FR - BPP - Text 2023

ACCA
Applied Skills
Financial
Reporting (FR)
Workbook
For exams in June 2022,

September 2022, December
2022 and March 2023
HB2022
These materials are provided by BPP

Third edition 2022
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HB2022 2022

Inhalt
Einführung
Helping you to pass v
Introduction to the Essential reading vii
Introduction to Financial Reporting (FR) ix
Essential skills areas to be successful in Financial Reporting (FR) xiii
1 The Conceptual Framework 1

2 The regulatory framework 23
3 Tangible non-current assets 37
4 Intangible assets 65
5 Impairment of assets 83
Skills checkpoint 1 101
6 Revenue and government grants 111
7 Introduction to groups 149
8 The consolidated statement of financial position 173
9 The consolidated statement of profit or loss and other comprehensive income 217
10 Changes in group structures: disposals 243
11 Accounting for associates 257
12 Financial instruments 293
13 Leasing 315
14 Provisions and events after the reporting period 343
15 Inventories and biological assets 365
16 Taxation 377
17 Presentation of published financial statements 399
18 Reporting financial performance 423
19 Earnings per share 463
20 Interpretation of financial statements 481
21 Limitations of financial statements and interpretation techniques 515
22 Statement of cash flows 529
23 Specialised, not-for-profit and public sector entities 555
HB2022

Essential Reading
Tangible non-current assets 565

Intangible assets 575
Impairment of assets 578
Revenue and government grants 583
Introduction to groups 588
The consolidated statement of financial position 592
The consolidated statement of profit or loss and other comprehensive income 605
Accounting for associates 610
Financial instruments 621
Leasing 628
Provisions and events after the reporting period 634
Inventories and biological assets 649
Taxation 652
Presentation of published financial statements 659
Reporting financial performance 670
Earnings per share 679
Interpretation of financial statements 686
Limitations of financial statements and interpretation techniques 699
Statement of cash flows 702
Specialised, not-for-profit and public sector entities 713
Further question practice 719

Further question solutions 762
Glossary 821
Index 833
Bibliography 841
HB2022

HB2022

Helping you to pass
BPP Learning Media – ACCA Approved Content Provider
As an ACCA Approved Content Provider, BPP Learning Media gives you the opportunity to use
study materials reviewed by the ACCA examining team. By incorporating the examining team’s
comments and suggestions regarding the depth and breadth of syllabus coverage, the BPP
Learning Media Workbook provides excellent, ACCA-approved support for your studies.
These materials are reviewed by the ACCA examining team. The objective of the review is to
ensure that the material properly covers the syllabus and study guide outcomes, used by the
examining team in setting the exams, in the appropriate breadth and depth. The review does not
ensure that every eventuality, combination or application of examinable topics is addressed by
the ACCA Approved Content. Nor does the review comprise a detailed technical check of the
content as the Approved Content Provider has its own quality assurance processes in place in this
respect.
BPP Learning Media do everything possible to ensure the material is accurate and up to date
when sending to print. In the event that any errors are found after the print date, they are
uploaded to the following website: www.bpp.com/learningmedia/Errata.
The PER alert

Before you can qualify as an ACCA member, you not only have to pass all your exams but also
fulfil a three-year practical experience requirement (PER). To help you to recognise areas of the
syllabus that you might be able to apply in the workplace to achieve different performance
objectives, we have introduced the ‘PER alert’ feature (see the next section). You will find this
feature throughout the Workbook to remind you that what you are learning to pass your ACCA
exams is equally useful to the fulfilment of the PER requirement. Your achievement of the PER
should be recorded in your online My Experience record.
HB2022 v Financial Reporting (FR)

Chapter features
Studying can be a daunting prospect, particularly when you have lots of other commitments. This
Workbook is full of useful features, explained in the key below, designed to help you to get the
most out of your studies and maximise your chances of exam success.
Key term
Central concepts are highlighted and clearly defined in the Key terms feature.
Key terms are also listed in bold in the Index, for quick and easy reference.
Formula to learn
This boxed feature will highlight important formula which you need to learn for
your exam.
PER alert
This feature identifies when something you are reading will also be useful for your
PER requirement (see ‘The PER alert’ section above for more details).
Real world examples

These will give real examples to help demonstrate the concepts you are reading
about.
Illustration
Illustrations walk through how to apply key knowledge and techniques step by step.
Activity
Activities give you essential practice of techniques covered in the chapter.
Essential reading
Links to the Essential reading are given throughout the chapter. The Essential
reading is included in the free eBook, accessed via the Exam Success Site (see inside
cover for details on how to access this).
At the end of each chapter you will find a Knowledge diagnostic, which is a summary of the main
learning points from the chapter to allow you to check you have understood the key concepts. You
will also find a Further study guidance which contains suggestions for ways in which you can
continue your learning and enhance your understanding. This can include: recommendations for
question practice from the Further question practice and solutions, to test your understanding of
the topics in the Chapter; suggestions for further reading which can be done, such as technical
articles, and ideas for your own research.
HB2022
Introduction vi

Introduction to the Essential reading
The electronic version of the Workbook contains additional content, selected to enhance your
studies. Consisting of revision materials and further explanations of complex areas including
illustrations and activities, as well as practice questions and solutions and background reading, it
is designed to aid your understanding of key topics which are covered in the main printed
chapters of the Workbook.
A summary of the content of the Essential reading is given below.
Chapter Summary of Essential reading content

3 Tangible non-current assets Further reading behind the cost and depreciation
criteria for non-current assets
Further reading on borrowing costs (IAS 23) and
investment property (IAS 40), together with worked
examples and activities
4 Intangible assets Revision of research and development costs
5 Impairment of assets Further reading on the definitions of fair value, value in

use, as well as examples of impairment of an asset and
impairment of a cost generating unit
6 Revenue and government Further reading and a worked example covering

grants performance obligations satisfied over time
Additional activities on government grants (income and
capital)
7 Introduction to groups Exemptions from preparing consolidated financial

statements
Further reading on the definitions of goodwill, including
resulting from business combinations
Consistency of accounting policies requirement
8 The consolidated statement Forms of consideration (deferred, share exchange and

of financial position contingent)
IFRS 13 Fair Value in the scope of IFRS 3
Example of subsidiary acquired mid-year
9 The consolidated statement Example of subsidiary acquired mid-year

of profit or loss Fair value adjustments
11 Accounting for associates Further reading on the requirement to use the equity
method when accounting for associates and activities
with consolidation including an associate
12 Financial instruments Further activities on financial instruments and

additional reading on the following:
• Compound instruments
• Business model test
• Contractual cash flow test
13 Leasing Further reading on identifying and accounting for a

lease, including a detailed worked example.
Sale and leaseback not on market terms is also
covered.
14 Provisions and events after Revision of IAS 37 covered in earlier studies, including
the reporting period practice activities
HB2022 vii Financial Reporting (FR)

