow short-term receivables/debtors with no stated interest rate to be measured at th You're Reading a Preview original invoice amount, if the effect of discounting is immaterial. This would apply to trade receivables/debtors and therefore, they will bewith carried the invoice amount. Unlock fullstill access a free at trial.
whet However, FRS 26 and IAS 39 state that an entity must assess balance sheet date Signat upeach to vote on this title Download With Free Trial there is any objective evidence that a financial asset or group of financial assets usefulis impaired. I Useful Not there is objective evidence that an impairment loss on the financial assets has been incurred, t loss must be recognised in profit or loss. Since trade receivables/debtors are financial assets,
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Impairment of individually significant balances must be separately assessed and an allowance made when it is probable that the cash due will not be received in full.
Impairment of individually non-significant balances can be measured on a portfolio or group basis. Any receivables that are not thought to be impaired are included in the group assessme If information becomes available that identifies losses on a receivable in the group then it is removed and individually assessed.
The collective assessment of impairment requires the splitting of the list of receivables into groups of trade receivables that share similar credit risk characteristics. The credit risk groups to be assessed for impairment using historical loss experience for each group. Such historical loss experience would be adjusted to reflect the effects of current conditions. An individual receivable/debtor impairment factor is likely to be specific to that receivable/debtor - pending liquidation of the entity, for example.
A collective impairment factor is likely to be as a result of past economic events that affect th receivables in general (eg interest rates). Impairment losses will be recognised only when the are incurred. Thus, if there is deterioration in the credit quality of the financial assets as a res of a past event, then an impairment loss may have occurred. You're Reading a Preview
The recognition of future losses based on possible or expected future trends is not in accordan Unlock full access with a free trial. with the IASB Framework and IAS 37/FRS 12, Provisions, Contingent Liabilities and Contingent Assets. General provisions would therefore not be allowed as the historical Sign up to vote on this title Download With Free Trial experience is zero and it is unlikely to produce an acceptable estimate of the cash flows to be Useful Not useful received. Conclusion
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RELEVANT TO ACCA QUALIFICATION PAPER F7
Studying Paper F7? Performance objectives 10 and 11 are relevant to this exam
ACCOUNTING FOR LEASES The accounting topic of leases is a popular Paper F7 exam area that could feature to varying degrees in Questions 2, 3, 4 or 5 of the exam. This topic area is currently covered by IAS 17, Leases. IAS 17, Leases takes the concept of and applies it to the specific accounting area of leases.
When applying this concept, it is often deemed necessary to account for the substance of a transaction, ie its commercial reality, rather than its strict legal form. In other words, the legal basis of a transaction can be used to hide the true nature of a transaction. It is argued that by applying substance, the financial statements become more reliable and ensure that the lease is faithfully represented.
Why do we need to apply substance to a lease? A lease agreement is a contract between two parties, the lessor and the lessee. The lessor is the legal owner of athe asset, the lessee obtains the You're Reading Preview Sign up to vote on this title right to use the asset in return for rental payments. Unlock full access with a free trial. Useful Not useful Historically, assets that were used but not owned were not shown on the Download With Free Trial statement of financial position and therefore any associated liability was
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2 ACCOUNTING FOR LEASES
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OCTOBER 2010 A finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership of an asset to the lessee.
An operating lease is defined as being any lease other than a finance lease.
In order to gain classification of the type of lease you are dealing with, you must first look at the information provided within the scenario and determine if the risks and rewards associated with owning the asset are with the lessee or the lessor. If the risks and rewards lie with the lessee then it is said to be a finance lease, if the lessee does not take on the risks and rewards, then the lease is said to be an operating lease.
There are many risks and rewards outlined within the standard, but for the purpose of the Paper F7 exam there are several important areas. The main reward is where the lessee has the right to use the asset for most of, or all of, its useful economic The primary risks are where You're Readinglife. a Preview the lessee pays to insure, maintain and repair Signthe up toasset. vote on this title Unlock full access with a free trial. Useful Not useful When the risks and rewards remain with the lessee, the substance is such that even though theDownload lessee isWith not Free the Trial legal owner of the asset, the
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3 ACCOUNTING FOR LEASES
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OCTOBER 2010 Dr Non-current assets Cr Finance lease liability (This should be done by using the lower of the fair value of the asset or the present value of the minimum lease payments*.) *Note The present value of the minimum lease payments is essentially the lease payments over the life of the lease discounted to present value – you will either be given this figure in the Paper F7 exam or, if not, use the fair value of the asset. You will not be expected to calculate the minimum lease payments..
Depreciation Following the initial capitalisation of the leased asset, depreciation should be charged on the asset over the shorter of the lease term or the useful economic life of the asset. The accounting for this will be: Dr Depreciation expense Cr Accumulated depreciation Lease rental/interest When you look at a lease agreement it should be relatively easy to see that there is a finance costYou're tied up within the transaction. For example, Reading a Preview a company could buy an asset with a useful Sign economic oftitle four years up to votelife on this access with a free trial. for $10,000 or lease it forUnlock four full years payinga Useful rental of Not $3,000 useful per annum. Download With Free Trial
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4 ACCOUNTING FOR LEASES
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OCTOBER 2010 agreement – again this will be required to calculate it.
and you are not
One of the easiest ways to apply the actuarial method in the exam is to use a leasing table. Please take note of when the rental payment is actually due, is it in advance (ie rental made at beginning of the lease year) or is it in arrears (ie rental made at the end of the lease year)? This will affect the completion of the lease table as highlighted below: Rental payments in advance Year B/fwd Rental
X
X
(X)
Capital o/s X
Interest (rate given) X To income statement (finance costs)
C/fwd
X To statement of financial position (liability)
Rental payments in arrears You're Reading a Preview Sign up to vote on this C/fwd title Year B/fwd Interest Rental Unlock full access with a free trial. (rate given) Useful Not useful X X X (X) X Download With Free Trial To income To statemen
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5 ACCOUNTING FOR LEASES
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OCTOBER 2010
Solution The lease should be classified as a finance lease as the estimated life of the asset is four years and Bush retains the right to use this asset for four years in accordance with the lease agreement therefore enjoying the rewards of the asset.
recognise the asset and the lease liability Dr Property, plant and equipment 14,275 Cr Finance lease obligations 14,275 depreciation Dr Depreciation expense ($14,275 / 4 years) Cr Accumulated depreciation
3,568 3,568
lease rental/interest Tip: use the lease table and complete next year as well to help you complete the split between non-current and current liabilities. Year
B/fwd
1 2
14,275 11,416
Interest Rental C/fwd (15%) You're Reading a Preview Sign up to vote on this title 2,141 (5,000) 11,416 Unlock full access with a free trial. Useful Not useful 1,712 8,128 (5,000) Download With Free Trial
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6 ACCOUNTING FOR LEASES
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OCTOBER 2010 relating to the asset. Annual rentals of $8,000 are payable in advance from 1 April 2009. The machine is expected to have a nil residual value at the end of its life. The machine had a fair value of $28,000 at the inception of the lease. The lessor includes a finance cost of 10% per annum when calculating annual rentals. How should the lease be accounted for in the financial statements of Shrub for the year end 31 March 2010?