Chapter Summary of Essential reading content
Additional detailed worked example of the discounting
of a provision
Revision of contingent assets and liabilities, and IAS 10
Events after the Reporting Period
15 Inventories and biological Revision of IAS 2 Inventories.

assets Further reading on IAS 41 Biological Assets
16 Taxation Further activities to consolidate your knowledge of

deferred tax
17 Presentation of published Further reading on IAS 1, including proforma financial

financial statements statements
18 Reporting financial Activities on the following:

performance • IAS 21
• IFRS 5
• Accounting errors
• Changes in accounting policies
19 Earnings per share Activities on the following:

• Basic calculation of EPS
• Rights issue
• Diluted EPS
20 Interpretation of financial Detailed further reading on ratios, including examples

statements and activities
21 Limitations of financial Further reading on the limitations of financial

statements and statements regarding seasonable trading, intragroup
interpretation techniques transactions and the impact of accounting policy
choices
22 Statements of cash flow Revision of the methodology of preparing extracts from

the statement of cash flows
23 Specialised, not-for-profit Detail behind the primary aims and regulatory

and public sector entities framework for these specialised entities.
Additional detail and activities behind their
performance measurement KPIs
HB2022
Introduction viii

Introduction to Financial Reporting (FR)
Overall aim of the syllabus
To develop knowledge and skills in understanding and applying accounting standards and the
theoretical framework in the preparation of financial statements of entities, including groups and
how to analyse and interpret those financial statements.
Brought forward knowledge

Financial Reporting advances your Financial Accounting knowledge and skills. New Financial
Reporting topics include the analysis of consolidated financial statements, contracts where
performance obligations are satisfied over a period of time, biological assets, financial
instruments, leases and foreign currency. There is also coverage of creative accounting and the
limitations of financial statements and ratios.
The syllabus
The broad syllabus headings are:
A The conceptual and regulatory framework for financial reporting
B Accounting for transactions in financial statements
C Analysing and interpreting the financial statements of single entities and groups
D Preparation of financial statements
E Employability and technology skills
Main capabilities
On successful completion of this exam, you should be able to:
A Discuss and apply conceptual and regulatory frameworks for financial reporting
B Account for transactions in accordance with IFRS Standards
C Analyse and interpret financial statements
D Prepare and present financial statements for single entities and business combinations
in accordance with IFRS Standards
E Demonstrate employability and technology skills
Links to other exams
Strategic Business Strategic Business

Reporting (SBR) Leader (SBL)
Corporate and Financial Audit and

Business Law (LW) Reporting (FR) Assurance (AA)
Financial
Accounting (FA)
HB2022 ix Financial Reporting (FR)

This diagram shows where direct (solid line arrows) and indirect (dashed line arrows) links exist
between this exam and others that may precede or follow it.
The financial reporting syllabus assumes knowledge acquired in Financial Accounting and
develops and applies this further and in greater depth. Strategic Business Reporting, assumes
knowledge acquired at this level including core technical capabilities to prepare and analyse
financial reports for single and combined entities.
Achieving ACCA’s Study Guide Outcomes

This BPP Workbook covers all the Financial Reporting syllabus learning outcomes. The tables
below show in which chapter(s) each area of the syllabus is covered.
A The conceptual and regulatory framework for financial reporting
A1 The need for a conceptual framework and the characteristics Chapter 1

of useful information
A2 Recognition and measurement Chapter 1
A3 Regulatory framework Chapter 2
A4 The concepts and principles of groups and consolidated Chapters 7–11

financial statements
B Accounting for transactions in financial statements
B1 Tangible non-current assets Chapter 3
B2 Intangible non-current assets Chapter 4
B3 Impairment of assets Chapter 5
B4 Inventory and biological assets Chapter 15
B5 Financial instruments Chapter 12
B6 Leasing Chapter 13
B7 Provisions and events after the reporting period Chapter 14
B8 Taxation Chapter 16
B9 Reporting financial performance Chapters 18 and

19
B10 Revenue Chapter 6
B11 Government grants Chapter 6
B12 Foreign currency transactions Chapter 18
C Analysing and interpreting the financial statements of single entities and groups
C1 Limitations of financial statements Chapter 21
C2 Calculation and interpretation of accounting ratios and Chapter 20

trends to address users’ and stakeholders’ needs
C3 Limitations of interpretation techniques Chapter 21
C4 Specialised, not-for-profit and public sector entities Chapter 23
HB2022
Introduction x

D Preparation of financial statements
D1 Preparation of single entity financial statements Chapters 17 and

22
D2 Preparation of consolidated financial statements for a simple Chapters 7–11

group
E Employability and technology skills
E1 Use computer technology to efficiently access and Skills checkpoints

manipulate relevant information
E2 Work on relevant response options, using available functions Skills checkpoints

and technology, as would be required in the workplace
E3 Navigate windows and computer screens to create and Skills checkpoints

amend responses to exam requirements, using the
appropriate tools
E4 Present data and information effectively, using the Skills checkpoints

appropriate tools
The complete syllabus and study guide can be found by visiting the exam resource finder on the
ACCA website: www.accaglobal.com
The exam
Computer-based exams
Applied Skills exams are all computer-based exams (CBE).
Approach to examining the syllabus

The examination lasts three hours and all questions are compulsory.
The exam format will comprise three exam sections.
Section Style of question Description Proportion of

type exam %
A Objective test (OT) 15 questions × 2 30
marks
B Objective test (OT) 3 questions × 10 30

marks
Each question will
contain five sub-parts
each worth two marks
C Constructed 2 questions × 20 40
response (long form marks
questions)
Total 100
Section A and B questions will be selected from the entire syllabus. These sections will contain a
variety of OT questions. The responses to each question, or subpart in the case of OT case
questions, are marked automatically as either correct or incorrect by computer.
Section C questions will mainly focus on the following syllabus areas, but a minority of marks can
be drawn from any other area of the syllabus.
HB2022 xi Financial Reporting (FR)

• Analysing and interpreting the financial statements of single entities and groups (syllabus
area C)
• Preparation of financial statements (syllabus area D)
The responses to these questions are expert marked.
It is essential that you use the ACCA Exam Practice Platform (www.accaglobal.com) when
preparing for your Financial Reporting exam. The Exam Practice Platform contains a number of
full CBE questions that are aligned to the current syllabus and are consistent with the format and
structure of questions you will face in your exam. The Exam Practice Platform allows you to
attempt questions under exam conditions and to mark your own answers using the suggested
solution and marking guide.
HB2022
Introduction xii

Essential skills areas to be successful in Financial
Reporting (FR)
We think there are three areas you should develop in order to achieve exam success in FR:
(a) Knowledge application
(b) Specific FR skills
(c) Exam success skills
These are shown in the diagram below.
cess skills
Exam suc
r planning
Answe
c FR skills C
n Specifi o
tio
rr req
a
ec ui
of
m
t i rem
or
nt
inf
erp ents
ng
Approach to Application
reta
agi
objective test of accounting

(OT) questions standards
Man
tion
Spreadsheet Interpretation
l y si s
Go od
skills skills
ana
ti m
c al
Approach
em
to Case
e ri
OTQs
an
um
ag
tn
em
en
en
t ci
Effi
Effe cti
ve writing
a nd p r
esentation
Specific FR skills
These are the skills specific to FR that we think you need to develop in order to pass the exam.
In this Workbook, there are five Skills Checkpoints which define each skill and show how it is
applied in answering a question. A brief summary of each skill is given below.
HB2022 xiii Financial Reporting (FR)

Skill 1: Approach to objective test questions
As 60% of your marks will be gained by correctly answering objective test (OT) questions, you
need to ensure that you are familiar with the different types of OT questions and the best
approach to tackling them in the exam.
A step-by-step technique for ensuring that you approach the OT questions in the most efficient
and effective way is outlined below:
STEP 1: Answer the questions you know first.

If you’re having difficulty answering a question, move on and come back to tackle it
once you’ve answered all the questions you know.
It is often quicker to answer discursive style OT questions first, leaving more time
for calculations.
STEP 2: Answer all questions.

There is no penalty for an incorrect answer in ACCA exams; there is nothing to be
gained by leaving an OT question unanswered. If you are stuck on a question, as a
last resort, it is worth selecting the option you consider most likely to be correct
and moving on. Flag the question, so if you have time after you have answered the
rest of the questions, you can revisit it.
STEP 3: Read the requirement first!

The requirement will be stated in bold text in the exam. Identify what you are
being asked to do, any technical knowledge required and what type of OT
question you are dealing with. Look for key words in the requirement such as
"Which TWO of the following," or "Which of the following is NOT".
STEP 4: Apply your technical knowledge to the data presented in the question.
Work through calculations taking your time and read through each answer option
with care. OT questions are designed so that each answer option is plausible. Work
through each response option and eliminate those you know are incorrect
Skills checkpoint 1 covers this technique in detail through application to an exam-standard

question.
HB2022
Introduction xiv

Skill 2: Approach to case OT questions
In the exam, you will have three case OT questions, each comprising five questions worth 2 marks
each. They are OT questions, however, they will be linked along a common theme, such as
recognising revenue (including government grants) or accounting for non-current asset
acquisitions and resulting deferred tax adjustments. This allows the Examining Team to ask
questions on specific areas in greater detail than just one OT question will permit.
Therefore, it is imperative that you are familiar with the approach to case OT questions.
A case question will be scenario based, so there will be a short description together with some
financial information, and five questions will be asked about the information. There will be a
combination of narrative and numerical questions.
Key steps in developing and applying this skill are outlined below:
STEP 1: Read the scenario carefully

Read the introduction to the question carefully, ensuring you understand what the
questions are asking you to do. Skimming the questions requirement will help you
to identify whether the questions are narrative or numerical in style.
STEP 2: Start with narrative questions

Attempt the narrative questions first as this will allow you to use any remaining
time to focus on the numerical and calculation questions. The case is usually split
into three narrative questions with two further, calculation based questions.
STEP 3: Work through numerical questions methodically

Apply your technical knowledge to the data presented in the question.
through each response option and eliminate those you know are incorrect.
STEP 4: Be aware of time

Stick to your time carefully, as each question is worth two marks, so spending more
than the allocated time of 18 minutes on each case question is an inefficient use of
your time, as you will need to move onto the Section C questions. If you are
running out of time, or you cannot answer any of the questions, guess the answer
from the options provided. You do not lose marks for incorrect answers.
Skills Checkpoint 2 covers this technique in detail through application.
HB2022 xv Financial Reporting (FR)

Skill 3: Using spreadsheets effectively
Section C will require the use of the spreadsheet functionality in the exam, so you need to be
familiar with the software and what the FR examining team is expecting to see in terms of
presentation.
The Section C question which requires you to prepare extracts from the financial statements (this
may be for a single entity or for a group, and it may be any of the primary financial statements)
will require you to use the spreadsheet software.
A step-by-step technique for using spreadsheets in the exam is outlined below:
STEP 1: Understanding the data in the question

Where a question includes a significant amount of data, read the requirements
carefully to make sure that you understand clearly what the question is asking
you to do. You can use the highlighting function to pull out important data from
the question. Use the data provided to think about what formula you will need to
use. For example, if the company calculates the allowance for receivables as a
percentage of the balance, use the percentage function.
STEP 2: Use a standard proforma working.

You will be asked to prepare an extract or a set of financial statements. Set out
your statement of profit or loss or the statement of financial position before you
start to work through the question. This will give you the basic structure from
where you can enter the data in the question.
Format your cells to ensure the workings look consistent, for example, using the
comma function to mark the thousands in numerical answers.
STEP 3: Use spreadsheet formulae to perform basic calculations.