Solution The lease should be classified as a finance lease as the estimated life of the asset is four years and Shrub retains the right to use this asset for four years in accordance with the lease agreement therefore enjoying the rewards of the asset. In addition to this Shrub is required to maintain and insure the asset, therefore retaining the risks of asset ownership.
recognise the asset and the lease liability Dr Property, plant and equipment 28,000 Cr Finance lease obligations 28,000 depreciation You're Reading a Preview
Dr Depreciation expense 7,000 Sign up to vote on this title Unlock full access with a free trial. ($28,000 / 4 years) Useful Not useful Cr Accumulated depreciation 7,000 Download With Free Trial
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7 ACCOUNTING FOR LEASES
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OCTOBER 2010 Non-current assets
Carrying value machine (28,000 – 7,000)
21,000
Non-current liabilities
Lease obligation
14,000
Current liabilities
Lease obligation Accrued interest Capital ((22,000 – 14,000) –2,000)
2,000 6,000
Example 3 – Split lease year treatment On 1 October 2008 Number Co entered into an agreement to lease a machine that had an estimated life of four years. The lease period is also four years with annual rentals of $10,000 payable in advance from 1 October 2008. The machine is expected to have a nil residual value at the end of its life. The machine had a fair value of $35,000 at the inception of the lease. TheYou're lessor includes a finance cost of 10% per Reading a Preview annum when calculating annual rentals. Sign up to vote on this title Unlock full access with a free trial. Useful Not useful How should the lease be accounted for in the financial statements of Download Free Trial Number for the year end 31 March With 2010?
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8 ACCOUNTING FOR LEASES
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OCTOBER 2010 Dr Depreciation expense ($35,000 / 4 years x 6/12) Cr Accumulated depreciation
4,375
Dr Depreciation expense ($35,000 / 4 years) Cr Accumulated depreciation
8,750
4,375
8,750
lease rental/interest Tip: you are looking for the outstanding value of the lease 18 months after the lease agreement began. It is advisable that you extend your lease table so that you have two separate ‘c/fwd’ balances – the balance at the end of the accounting year (31 March) and the balance at the end of the lease year (30 September). Year B/fwd
1 2 3
Rental
Capital o/s
Interest C/fwd Interest (10%) (31 (10%) (6 Mar) (6 months) months) 35,000 (10,000) You're 25,000 1,250 26,250 1,250 Reading a Preview Sign up to vote on this title 18,375 27,500 (10,000) 17,500 875 875 Unlock full access with a free trial. 19,250 (10,000) 9,250 Useful Not useful NCLTrial Download With Free
C/fwd (30 Sep)
27,500 19,250
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9 ACCOUNTING FOR LEASES
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OCTOBER 2010 Operating lease accounting As the risks and rewards of ownership of an asset are not transferred in the case of an operating lease, an asset is not recognised in the statement of financial position. Instead rentals under operating leases are charged to the income statement on a straight-line basis over the term of the lease, any difference between amounts charged and amounts paid will be prepayments or accruals. Example 4 – Operating lease treatment On 1 October 2009 Alpine Ltd entered into an agreement to lease a machine that had an estimated life of 10 years. The lease period is for four years with annual rentals of $5,000 payable in advance from 1 October 2009. The machine is expected to have a nil residual value at the end of its life. The machine had a fair value of $50,000 at the inception of the lease.
How should the lease be accounted for in the financial statements of Alpine for the year end 31 March 2010? Solution In the absence of any further information, this transaction would be You're Reading a Preview classified as an operating lease as Alpine does usetitle the asset Signnot up toget vote to on this Unlock full access with a free trial. for most of/all of the assets useful economic and therefore Useful Not useful it can be life argued that they do not enjoy all the rewards from this asset. Download With Free Trial
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10 ACCOUNTING FOR LEASES
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OCTOBER 2010 Lease expense
2,500
Current assets: Prepayments
2,500
Example 5 – Initial rent free incentive A Co entered into an agreement to lease office space on 1 April 2009 for a fixed period of five years. As an incentive to encourage the office space to be occupied, a first year rent-free period was included in the agreement after which A Co is required to pay an annual rental of $36,000.
How should the lease be accounted for in the year ended 31 March 2010? Solution The total cost of leasing the office space is $144,000 ($36,000 4 years). Despite there being a ‘rent-free’ period the total cost of the lease should be matched to the period in which it relates.