Ensure you are showing your workings by using the spreadsheet formula for simple
calculations, for example, the cost of sale figure will be made up of different
balances, so add them together using the formula. Cross refer any more detailed
workings, and link workings into your main answer.
Step 4: Include the results of workings in the proforma

You must ensure that you include your workings form in the proforma and
complete your final answer. Remember to show how you have included your
workings by cross referencing to the relevant working and by using the formula
within the cell to add/subtract the balance.

question.
HB2022
Introduction xvi

Skill 4: Application of IFRS Standards
Knowledge of the IFRS Standards will be required in all sections of the FR exam. You may be asked
to identify the key requirements of an IFRS Standard in a knowledge based narrative question and
are likely to be asked questions about the application or impact of IFRS Standards in an OT
question. Knowledge of the requirements of IFRS Standards is essential when preparing financial
statements and may be relevant in the interpretation of an entity’s performance and position in
Section C.
A step-by-step technique for applying your knowledge of accounting standards is outlined below:
STEP 1: Overview of key standards

Ensure you have a high-level overview of the key standards covered in the FR
exam. Use the summary diagrams at the end of the chapters in the Workbook to
act as your summaries. These are a useful way of remembering the key points.
STEP 2: Numerical question practice

Practice the numerical questions in the Workbook and in the Practice & Revision
Kit. These will test your knowledge of the mechanics of the accounting standards.
Often there can be a difference between understanding what the standard does
and how it applies to a specific scenario. Practice OTQs as well as longer, Section C
questions to consolidate your knowledge.
STEP 3: Narrative question practice

Practice the narrative questions which test your understanding of how the standard
can affect the financial statements. This will help you to revise your understanding
of why the accounting standard is important in a scenario. For example, what are
the key tests for impairment of assets and why would this be important for the
financial statements?

question.
HB2022 xvii Financial Reporting (FR)

Skill 5: Interpretation skills
Section C of the FR exam will contain two questions. One of these will require you to interpret the
financial statements of a single entity or group or extracts from a set of financial statements. The
interpretation is likely to require the calculation of ratios, but your focus should be on the
interpretation of those ratios to explain the performance and position of the single entity or group
you are presented with.
Given that the interpretation of financial statements will feature in Section C of every exam, it is
essential that you master the appropriate technique for analysing and interpreting information
and drawing relevant conclusions in order to maximise your chance of passing the FR exam.
STEP 1: Read and analyse the requirement.

Read the requirement carefully to see what calculations are required and how many
marks are set for the calculation and how many for the commentary.
Work out how many minutes you have to answer each sub-requirement.
STEP 2: Read and analyse the scenario.

Identify the type of company you are dealing with and how the financial topics in
the requirement relate to that type of company. As you go through the scenario,
you should be highlighting key information which you think will play a key role in
answering the specific requirements.
STEP 3: Plan your answer.

You will have calculated the ratios and understand the performance and position of
the company. You must now plan the points you will make in interpreting the ratios.
Read through the information in the scenario and identify the points that help you
to explain the movement in ratios. Using each ratio as a heading, create a bullet
point list of the relevant points.
STEP 4: Type your answer.

You should now take the bullet point list created at the planning stage and expand
the points, remembering to use information given in the scenario and to avoid
generic explanations.
As you write your answer, explain what you mean – in one (or two) sentence(s) –
and then explain why this matters in the given scenario. This should result in a
series of short paragraphs that address the specific context of the scenario.

question.
HB2022
Introduction xviii

Exam success skills
Passing the FR exam requires more than applying syllabus knowledge and demonstrating the
specific FR skills; it also requires the development of excellent exam technique through question
practice.
We consider the following six skills to be vital for exam success. The Skills Checkpoints show how
each of these skills can be applied specifically to the FR exam.
Exam success skill 1

Managing information
Questions in the exam will present you with a lot of information. You need to be confident in how
to handle this information to make the best use of your time. The key is determining how you will
approach the exam and then actively reading the questions.
Advice on developing managing information
Approach
The exam is three hours long. There is no designated ‘reading’ time at the start of the exam, but it
is a good idea to take time to skim read the question before you begin.
Once you feel familiar with the exam, consider the order in which you will attempt the questions;
always attempt them in your order of preference. For example, you may want to leave to last the
question you consider to be the most difficult.
If you do take this approach, remember to adjust the time available for each question
appropriately – see Exam success skill 6: Good time management.
If you find that this approach doesn’t work for you, don’t worry – you can develop your own
technique.
Active reading
You must take an active approach to reading each question. Focus on the requirement first,
underlining key verbs such as ‘prepare’, ‘comment’, ‘explain’, ‘discuss’, to ensure you answer the
question properly. Then read the rest of the question, underlining and annotating important and
relevant information, and making notes of any relevant technical information you think you will
need.

Correct interpretation of the requirements
The active verb used often dictates the approach that written answers should take (eg ‘explain’,
‘discuss’, ‘evaluate’). It is important you identify and use the verb to define your approach. The
correct interpretation of the requirements skill means correctly producing only what is being
asked for by a requirement. Anything not required will not earn marks.
Advice on developing correct interpretation of the requirements
This skill can be developed by analysing question requirements and applying this process:
Step 1 Read the requirement
Firstly, read the requirement a couple of times slowly and carefully and highlight the
active verbs. Use the active verbs to define what you plan to do. Make sure you identify
any sub-requirements
Step 2 Read the rest of the question
By reading the requirement first, you will have an idea of what you are looking out for as
you read through the case overview and exhibits. This is a great time saver and means
you don’t end up having to read the whole question in full twice. You should do this in an
active way – see Exam success skill 1: Managing Information.
Step 3 Read the requirement again
Read the requirement again to remind yourself of the exact wording before starting your
written answer. This will capture any misinterpretation of the requirements or any missed
HB2022 xix Financial Reporting (FR)

requirements entirely. This should become a habit in your approach and, with repeated
practice, you will find the focus, relevance and depth of your answer plan will improve.

Answer planning: Priorities, structure and logic
This skill requires the planning of the key aspects of an answer which accurately and completely
responds to the requirement.
Advice on developing answer planning: priorities, structure and logic
Everyone will have a preferred style for an answer plan. For example, it may be a mind map,
bullet-pointed lists or simply highlighting and making notes on the question using the scratchpad
within the exam. Choose the approach that you feel most comfortable with, or, if you are not
sure, try out different approaches for different questions until you have found your preferred
style.
For a discussion question, highlighting and annotating the question is likely to be insufficient. It
would be better to draw up a separate answer plan. You should consider copying relevant
sections, keywords or headings from the question into the response area to help give your answer
structure and encourage logical writing.

Efficient numerical analysis
This skill aims to maximise the marks awarded by making clear to the marker the process of
arriving at your answer. This is achieved by laying out an answer such that, even if you make a
few errors, you can still get some credit for your calculations. It is vital that you do not lose marks
purely because the marker cannot follow what you have done.
Advice on developing efficient numerical analysis
This skill can be developed by applying the following process:
Step 1 Use a standard proforma working where relevant
If answers can be laid out in a standard proforma then always plan to do so. This will
help the marker to understand your working and allocate the marks easily. It will also
help you to work through the figures in a methodical and time-efficient way.
Some interpretations questions have a preformatted response area which requires you to
show your calculations and final answer for each of the required ratios. If the exam
includes a pre-formatted response area, you must complete it as indicated.
Step 2 Show your workings
Keep your workings as clear and simple as possible and ensure they are cross-
referenced to the main part of your answer. Where it helps, provide very brief narrative
explanations to help the marker understand the steps in the calculation. This means that
if a mistake is made you should not lose any subsequent marks for follow-on
calculations.
Step 3 Keep moving!
It is important to remember that, in an exam situation, it is difficult to get every number
100% correct. The key is therefore ensuring you do not spend too long on any single
calculation. If you are struggling with a solution then make a sensible assumption, state
it and move on.

Effective writing and presentation
Written answers should be presented so that the marker can clearly see the points you are
making, presented in the format specified in the question. The skill is to provide efficient written
answers with sufficient breadth of points that answer the question, in the right depth, in the time
available.
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Introduction xx

Advice on developing effective writing and presentation
Step 1 Use headings
Using the headings and sub-headings from the question will give your answer structure,
order and logic. You can copy and paste short sections from the question into the
response area. This will ensure your answer links back to the requirement and is clearly
signposted, making it easier for the marker to understand the different points you are
making. Underlining your headings will also help the marker.
Step 2 Write your answer in short, but full, sentences
Use short, punchy sentences with the aim that every sentence should say something
different and generate marks. Write in full sentences, ensuring your style is professional.
Step 3 Do your calculations first and explanation second
Interpretation questions will require you to calculate ratios then provide explanation as to
the differences/trends that the ratios show. You must perform the calculations first then
use the information in the question to form your explanations.

Good time management
This skill means planning your time across all the requirements so that all tasks have been
attempted at the end of the three hours available and actively checking on time during your
exam. This is so that you can flex your approach and prioritise requirements which, in your
judgment, will generate the maximum marks in the available time remaining.
Advice on developing Good time management
The exam is three hours long, which translates to 1.8 minutes per mark. Therefore a 10-mark
requirement should be allocated a maximum of 18 minutes to complete your answer before you
move on to the next task. At the beginning of a question, work out the amount of time you should
be spending on each requirement and write the finishing time next to each requirement on your
exam paper.
Keep an eye on the clock
Aim to attempt all requirements, but be ready to be ruthless and move on if your answer is not
going as planned. The challenge for many is sticking to planned timings. Be aware this is difficult
to achieve in the early stages of your studies and be ready to let this skill develop over time.
If you find yourself running short on time and know that a full answer is not possible in the time
you have, consider recreating your plan in overview form and then add key terms and details as
time allows. Remember, some marks may be available, for example, simply stating a conclusion
which you don’t have time to justify in full.
Question practice
Question practice is a core part of learning new topic areas. When you practice questions, you
should focus on improving the Exam success skills – personal to your needs – by obtaining
feedback or through a process of self-assessment.
Sitting this exam as a computer-based exam and practicing as many exam-style questions as
possible in the ACCA Exam Practice Platform will be the key to passing this exam. You should
attempt questions under timed conditions and ensure you produce full answers to the discussion
parts as well as doing the calculations. Also ensure that you attempt all mock exams under exam
conditions.
ACCA have launched a free on-demand resource designed to mirror the live exam experience
helping you to become more familiar with the exam format. You can access the platform via the
Study Support Resources section of the ACCA website navigating to the CBE question practice
section and logging in with your my ACCA credentials. Question practice is a core part of learning
new topic areas. When you practice questions, you should focus on improving the Exam success
skills – personal to your needs – by obtaining feedback or through a process of self-assessment.
HB2022 xxi Financial Reporting (FR)

The Conceptual
1 Framework
Learning objectives
On completion of this chapter, you should be able to:
Syllabus reference no.
Describe what is meant by a conceptual framework for financial A1(a)

reporting.
Discuss whether a conceptual framework is necessary and what A1(b)

an alternative system might be.
Discuss what is meant by relevance and faithful representation A1(c)

and describe the qualities that enhance these characteristics.
Discuss whether faithful representation constitutes more than A1(d)

compliance with IFRS Standards.
Discuss what is meant by understandability and verifiability in A1(e)

relation to the provision of financial information.
Discuss the importance of comparability and timeliness to users A1(f)

of financial statements.
Discuss the principle of comparability in accounting for changes A1(g)

in accounting policies.
Define what is meant by ‘recognition’ in financial statements and A2(a)

discuss the recognition criteria.
Apply the recognition criteria to: A2(b)

(i) assets and liabilities
(ii) income and expenses
Explain and compute amounts using the following measures: A2(c)

(i) historical cost
(ii) current cost
(iii) value in use/fulfilment value
(iv) fair value
Discuss the advantages and disadvantages of the use of A2(d)

historical cost accounting.
Discuss whether the use of current value accounting overcomes A2(e)

the problems of historical cost accounting.
1
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Exam context
The IASB’s Conceptual Framework for Financial Reporting (the Conceptual Framework) underpins
the methods used in financial reporting. It is used as the basis to develop IFRS Standards and
offers valuable guidance on how to account for an item where no IFRS Standard exists, and how
to understand and interpret IFRS Standards. Knowledge of the Conceptual Framework will be
examined by objective test questions in Section A or Section B of the FR exam, although it may
also be relevant when interpreting financial statements in Section C.
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2 Financial Reporting (FR)

1
Chapter overview
The Conceptual Framework
What is a The IASB’s The objective of

conceptual Conceptual general purpose
framework? Framework financial reporting
Advantages Purpose Accrual accounting
Disadvantages Status Going concern
Inhalt
Qualitative The elements Recognition

characteristics of useful of financial and
financial information statements derecognition
Fundamental qualitative Asset Recognition criteria

characteristics
Liability Derecognition
Enhancing qualitative
characteristics
Equity
The cost constraint