Therefore, in year 1:
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Rental
Useful
$28,800
Not useful
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TEchnical
deferred ta
rElEVanT To acca qualiicaTion papErs 7
Deferred tax is a topic that is consistently tested in Paper F7, Financial Reporting and is often tested in further detail in Paper P2, Corporate Reporting . This article will start by considering aspects of deferred tax that are relevant to Paper F7, before moving on to the more complicated situations that may be tested in Paper P2. Te Deferred tax is accounted for in accordance with IAS 12, Income Taxes. In Paper F7, deferred tax normally results in a liability being recognised within the Statement of Financial Position. Position. IAS 12 defines a deferred tax liability as being the amount of income tax payable payable in future periods in respect of taxable temporary differences. differences. So, in simple terms, deferred tax is tax that is payable in the future. However, to understand this definition more fully, fully, it is necessary to explain the term ‘taxable temporary differences’. Temporary differences are defined as being differences between the carrying amount of an asset (or liability) within the Statement of Financial Position Position and its tax base ie the amount at which the asset (or liability) is valued for tax purposes by the
E and the cumulative capital allowances c are different, different, the carrying value of the a m . o n (cost less accumulated depreciation) w c y o different to its tax base (cost less accum i n capital allowances) and hence a taxable i T T i i , l 2 i s difference arises. 1 b o s a i p Ee 1 A non-current asset costing $2,000 was a i l l the start of year 1. It is being depreciat i h a a line over four years, resulting in annual T i n i c charges of $500. Thus a total of $2,00 s n w a depreciation is being charged. The capi E T allowances granted on this asset are: l n c u i f n s $ f a E Y ear 1 800 r D y o Year 2 600 r l T 360 o l n Year 3 Y ear 4 240 E a c T otal capital allowances 2,000 c m m Sign up to vote on this title a r E Useful Notcarrying useful value of the Table 1 shows o T n i n a tax base of the asset and therefore the r x T s difference at the end of each year. year. o a
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sTuDEnT accounTanT 08/2009 Studying Papers F7 or P2? pee ojetve 10 d 11 e ked
s a E r u T u f E h T – n s i E E c l n b E a r y E a f p f i g D n i y E r b a x r a o T p i m n E T T l E u l s b E a r . x T s a a E T h s n T r E o s V
TablE 1: ThE carrying ValuE, ThE Tax basE o ThE assET anD ThEr EorE ThE TEmpo DiErEncE aT ThE EnD o Each yEar (ExamplE 1) ye y e
1 2 3 4
c ve (ct - ted deet) $ 1,500 1,000 500 Nil
In the above example, when the capital allowances are greater than the depreciation expense in years 1 and 2, the entity has received tax relief early. early. This is good for cash flow in that it delays (ie defers) the payment of tax. However, However, the difference is only a temporary difference and so the tax will have to be paid in the future. In years 3 and 4, when the capital allowances for the year are less than the depreciation charged, the entity is being charged additional tax and the temporary difference is reversing. Hence the temporary differences can be said to be taxable
T e (ct - ted t e) $ 1,200 600 240 Nil
Assuming that the tax rate applicab company is 25%, the deferred tax be recognised at the end of year 1 is $75. This will be recorded by creditin a deferred tax liability in the Statem Position Position and debiting (increasing) the the Income Statement. endon of this yeartitle 2, the entity has SignBy up the to vote temporary difference of $400, ie the Useful from forward Not yearuseful 1, plus the additio of $100 arising in year 2. A liability is recorded equal to 25% x $400 = $10
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TEchnical , s E i T i l i T b i , a i r l E V y D E r n w . a a T r s o n o T h . E p E ’ h m m s s E a c E T a T a f f o T o o r s p E E E p s V i a a m T b T o c x E c E a E n p T h i s s E r D h E n E T p c E a n n h E a o l T u l a T c m a b ‘ E V o r g a f f n E f E k x i a E a y r T T h T
The movements in the liability are recorded in the Income Statement as part of the taxation charge
Te e tteet As IAS 12 considers deferred tax from t perspective of temporary differences b Year 1 2 3 4 carrying value and tax base of assets a $ $ $ $ the standard can be said to take a ‘bala Opening deferred approach’. However, it will be helpful to tax liability 0 75 100 65 effect on the Income Statement. Increase/(decrease) Continuing with the previous example in the year 75 25 (35) (65) that the profit before tax of the entity fo Closing deferred of years 1 to 4 is $10,000 (after char tax liability 75 100 65 0 depreciation). Since the tax rate is 25% then be logical to expect the tax expens You're Reading a Preview year to be $2,500. However, income tax The closing figures are reported in the Statement of taxable profits not on the accounting pr Financial Position as part of the deferred tax liability. Unlock full access with a free trial. The taxable profits and so the actual p for each year could be calculated as in Example 1 provides a proforma, which may be a The income tax liability is then record Download With useful format to deal with deferred tax within a Free Trial a tax expense. As we have seen in the ex published accounts question. accounting for deferred tax then results The movement in the deferred tax liability in the increase or decrease in the tax expense year is recorded in the Income Statement where: the tax expense each year repo Signfinal up to vote on thisfor title ¤ an increase in the liability, increases the Income Statement would be as in Table Notbeuseful tax expense ItUseful can therefore said that accounti ¤ a decrease in the liability, decreases the deferred tax is ensuring that the match tax expense. is applied. The tax expense reported in
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sTuDEnT accounTanT 08/2009
E h r T E f T a o E n r g o i n T i s E D u E q T s s E T T n g u n o i c E b c f a o D , E r h E s i V l E b w u o p h E T . h u m T a o n i D x E D E E E l h T u r s T E E f T b o
TablE 2: TaxablE proiT anD acTua l Tax liabiliTy calculaTion (ExamplE 1)
Profit before tax Depreciation Capital allowances Taxable profits Tax liability @ 25% of taxable profits
Year 1 $ 10,000 500 (800) 9,700
Year 2 $ 10,000 500 (600) 9,900
Year 3 $ 10,000 500 (360) 10,140
2,425
2,475
2,535
You're Reading a Preview
Unlock access with a freeincomE trial. TablE 3: inal Tax ExpEnsE orfull Each rEporTED sTaTEmEnT yEar (ExamplE 1
Year 1 Download With Free Trial Income tax 2,425 Increase/(decrease) due to deferred tax 75 Total tax expense 2,500
Year 2 2,475 25 2,500
Sign up to vote on this title ThE papEr 7 Exam Deferred tax is consistently tested in the published accounts question of the Paper F7 exam. (It should
Year 3 2,535 (35) 2,500
Useful 2 Not useful Ee
The trial balance shows a credit balan in respect of a deferred tax liability
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TEchnical
TablE 4: ExamplE 2 – publishED accounTs quEsTion stt 1 Opening deferred tax liability Increase in the year to be taken to IS as an increase in tax expense Closing deferred tax liability to be reported in SFP
$ 1,500
Provided in trial balance
1,000 2,500
Balancing figure Provided in information
$ stt 2 Opening deferred tax liability 1,500 Provided in trial balance You're Reading a Preview Increase in the year to be taken to IS as an increase in tax expense 1,000 Provided in information Unlock full access with a free trial. Closing deferred tax liability to be reported in SFP 2,500 Balancing figure
Download With $ Free Trial stt 3 Provided in trial balance Opening deferred tax liability 1,500 Increase in the year to be taken to IS as an increase in tax expense 1,000 SignBalancing up to votefigure on this title Closing deferred tax liability to be reported in SFP 2,500 Calculated from information Useful Not useful (25% x $10,000) stt 4
$
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sTuDEnT accounTanT 08/2009
TablE 5: rEValuED assET aT ThE EnD o yEar 2 (ExamplE 1) ye 2
Opening balance Depreciation charge/capital allowance Revaluation Closing Balance
c ve (ct - ted deet) $ 1,500 (500) 1,500 2,500
T e (ct - ted t e) $ 1,200 (600) 600
Te deee $ 300 100 1,500 1,900
You're Reading a Preview The carrying value will now be $2,500 while the given situation. Some of the situations that may free trial. below. In all of the following tax base remains at $600. There is, therefore, aUnlock full beaccess seenwith are adiscussed temporary difference of $1,900, of which $1,500 situations, assume that the applicable tax rate relates to the revaluation surplus. This gives rise to is 25%. With Free Trial a deferred tax liability of 25% x $1,900 = $475 Download at Deeed t et the year-end to report in the Statement of Financial Position. The liability was $75 at the start of the It is important to be aware that temporary year (Example 1) and thus there is an increase of differences can result intoneeding record Sign up vote onto this title a $400 to record. deferred tax asset instead of a liability. Temporary Useful useful the However, the increase in relation to the differences affect timing of Not when tax is paid revaluation surplus of 25% x $1,500 = $375 will or when tax relief is received. While normally they be charged to the revaluation reserve and reported result in the payment being deferred until the
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TEchnical g n i y s r T r n a E c E m E s T h a s T b u j o x D T a T a s E n r E h T o i f E T r E a b E l D i u l l l i o a w s V E n g s a o n i c y b n r x a o r a T s c E n E h T o i h E T T i , l a s h . c i T w l n s p u s T n m i o T u x c n u o
TablE 6: impairmEnT o non-currEnT assET (ExamplE 3) c ve te et $ 2,800
T e te et $ 3,500
Te deee $ (700)
Deeed t et
TablE 7: wriTE Down o inVEnTory (ExamplE 4) c ve te et $ 9,000
T e te et Te deee You're Reading $a Preview $ 10,000 (1,000)
Deeed t et
Unlock full access with a free trial.