Income and expenses
Measurement
Historical cost
Current value
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1: The Conceptual Framework 3

1 What is a conceptual framework?
A conceptual framework for financial reporting is a statement of generally accepted theoretical
principles, which form the frame of reference for financial reporting.
Its theoretical principles provide the basis for:
• The development of accounting standards; and
• The understanding and interpretation of accounting standards.
Therefore, a conceptual framework will form the theoretical basis for determining which events
should be accounted for, how they should be measured and how they should be communicated
to users of financial statements.
1.1 Advantages of a conceptual framework

(a) Accounting standards are developed on the same theoretical principles – which avoids a
haphazard approach to setting standards and should lead to standardised accounting
practices.
(b) The development of accounting standards is less subject to political pressure – pressure on
standard setters to adopt a certain approach would only prevail if it was acceptable under
the conceptual framework.
(c) Accounting standards use a consistent approach – eg without a conceptual framework, some
standards may concentrate on profit or loss whereas some may concentrate on the
valuation of net assets.
(d) A principles-based approach avoids the need for large volumes of ‘rules’ to address every
scenario. Instead, the same underlying principles can be applied to any scenario.
1.2 Disadvantages of a conceptual framework

(a) Financial statements are intended for a variety of users, and it is not certain that a single
conceptual framework can be devised which will suit all users.
(b) Given the diversity of user requirements, there may be a need for a variety of accounting
standards, each produced for a different purpose (and with different concepts as a basis).
(c) It is not clear that a conceptual framework makes the task of preparing and then
implementing standards any easier than without a framework.
2 The IASB’s Conceptual Framework

2.1 Purpose
IFRS Standards are based on the Conceptual Framework for Financial Reporting (the ‘Conceptual
Framework’) which addresses the concepts underlying the information presented in general
purpose financial statements.
The purpose of the Conceptual Framework is to:
• Assist the IASB to develop IFRS Standards that are based on consistent concepts;
• Assist preparers of accounts to develop accounting policies in cases where there is no IFRS
Standard applicable to a particular transaction, or where a choice of accounting policy exists;
and
• Assist all parties to understand and interpret IFRS Standards.
(Conceptual Framework: para. SP1.1)
2.2 Status
The Conceptual Framework is not an IFRS Standard. It does not override any IFRS Standard, but
instead forms the conceptual basis for the development and application of IFRS Standards.
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2.3 Contents
The Conceptual Framework is divided into eight chapters. You do not need to know all of the
content of the Conceptual Framework for the Financial Reporting exam. In the rest of this chapter,
we will cover the key parts of the Conceptual Framework that are included in the Financial
Reporting syllabus.
2.4 The objective of general purpose financial reporting

The objective of general purpose financial reporting is ‘to provide financial information about the
reporting entity that is useful to existing and potential investors, lenders and other creditors in
making decisions about providing resources to the entity’ (Conceptual Framework: para. 1.2).
Existing and potential investors, lenders and other creditors are referred to as the ‘primary users’
of financial statements (Conceptual Framework: para. 1.5).
Primary users may make decisions about buying, selling or holding shares or debt instruments or
providing or settling loans (Conceptual Framework: para. 1.2).
To make decisions, primary users need information about:
• The economic resources of the entity, claims against the entity and changes in those
resources and claims
• Management’s stewardship: how efficiently and effectively the entity’s management and
governing board have discharged their responsibilities to use the entity’s economic resources
(Conceptual Framework: para. 1.4).
2.5 Accrual accounting

The Conceptual Framework requires financial statements to be prepared using accrual
accounting. That is, the effects of transactions and events are reported in the periods in which
those effects occur, even if the resulting cash receipts and payments occur in a different period.
This is also referred to as the ‘matching’ concept.
2.6 Underlying assumption: Going concern

Financial statements are normally prepared on the assumption that an entity is a going concern
and will continue in operation for the foreseeable future.
This means that it is assumed that the entity has neither the intention nor the need to liquidate or
curtail materially the scale of its operations.
However, if such an intention or need exists, the financial statements may have to be prepared on
a different basis such as the ‘break-up basis’.
3 Qualitative characteristics of useful financial

information
The Conceptual Framework identifies the characteristics of information that make that
information useful to users of financial statements.
There are two fundamental qualitative characteristics and four enhancing qualitative
characteristics.
3.1 Fundamental qualitative characteristics

The two fundamental qualitative characteristics are: relevance and faithful representation.
Information is useful if it is relevant and faithfully represents what it purports to represent
(Conceptual Framework, para. 2.4).
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Fundamental qualitative characteristics
Relevance Faithful representation

Relevant information is capable of making a A faithful representation reflects economic
difference in the decisions made by users. substance rather than legal form, and is:
It has predictive and/or confirmatory value. • Complete – all information necessary for
Consideration should be given to materiality. understanding
• Neutral – without bias, supported by
Materiality exercise of prudence
Information is material if omitting, misstating • Free from error – processes and descriptions
or obscuring it could reasonably be expected without error, does not mean perfect
to influence decisions that the primary users
of general purpose financial statements make Prudence
on the basis of those financial statements Prudence is exercising caution, particularly
(IAS 1: para. 7) with areas where judgement or estimation is
required.
Supports the concept of neutrality
(Conceptual Framework, paras. 2.6, 2.7, 2.11-2.17)
3.2 Enhancing qualitative characteristics

The enhancing qualitative characteristics are:
• Comparability
• Verifiability
• Timeliness
• Understandability
(Conceptual Framework: paras. 2.23–2.38)
The usefulness of information is enhanced if these characteristics are maximised.
Enhancing qualitative characteristics cannot make information useful if the information is
irrelevant or if it is not a faithful representation.
The benefits of reporting information should justify the costs incurred in reporting it. This is known
as the ‘cost constraint’.
3.2.1 Comparability
Comparability: The qualitative characteristic that enables users to identify and understand
KEY
TERM similarities in, and differences among, items (Conceptual Framework: para. 2.25).
For example:
• Consider the disclosure of accounting policies. Users must be able to distinguish between
different accounting policies in order to be able to compare similar items in the accounts of
different entities.
• When an entity changes an accounting policy, the change is applied retrospectively so that
the results from one period to the next can still be usefully compared.
• Comparability is not the same as uniformity. Accounting policies should be changed if the
change will result in information that is reliable and more relevant, or where the change is
required by an IFRS Standard.
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3.2.2 Verifiability
Verifiability: This helps assure users that information faithfully represents the economic
KEY
TERM phenomena it purports to represent. Verifiability means that different knowledgeable and
independent observers could reach consensus, although not necessarily complete agreement,
that a particular depiction is a faithful representation (Conceptual Framework: para. 2.30).
Information can be verified to a model or formula or by direct observation, such as undertaking

an inventory count. Independent verification can be carried out, eg a valuation by a specialist.
3.2.3 Timeliness
Timeliness: This means having information available to decision-makers in time to be capable

KEY
TERM of influencing their decisions. Generally, the older information is the less useful it is
There is a balance between timeliness and the provision of reliable information.