With(ExamplE Free Trial5) TablE 8: accruED pEnsion Download conTribuTions c ve te et $ (25,000)
T e te et $ Nil
Te deee Deeed t et $ Sign up to vote on this title (25,000)
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sTuDEnT accounTanT 08/2009
D i g E V n i E r l x E s a b i T m x l E a a . m T . u s E D i s Provisions for unrealised profits (PUPs) The contributions will only be recognised for tax r x a purposes when they are paid in the future. Hence When goods are sold between group i E T V h c the pension expense is currently ignored within the T o D o remain in the inventory of the buying r T n tax computations and so the liability has a nil tax the year-end, an adjustment is made i o T r r base, as shown in Table 8. The entity will receive tax p unrealised profit from the consolidate i relief in the future and so a deferred tax asset of w c E n This adjustment also reduces the inve 25% x $25,000 = $6,250 should be recorded at the original cost when a group company s o i E j h i it. However, the tax base of the inven reporting date. T T T i b u D a based on individual financial stateme , g f tteet will be at the higher transfer price. Co s s n D T T a i When dealing with deferred tax in group accounts, l a deferred tax asset will arise. Recogn n o p o asset and the consequent decrease in it is important to remember that a group does u n u s expense will ensure that the tax alrea You're Reading a Preview not legally exist and so is not subject to tax. o Instead, tax is levied on the individual legal entities o n the individual selling company is not s i c ra o free trial. within the group and their individual tax assets Unlock full access with current year’s consolidated income st c c g o and liabilities are cross-cast in the consolidation a s E E will be matched against the future pe process. To calculate the deferred tax implications profit is recognised by t he group. pWith h h Download Free Trial D on consolidation adjustments when preparing the u n T T group accounts, the carrying value refers to the o a n n Ee 6 carrying value within the group accounts while r i i P owns 100% of the equityshare ca h TSign the tax base will be the tax base in the entities’ P sold to this S for $1,000 recordin g T up togoods vote on title s T s i individual accounts. of $200. All of the goods remain in t i n Not useful a ofUseful i x w S at the year-end. Table 9 shows t x E s c tax asset of 25% x $200 = $50 shou Fair value adjustments a y s At the date of acquisition, a subsidiary’s net T l i s within the group financial statements l E
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TEchnical
TablE 9: proVision or unrEalisED proiTs (ExamplE 6)
Cost to S PUP
c ve te et t t $ 1,000 (200) 800
T e te et dvd ett t $
Te deee
1,000
(200)
Deeed t et t?
$
Asset
You're Reading a Preview The primary reason behind this is that it would Thus, IAS 12 considers the overriding accounting full access withdeferred a free trial. be necessary for entities to determine when the Unlockissue behind tax to be the application of future tax would be recovered or paid. In practice matching – ensuring that the tax consequences of this is highly complex and subjective. Therefore, to an item reported within the financial statements Download With Free require discounting of deferred tax liabilities would are reported in theTrial same accounting period as the result in a high degree of unreliability. Furthermore, item itself. to allow but not require discounting would result For example, in the case of a revaluation surplus, in inconsistency and so a lack of comparability since the gain has been recognised thetitle financial Sign up to vote oninthis between entities. statements, the tax consequences of this gain useful Useful– that isNot should also be recognised to say, a tax charge. In order to recognise a tax charge, it is Deeed t d te ek As we have seen, IAS 12 considers deferred tax by necessary to complete the double entry by also
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How to approach performance appraisal questions by Steve Scott 01 May 2006
Performance appraisal is an important topic in Paper F7, Financial Reporting. This article is intended to give candidates some guidance as to what is expected from a good answer to performance appraisal questions and how to approach such questions. The scenario of a performance appraisal question can take many forms.
Vertical or trend analysis
A company's performance may be compared to its previous period's performance. Past resul may be adjusted for the effects of price changes. This is referred to as trend or vertical analys A weakness of this type of comparison is that there are no independent benchmarks to determine whether the chosen company's current year results are good or bad. Just because a company's results are better than its results in the previous financial period - it does not me the results are good. It may be that its results in the prior year were particularly poor. You're Reading a Preview
Horizontal analysis
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Sign up to vote on this title Download With Free To try to overcome the problem of vertical analysis, it is Trial common to compare a company's useful Not company performance for a particular period with the performance ofUseful an equivalent for the same period. This introduces an independent yardstick to the comparison. However, it is important to pick a similar sized company that operates in the same industry. Again, this t
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Question scenarios
Most questions on this topic will have information in the scenario that requires particular consideration. A common complaint from markers is that candidates often make no referenc such circumstances. In effect, the same answer would be given regardless of what the questio said. It is worth noting that there are many 'clues' in the question - ignore them at your peril. Examples of such circumstance include: Related party relationships and transactions: these have the potential to distort the results of company (either favourably or unfavourably). Examples of related party transactions are:
goods have been supplied to a company on favourable terms (in terms of price and c arrangements) a subsidiary may enjoy the benefits of head office expertise (eg research knowledge) without any charge being made by the head office loans may be advanced at non-commercial interest rates.
A company may have entered into certain arrangements that mean its previous results are directly comparable with its current results. Examples of this include:
a sale and leaseback of property, plant or equipment. Such an arrangement would low the operating assets and thusYou're improve asset utilisation Reading a Preview entering into debt factoring (the sale of receivablesto a finance house). This would full access withwould a free trial. obviously reduce collection Unlock periods, but this not be through improved credit control procedures Sign vote oncapital this titleemployed (an a general revaluation of non-current assets leadup totohigher Download Withwould Free Trial thus a lower return on capital employed) without there being any real change in Useful Not useful operating capacity or profitability a company may have implemented certain policy changes during the year (eg loweri
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By far the most common complaint by markers is that candidates' comments explaining the movement or differences in reported ratios lack any depth or commercial understanding. A typical comment may be that receivables collection has improved from 60 days to 40 days. S a comment does not constitute interpretation - it is a statement of fact. To say a ratio has gon up or down is not helpful or meaningful.
What is required from a good answer are the possible reasons as to why the ratio has change There may be many reasons why a ratio has changed and no-one can be certain as to exactly what has caused the change. All that is required are plausible explanations for the changes. Even if they are not the actual cause, marks will be awarded. There is no single correct answ to an interpretation question, and remember there may be clues in the scenario that would account for some of the changes in the ratios.
Exam approach
In an exam there is a (time) limit to the amount of ratios that may be calculated. A structured approach is useful where the question does not specify which ratios to calculate:
limit calculations to important areas and avoid duplication (eg inventory turnover and inventory holding periods) it is important to come to conclusions, as previously noted, candidates often get carri You're Reading a Preview away with the ratio calculations and fail to comment on them Unlock full access with free trial. often there are some 'obvious' conclusions thata must be made (eg liquidity has deteriorated dramatically, or a large amount of additional non-current assets have bee Sign up to vote on this title purchased without a proportionate increase sales). Download WithinFree Trial
Suggested structure to a typical answer
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1. Gross and net profit margin %: Profit (gross or net)/sales x 100 2. Asset utilisation: sales/net assets
For example, an improvement in the ROCE is either because of improved margins or better of assets. Increases may be due to increases in selling prices or reductions in manufacturing purchased) costs. They may also be caused by changes in sales mix or inventory counting errors. A change in the net profit margin is a measure of how well a company has controlled overheads. The asset utilisation ratio (sales/net assets) shows how efficiently the assets are being used.
Liquidity
Current ratio: current assets/current liabilities. Ideally it is thought that this should be betwee 1.5 and 2 to 1, but it can vary depending upon the market sector (eg retailers have relatively receivables so the current, and quick, ratios may be meaningless for such businesses).
Quick ratio (or acid test): current assets less inventory/current liabilities. This is expected to at parity, ie 1 to 1. If the above liquidity ratios appear to be outside 'normal ranges' further investigation is required and inventory, receivables, and payables ratios should be looked at. These ratios can be calculated either as time periods (eg 'days') or as turnovers. You're Reading a Preview Receivables collection period (in days): receivables/credit sales) x 365 Unlock(trade full access with a free trial. Inventory turnover: cost of sales/(average or closing) inventory Sign up to vote on this title Download With Free Trial
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Payables payment period (in weeks): (trade payables/purchases on credit*) x 52 *Note: you may have to use cost of sales if purchases figure is not available.
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Liquidity problems may also be caused by 'overtrading'. In some ways this is a symptom of success of the business. It is usually a lack of adequate financing and may be solved by an injection of capital.
Gearing
This is a far more important ratio than most candidates seem to be aware of. Company direc often spend a great deal of time and money to make this ratio appear in line with acceptable levels.
Its main importance is that as borrowings rise, risk increases (in many ways) an d as such, further borrowing is difficult and expensive. Many compan ies have limits to the amount of borrowings they are permitted to have. These may be in the form of debt covenants imposed lenders or they may be contained in a company's Articles, such as a multiple of shareholders funds.
Measures of gearing Gearing is basically a comparison of debt to equity. Preference shares are usually treated for this purpose. There are two alternatives: Debt/equity or Deb t/debt + equity.
You're Reading a Preview In any comparison of gearing it is important to use the same basis to calculate the gearing percentage in order for any interpretation to access be meaningful. A question often asked is what l Unlock full with a free trial. should a company's gearing be? There is no easy answer to this - a lot will depend on the na of the industry and composition of the balance With sheetFree assets. For companies with lar Sign upexample, to vote on this title Download Trial property portfolios often have high levels of gearing without it troubling But useful Useful Notinvestors. companies that have large amounts of intangible assets are not considered to have a desirabl type of security to support large borrowings. It is important that the effect of debt is understo
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(+60%)
(-60%)
Note that when profits increase by 30%, the increase in the return to equity shareholders is double this increase (a 16% return is 60% higher than a 10% return). However, the down sid that when profits fall by 30%, the reverse applies. The existence of debt increases the risks (favourable and unfavourable) to the equity shareholders. By contrast, the return to preferen shareholders is 10% at all levels profit.
Investment Ratios Earnings per share
In isolation, this ratio is meaningless for inter-company comparisons. Its major usefulness is part of the P/E ratio, and as a measure of profit trends.
Price/earnings ratio
This is calculated by dividing a company's market price by its EPS. Say the price of a company's shares is $2.40, and its last reported EPS was 20c. It would have a P/E ratio of 12 The mechanics of the movement of a company's P/E ratio are complex, but if this company' EPS improved to 24c in the following year,Reading it woulda not mean that its P/E ratio would be You're Preview calculated as 10 ($2.40/24c). It is more likely that its share price would increase such that it with a price free trial. maintained or even improved its P/EUnlock ratio.fullIfaccess the share increased to say $2.88, the P/E r would remain at 12 ($2.88/24c). This demonstrates the real importance of EPS in the way it Sign up to vote on this title Download a major influence on a company's share price. With Free Trial
Earning yield
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Example 2 Realm has 5 million ordinary shares of 25c each in issue. The stock market price of the shar ust before its year end is $3.00 each. The dividend yield for companies in the same sector a Realm is 5%. Realm has paid an interim dividend of $200,000, and its profit after tax is $1,250,000. Required, calculate: i. ii. iii.
the final dividend (in pence per share) to be declared such that Realm's dividend y would equal its market sector Realm's P/E ratio Realm's dividend cover.