If information is reported on a timely basis when not all aspects of the transaction are known, it
may not be complete or free from error. Conversely, if every detail of a transaction is known, it
may be too late to publish the information because it has become irrelevant. The overriding
consideration is how best to satisfy the economic decision-making needs of the users.
3.2.4 Understandability
Understandability: Classifying, characterising and presenting information clearly and

KEY
TERM concisely makes it understandable (Conceptual Framework: para. 2.34).
Financial reports are prepared for users who have a reasonable knowledge of business and
economic activities and who review and analyse the information diligently (Conceptual
Framework: para. 2.36).
Activity 1: Qualitative characteristics
Which of the following statements correctly describes comparability?

 The non-cash effects of transactions should be reflected in the financial statements for the
accounting period in which they occur and not in the period where any cash involved is
received or paid.
 Information should be provided to a decision maker in time to be capable of influencing
decisions.
 Information must have a predictive and/or confirmatory value.
 Similar items within a single set of financial statements should be given similar accounting
treatment.
4 The elements of the financial statements

The Conceptual Framework defines the elements of the financial statements.
The five elements of financial statements are assets, liabilities, equity, income and expenses.
Asset: A present economic resource controlled by the entity as a result of past events
KEY
TERM (Conceptual Framework: para. 4.2).
An economic resource is a right that has the potential to produce economic benefits (Conceptual
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An entity controls an economic resource if it has the present ability to direct the use of the
economic resource and obtain the economic benefits that may flow from it (Conceptual
Economic benefits include:
• Cash flows, such as returns on investment sources
• Exchange of goods, such as by trading, selling goods, provision of services
• Reduction or avoidance of liabilities, such as paying loans
(Conceptual Framework: para. 4.16)
Liability: A present obligation of the entity to transfer an economic resource as a result of past
KEY
TERM events (Conceptual Framework: para. 4.2).
An essential characteristic of a liability is that the entity has an obligation. An obligation is ‘a duty
or responsibility that the entity has no practical ability to avoid’ (Conceptual Framework: para.
4.29).
Equity: The residual interest in the assets of an entity after deducting all its liabilities
KEY
TERM (Conceptual Framework: para. 4.2).
Remember that EQUITY = SHARE CAPITAL + RESERVES = NET ASSETS
Income: Increases in assets, or decreases in liabilities, that result in increases in equity, other
KEY
TERM than those relating to contributions from equity participants (Conceptual Framework: para.
4.2).
Expenses: Decreases in assets, or increases in liabilities, that result in decreases in equity,
other than those relating to distributions to equity participants (Conceptual Framework: para.
4.2).
The Conceptual Framework describes financial reporting as providing information about financial
position and changes in financial position: assets and liabilities are defined first, and income and
expenses are defined as changes in assets and liabilities, rather than the other way around.
Activity 2: Asset or liability?
Consider the following situations and in each case determine whether an asset, liability or neither
exists as defined by the Conceptual Framework.
1 PAT Co purchased a licence for $20,000. The licence gives PAT Co sole use of a particular
manufacturing process which, in turn, will save them $3,000 a year for the next five years.
2 BAW Co gifted an individual, Don Brennan, $10,000 to set up a car repair shop. In return, BAW
Co has requested that priority treatment is given to the fleet of cars used by BAW Co’s
salesmen.
3 DOW Co operates a car dealership and provides a warranty with every car it sells. The
warranty guarantees that the cars will operate as expected for a period of 12 months from the
date of purchase.
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Solution
5 Recognition of the elements of financial statements

5.1 Recognition process
The Conceptual Framework defines recognition as ‘the process of capturing for inclusion in the
statement of financial position or the statement(s) of financial performance an item that meets
the definition of one of the elements of financial statements’ (para. 5.1).
Put simply, recognition means including an item in the financial statements, with a description in
words and a number value.
Recognising one element requires the recognition or derecognition of one or more other elements:
Eg
Recognise at the same time Derecognise Recognise

oder
an expense an asset a liability
Debit expenses Credit asset or Credit liability
5.2 Recognising an element

The Conceptual Framework requires an item to be recognised in the financial statements if:
(a) The item meets the definition of an element (asset, liability, income, expense or equity); and
(b) Recognition of that element provides users of the financial statements with information that is
useful, ie with:
- Relevant information about the element
- A faithful representation of the element
(Conceptual Framework, paras. 5.6-5.8)
Recognition is subject to cost constraints: the benefits of the information provided by recognising
an element should justify the costs of recognising that element (Conceptual Framework, para.
2.39).
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5.3 Derecognition
Derecognition normally occurs when the item no longer meets the definition of an element:
• For an asset – when control is lost (derecognise part of a recognised asset if control of that
part is lost)
• For a liability – when there is no longer a present obligation
(Conceptual Framework: para. 5.26)
Activity 3: Recognition
Consider the following situations:

(1) Company A reports under IFRS Standards and provides a training programme for all of its
members of staff.
(2) The directors of Company B, a publicly listed company reporting under IFRS Standards,
propose a dividend at the board meeting on 28 December. The dividend is communicated to
the markets on 10 February, after the financial statements for the year ended 31 December
have been prepared.
Required
Discuss what, if anything, should be recognised in the financial statements of Company A and
Company B relating to these situations.
Solution
6 Measurement
The Conceptual Framework specifically refers to two measurement bases:
• Historical cost
• Current value
It outlines the information provided by both, but stresses that the choice between them depends
on what information the primary users of the financial statements require.
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6.1 Historical cost
Historical cost: Historical cost for an asset is the cost that was incurred when the asset was
KEY
TERM acquired or created and, for a liability, is the value of the consideration received when the
liability was incurred.
Historical cost accounting (HCA) is the traditional form of accounting, modified in some instances
by revaluations of certain assets.
6.1.1 Advantages of the historical cost basis for measurement