Answer i.
ii. iii.
A dividend yield of 5% of a share price of $3.00 would be achieved if total dividend the period were 15c ((15/300) x 100 = 5%). An interim dividend of $200,000 on 5 million shares would be 4c per share. Thus the final dividend would need to be 11c p share. Profits of $1,250,000 on 5 million shares gives an EPS of 25c ($1,250,000/5 million The P/E ratio would be calculated as 12 (300c/25c) You're Reading Preview Dividends of 15c per share from earnings ofa25c per share would give a dividend c of 1.67 times (25c/15c). Unlock full access with a free trial.
In conclusion, candidates may be required to explain the weaknesses or limitations of ratio Sign up to vote on this title Download With Free Trial analysis. As a summary, it may be useful to read and work through a question. The first sect Useful Not useful of the answer deals with the limitations of ratios.
Example 3
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Receivables collection period Payables payment period Debt to equity Dividend yield Dividend cover
45 days 55 days 40% 6% 3 times
Comparator's financial statements for the year to 30 Se ptember 20X3 are set out below:
Income statement Turnover Cost of sales Gross profit Other operating expenses Operating profit Interest payable Exceptional item (note (ii)) Profit before taxation Taxation Profit after taxation
You're Reading a Preview
$000 2,425 (1,870) 555 (215) 340 (34) (120) 186 (90)
Unlock full access with a free trial.
Balance sheet Non-current assets (note i)
Sign up to vote on this title Download With Free Trial Useful $000 Not useful £000
540
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Taxation
85 500
Non-current liabilities 8% loan notes
300
Total equity and liabilities
1,135
Notes i.
The details of the non-current assets are:
At 30 Sept 20X3 ii. iii. iv.
Cost $000 3,600
Accumulated depreciation $000 3,060
Net book v $000 540
The exceptional item relates to losses on the sale of a batch of computers that had become worthless due to improvements in microchip design. The market price of Comparator’s shares throughout the year averaged $6.00 each You're Reading a Preview Dividends of $90,000 were paid during the year.
Required:
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Sign up to vote on this title With Free Trial a. Explain the problems that areDownload inherent when ratios are used to assess a company's Useful Not useful financial performance. Your answer should consider any additional problems that ma be encountered when using inter-firm comparison services such as that used by Comparator (7 marks).
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is also true that any assessment should also consider other information that may be available including non-financial information. More specific problem areas are:
Accounting policies: if two companies have different accounting policies, it can invalidate any comparison between their ratios. For example, return on capital emplo is materially affected by revaluations of non-current assets. Comparing this ratio for companies where one has revalued its non-current assets and the other carries noncurrent assets at depreciated historic cost would not be very meaningful. Similar examples may involve depreciation methods, inventory valuation policies etc. Accounting practices: this is similar to differing accounting policies in its effects. An example of this would be the use of debt factoring. If one company collects its debts the normal way, then the calculation of receivable days would be a reasonable indica of the efficiency of its credit control department. However if a company chose to fac its debts (ie 'sell' them to a finance company) then the calculation of its receivable da would be meaningless. A more controversial example would be the engineering of a lease such that it fell to be treated as an operating lease rather than a finance lease. Balance sheet averages: many ratios are based on comparing income statement items with balance sheet items. The above ratio of receivable days would be a good examp For such ratios to be meaningful, it is necessary to assume that the year-end balance sheet figures are representative of annual norms. Sea sonal trading and other factors m invalidate this assumption. For example, the level of receivables and inventory of a to You're a Preview manufacturer could vary largely dueReading to the nature of its seasonal trading. Inflation can distort comparisons over time. Unlock full access with a free trial. The definition of an accounting ratio. If a ratio is calculated by two companies using this are different definitions, then there is an obvious problem. Common examples of Sign up to vote on this title Download With Free Trial gearing ratios (some use debt/equity, others may use debt/debt + equity). Also, wher Useful Not useful differences ratio is partly based on a profit figure, there can be as to what is included what is excluded from the profit figure. Problems of this type include the treatment o exceptional items and finance costs.
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Some inter-firm comparison agencies produce the ratios ana lysed into quartiles to attempt to overcome this. It may be that the sector in which a company is included may not be sufficiently sim to the exact type of trade of the specific company. The type of products or markets m be different. Companies of different sizes operate under different economies of scale, this may no reflected in the industry average figures. The year-end accounting dates of the companies included in the averages are not goi to be all the same. This highlights issues of balance sheet averages and seasonal trad referred to above. Some companies try to minimise this by grouping companies with approximately similar year-ends together as in the example of this question, but this not a complete solution.
b. Refer to Figure 1. c. Analysis of Comparator's financial performance compared to the sector average for the pe to 30 September 20X3: To: From: A N Allison Date:
Figure 1: Calculation of specified You're ratios Reading a Preview Sector average Return on capital employed ((186 +Download 34 loan interest/635) Sign up to 34.6% vote on this title 22.1% With Free Trial Net assets turnover (2,425/635) Not useful 1.8 times Useful 3.8 times Gross profit margin (555/2,425 x 100) 22.9% 30% N t p fit ( l di ti l ) m in (306/2 425 x 100) 12 6% t a ail Unlock full access with a free trial.
Comparator
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Operating performance The return on capital employed of Comparator is impressive being more than 50% higher th the sector average. The components of the return on capital employed are the asset turnover profit margins. In these areas, Comparator's asset turnover is much higher (nearly double) th the average, but the net profit margin after exceptionals is considerably below the sector average. However, if the exceptionals are treated as one off costs and excluded, Comparator margins are very similar to the sector average.
This short analysis seems to imply that Comparator's superior return on capital employed is entirely to an efficient asset turnover (ie Comparator is making its assets work twice as efficiently as its competitors). A closer inspection of the underlying figures may explain why asset turnover is so high. It can be seen from the note to the balance sheet that Comparator's non-current assets appear quite old. Their net book value is only 15% of their original cost. T has at least two implications: they will need replacing in the near future and the company is already struggling for funding; and their low net book value gives a high figure for asset turnover. Unless Comparator has underestimated the life of its assets in its depreciation calculations, its non-current assets will need replacing in the near future. When this occurs it asset turnover and return on capital employed figures will be much lower. This aspect of rat analysis often causes problems and to counter this anomaly some companies calculate the as turnover using the cost of non-current assets rather than their net book value as this gives a more reliable trend. It is also possible that Comparator is using assets that a re not on its bala You're Reading a Previewof finance leases and thus the sheet. It may be leasing assets that do not meet the definition assets and corresponding obligations have not been recognised on the balance sheet. Unlock full access with a free trial.
aver A further issue is which of the two calculated margins should be compared to the sector Sign up to vote on this title Download With Free Trial (ie including or excluding the effects of the exceptionals). The gross profit margin of Useful Not useful Comparator is much lower than the sector average. If the exceptional losses were taken in trading account level, which they should be as they relate to obsolete inventory, Comparator gross margin would be even worse.
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As referred to above, gearing (as measured by debt/equity) is more than twice the level of th sector average. While this may be an uncomfortable level, it is currently beneficial for shareholders. The company is making an overall return of 34.6%, but only paying 8% intere on its loan notes. The level of gearing may become a serious issue if Comparator becomes unable to maintain the finance costs. The company already has an overdraft and the ability t make further interest payments could be in doubt.
Investment ratios Despite reasonable profitability figures, Comparator's dividend yield is poor compared to th sector average. It can be seen that total dividends are $90,000 out of available profit for the of only $96,000 (hence the very low dividend cover). It is surprising the company's share pr is holding up so well.
Summary The company compares favourably with the sector average figures for profitability. Howeve Comparator's liquidity and gearing position is quite poor and gives cause for concern. If it is replace its old fixed assets in the near future, it will need to raise further finance. With alread high levels of borrowing and poor dividend yields, this may become a serious problem for Comparator. Yours faithfully A N Allison
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Steve Scott is examiner for Paper F7 Sign up to vote on this title Download With Free Trial
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by Graham Holt 01 Oct 2005
This article sets out the accounting treatment for the impairment of trade receivables/debtors The provision for bad debts is now, in effect, governed by IAS 39, Financial Instruments: Recognition and Measurement for International stream students or FRS 26, Financial Instruments: Measurement for UK stream students. Adapted papers generally follow the con of IAS 39. This article covers the general accounting principles and then outlines its applicability to CAT Scheme Papers 1, 3 and 6, and Professional Scheme Paper F3.
General accounting principles (relevant to ACCA Qualification Papers F7 and P2) Trade receivables are financial assets falling under 'loans a nd receivables' in IAS 39 and FR 26. According to these standards, loans and receivables are measured at amortised cost using effective interest rate method. Initially, they will be carried at fair value at the time of recognition, which in the case of trade receivables/debtors will be the invoiced amount.
The effective interest rate method spreads the interest income or expense over the life of the financial asset or liability. Obviously, such a method does not seem to be relevant to trade receivables/debtors where normally there is no interest payment to spread. FRS 26 and IAS therefore allow short-term receivables/debtors with no stated interest rate to be measured at original invoice amount, if the effect of discounting is immaterial. This would apply to trade You're a Preview receivables/debtors and therefore, they willReading still be carried at the invoice amount. Unlock full access with a free trial.
However, FRS 26 and IAS 39 state that an entity must assess at each balance sheet date whe there is any objective evidence that a financial asset or group of financial assets is impaired. Sign up to vote on this title Download With Free Trial there is objective evidence that an impairment loss on the financial assets has been incurred, useful Useful Not loss must be recognised in profit or loss. Since trade receivables/debtors are financial assets, annual impairment assessments must be performed. The amount of the loss is determined by looking at the carrying value of the trade receivable/debtor and comparing it with the presen
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information becomes available that identifies losses on a receivable in the group then it is removed and individually assessed.
The collective assessment of impairment requires the splitting of the list of receivables into groups of trade receivables that share similar credit risk characteristics. The credit risk group are to be assessed for impairment using historical loss experience for e ach group. Such historical loss experience would be adjusted to reflect the effects of current conditions. An individual receivable/debtor impairment factor is likely to be specific to that receivable/debt pending liquidation of the entity, for example.
A collective impairment factor is likely to be as a result of past economic events that affect t receivables in general (eg interest rates). Impairment losses will be recognised only when th are incurred. Thus, if there is deterioration in the credit quality of the financial assets as a res of a past event, then an impairment loss may have occurred.
The recognition of future losses based on possible or expected future trends is not in accorda with the IASB Framework and IAS 37/FRS 12, Provisions, Contingent Liabilities and Contingent Assets. General provisions would therefore not be allowed as the historical experience is zero and it is unlikely to produce an acceptable estimate of the cash flows to b received.
You're Reading a Preview Conclusion Trade receivables/debtors fall into the category of loans and receivables under IAS 39/FRS Unlock full access with a free trial. They will be valued at fair value initially - which will be the invoiced amount. Because they normal short-term receivables they will not normally be subject to discounting, nor will they Sign up to vote on this title Download With Free Trial have an effective interest rate. They will have to be assessed for impairment at each balance Useful Not useful cash sheet date, and will be impaired if the present value of the flows is less than the carryin amount.
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answers will be similar to past examination questions.
Exampe 1 Note that the differences in terminology or narrative are in bold.
At 31 December 2004, a company's trade receivables/debtors totalled $864,000, and the allowance for receivables/debtors was$38,000. It was decided that specific debts totalling $13,000 were to be written off as the cash was considered to be irrecoverable, and the allow for receivables/debtors was to be adjusted to the equivalent of 5% of the trade receivables/debtors based on past experience.
Question What figure should appear in the balance sheet for trade receivables/debtors and in the incom statement/profit and loss account for the total of bad debts and the allowance for trade receivables/debtors? Answer Balance sheet
Trade receivables/debtors $808,450 ($864,000 - $13,000 - $42,550) Income statement/Profit and loss a/c You're Reading a Preview Bad debts $13,000 Allowance for trade receivables/ Unlock full access with a free trial. debtors ($42,550 - $38,000) $4,550 [($864,000 - $13,000) x 5% = $42,550] Sign up to vote on this title Download With Free Trial
is little need to wor The calculations are exactly the same as for the existing questions. There as the change is really in the terminology and not in the method of calculation for CAT and ACCA Qualification Paper F3 students. Useful
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IAS 10 and FRS 21, events after the balance sheet date by Neil Stein 15 Mar 2007
Events after the balance sheet date and before financial statements are issued can have important effects on the financial statements. For example, the bankruptcy of a major custom would normally be evidence that the trade receivable should be written off or an allowance made as at the balance sheet date.
There is another type of event after the balance sheet date - one that does not affect the posit at the balance sheet date, but which still needs disclosure in some way to prevent users being misled. An example of such an event might be a material fall in the market value of investments.
General provisions Events after the balance sheet date are divided into two types, corresponding to the two You're Reading a Preview examples just given. The definition in IAS 10 is: Unlock full access with a free trial.
Events after the balance sheet date are those events, both favourable and unfavourable, that occur between the balance sheet dateDownload and the date financial Sign up to votestatements on this title are authoris Withwhen Freethe Trial for issue. Useful Not useful Two types of events can be identified:
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(ii) sale of inventories at prices suggesting the need to reduce the balance sheet figure to the net value actually realised.
Nonadjusting events do not, by definition, require an adjustment to the financial statements, if they are of such importance that non-disclosure would affect the ability of users of the financial statements to make proper evaluations and decisions, the enterprise should disclose note: - the nature of the event; - an estimate of its financial effect, or a statement that such an estimate cannot be made. Examples of such events given in IAS 10 and FRS 21 are: (a) decline in market value of investments; (b) announcement of a plan to discontinue part of the enterprise; (c) major purchases and sales of assets; You're Reading a Preview (d) expropriation of assets by government; Unlock full access with a free trial.
(e) destruction of a major asset by fire etc;
Sign up to vote on this title Download With Free Trial (f) a major business combination after the balance sheet date;
(g) sale of a major subsidiary;
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statements after issue, that fact should be disclosed.
(b) Going concern If the management decides after the balance sheet date that it is necessary to liquidate the enterprise, the financial statements should not be prepared on a going concern basis.
(c) Dividends
Proposed dividends may no longer be recognised as liabilities if, as will normally be the case they are proposed or declared after the balance sheet date. The disclosure of proposed dividends may be given in one of two ways: (a) by note (b) on the face of the balance sheet as a separate component of equity.
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01chnical
performanc
rlVan o acca QUalificaion papr f7 a
prformanc appraiSal iS an imporan aSpc of papr f7, finan reporting . a hiS lVl yoU ar no only rQUird o prpar fina SamnS bU UndrSand h informaion Undrpinning h rSU Performance appraisal is an important aspect of Paper F7, Financial Reporting and of interest to Paper P3 students. At this level you are not only required to prepare financial statements but understand the information underpinning the results. In Question 3, you will often be required to make use of ratios to aid interpretation of the financial statements for the current year and to compare them to the results of a prior period, another entity, or against industry averages. Increasingly, candidate exam performance is demonstrating a lack of commercial awareness and knowledge that barely stretches past the ‘rote
Spcific problmS xampl When marking this style of question The question scenario may p there are some common weaknesses you with a set of financial st that are identified, some of which are and some further informatio highlighted below: as details of non-current ass ¤ limited knowledge of (potentially including a reval You're Reading a Preview ratio calculations a major acquisition or dispo ¤ appraisal not linked to scenario measures undertaken during full access with a free trial. ¤ poorUnlock understanding of the topic in an attempt to improve per ¤ limited understanding of what When constructing your answ accounting information represents must consider the effect tha With Free Trial ¤ lack Download of commercial awareness such as this would have on t ¤ discursive elements often company results. not attempted A major asset disposal wo ¤ inability to come to a conclusion likely a significant imp Sign up to vote on have this title ¤ poor handwriting (often illegible in company’s financial statem Useful usefulresult in a prof some instances) thatNot it would ¤ poor English. on disposal being taken to t statement and a cash inject
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SUdn accoUnan issue05/2010 Studying Paper F7 or P3? pee jetves 7, 8, 9, 10 11 e ke
appraisal It is often wor th calculating some of the results again (eg ROCE or operating profit margin) as part of your interpretation without the one-off disposal information, as arguably this will help make the information more comparable to the results that do not include such disposals (if time is limited a comment about the disposal’s effect will be sufficient). From a liquidity point of view the cash received on disposal of the asset will have aided cash flow during the year – ask yourself what would have happened if the company had not received this cash, ie are they already operating on an overdraft? If so, the cash flow position would be far worse without the disposal cash. If a revaluation of non-current assets has taken place during the year the capital employed base will grow – this will have the impact of reducing both the asset turnover and return on capital employed ratios without
If, for example, the purchase took place during the latter half of the year, the new asset will not have contributed to a full year’s profit and it may be that in future periods the business will begin to see a better return as a result of the investment. When analysing the performance and position of the company, if management have implemented measures during the year to improve performance it is worth considering whether or not these You're Reading Preview measures have actuallyabeen effective. If, for example, a company chose to give Unlock full access with free trial. rebates to customers for aorders above a set quantity level – this would have the impact of improving revenue at the Download Trial sacrifice of grossWith profitFree margin.
profiabiliy retu t ee
Profit before interest and Shareholders’ equity + d
This ratio is generally co to be the primary profita as it shows how well a has generated profit from long-term financing. An i ROCE is generally consid an improvement. Movements in return o employed are best interp examining profit margins turnover in more detail (o to as the secondary ratio made up of these compo Know h baSicS For example, an improve Ratios can generally be brokenSign down due to an impro up to votecould on thisbetitle into several key areas: profitability, margins or more efficient Useful Not useful liquidity, gearing and investment. As a student taking the Paper F7 exam asset tuve you need to know the formulae for the
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chnical
pt s Gross or Operating profit Revenue The gross profit margin looks at the performance of the business at the direct trading level. Typically variations in this ratio are as a result of changes in the selling price/sales volume or changes in cost of sales. For example, cost of sales may include inventory write downs that may have occurred during the period due to damage or obsolescence, exchange rate fluctuations or import duties. The operating profit margin (or net profit margin) is generally calculated by comparing the profit before interest and tax of a business to revenue, but, beware in the exam as sometimes the examiner specifically requests the calculation to include profit before tax. Analysing the operating profit margin enables you to determine how well
whn aSSSSing boh h cUrrn and h raioS, looK a h informaion proVidd h QUSion o conSidr whhr or no company iS oVrdrawn a h yar-nd. h oVrdraf iS an addiional facor indica ponial liQUidiy problmS. liQUidiy cuetYou're t Reading a Preview
The quick ratio excludes inv it takes longer to turn into c therefore places emphasis o Unlock full access with a free trial. Current assets business’s ‘quick assets’ an Current liabilities or not these are sufficient to current liabilities. Here the Download With Free Trial The current ratio considers how well thought to be 1:1 but as wit a business can cover the current ratio, this will vary dependin liabilities with its current assets. It industry in which the busine both the is a common belief that the ideal for Sign up to voteWhen on thisassessing title this ratio is between 1.5 and 2 to 1 and the quick ratios, look at Useful Not useful so that a business may comfortably information provided within cover its current liabilities should they to consider whether or not t fall due. company is overdrawn at th
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