(a) Amounts used are objective, as it is more difficult to manipulate cost-based figures.
(b) Amounts are reliable, they can always be verified, they exist on invoices and documents.
(c) The statement of financial position and statement of cash flows figures are consistent with
each other.
(d) There is less possibility for manipulation by using ‘creative accounting’ in asset valuation.
(e) Cost is a measure that is readily understood.
6.1.2 Limitations of the historical cost basis for measurement

(a) Overstatement of profit – it shows current revenues less out of date costs. During periods
where price inflation is low, profit overstatement will be marginal. The disadvantages of
historical cost accounting become most apparent in periods of inflation.
(b) Out of date asset values – based on their historical values.
(c) Return on assets/capital employed is distorted by both (a) and (b).
(d) Holding gains/losses (ie the fact that something is worth more or costs more over time simply
due to price rises) are not measured separately from operating results.
(e) HCA does not measure any gain/loss on monetary items arising from the impact of inflation
(ie the fact that savers lose because the purchasing power of their savings is eroded, while
borrowers gain because they still owe the same nominal amount while earnings have risen
due to inflation).
(f) HCA gives a misleading trend of results since comparative figures are not restated for the
effects of inflation.
6.2 Current value

Current value accounting attempts to address some of the problems of HCA by using information
updated to reflect conditions at the measurement date. Current value measurement bases
include:
• Fair value
• Value in use (for assets) or fulfilment value (for liabilities)
• Current cost
6.2.1 Fair value
Fair value: The price that would be received to sell an asset, or paid to transfer a liability, in an
KEY
TERM orderly transaction between market participants at the measurement date (Conceptual
Framework: para. 6.12 and IFRS 13: Appendix A).
Fair value is measured in accordance with IFRS 13 Fair Value Measurement.

Fair value is most commonly calculated by taking the open market value. Where there is no active
market for the asset or liability, the following should be used as a basis:
• Estimates of future cash flows
• Time value of money (discounting the future cash flows)
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6.2.2 Value in use and fulfilment value
Value in use: The present value of the cash flows, or other economic benefits, that an entity
KEY
TERM expects to derive from the use of an asset and from its ultimate disposal (Conceptual
Value in use cannot be directly observed. It looks at the likely future value to the entity of using
the asset.
Value in use considers entity-specific factors, whereas fair value is market specific.
Fulfilment value: The present value of the cash, or other economic resources, that an entity
KEY
TERM expects to be obliged to transfer as it fulfils a liability (Conceptual Framework: para. 6.17).
Fulfilment value is based on the future cash flows an entity expects to incur to fulfil a liability. Like
value in use for an asset, fulfilment value cannot be directly observed and is entity specific.
6.2.3 Current cost
Current cost of an asset: The current cost of an asset is the cost of an equivalent asset at the
KEY
TERM measurement date, comprising the consideration that would be paid at the measurement
date, plus the transaction costs that would be incurred at that date (Conceptual Framework:
para. 6.21).
Current cost of a liability: The current cost of a liability is the consideration that would be
received for an equivalent liability at the measurement date, minus the transaction costs that
would be incurred at that date (Conceptual Framework: para. 6.21).
Current cost differs from historical cost as current cost assesses the price to purchase at the
reporting date, rather than the date the asset was acquired or liability assumed.
Where the current cost cannot be obtained from information in the market, then the entity can
adjust for condition and age to buy a similar model.
6.2.4 Advantages of using current value

(a) Assets and liabilities are measured after management has considered the expected benefits
from their future use or cash flows incurred in their fulfilment. Current value is therefore a
useful guide for management in deciding whether to hold or sell assets and when to settle
liabilities.
(b) It is relevant to the needs of information users in:
(i) Assessing the stability of the business entity
(ii) Assessing the vulnerability of the business (eg to a takeover), or the liquidity of the
Geschäft
(iii) Evaluating the performance of management in maintaining and increasing the business
substance
(iv) Judging future prospects
6.2.5 Limitations of using current value

(a) The discount factor used to calculate the present value of future cash flows requires
subjective judgements by management. Also, the expected benefits from cash flows from the
asset or amounts required to fulfil obligations will be based on management’s best estimates
and judgements.
(b) There may be problems in deciding how to provide an estimate of current costs for non-
current assets which can only be purchased new, such as a bespoke or specialist piece of
machinery.
(c) As the Conceptual Framework allows different groups of assets and liabilities to be valued on
different bases (which are the most useful to users of the financial statements), this can mean
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that some assets (liabilities) will be valued at current cost, but others will be valued at value in
use (fulfilment value) or fair value.
Activity 4: Measurement
Ergo Co acquired an item of plant on 1 July 20X5 at a cost of $250,000. Ergo Co depreciates its
plant at a rate of 20% on a reducing balance basis. As at 30 June 20X6, the manufacturer still
makes the same item of plant and its current price is $300,000.
Required
What is the correct carrying amount to be shown in the statement of financial position of Ergo Co
as at 30 June 20X6 under historical cost and current cost?
 Historical cost: $200,000; Current cost: $300,000
 Historical cost: $250,000; Current cost $240,000
Activity 5: Asset carrying amounts
You have been asked to show the effect of different measurement bases for the following asset:
An item of equipment was purchased on 1 January 20X3 for $140,000. The equipment is
depreciated at 25% per annum using the reducing balance method.
The equipment is still available and its list price at 31 December 20X4 is $180,000, although the
current model is 20% more efficient than the model the entity purchased in 20X3.
It is estimated that the equipment could be sold for $44,000, although the company would have
to spend about $500 in advertising costs to do so. The asset is expected to generate net cash
inflows of $20,000 for the next five years after which time it will be scrapped. The company’s cost
of borrowing is 6%. The cumulative present value of $1 in five years’ time is $4.212.
Required
1 What is carrying amount of the equipment in the statement of financial position as at 31
December 20X4 using historical cost?
 $70,000
 $78,750
 $105,000
 $140,000
2 What is the carrying amount of the equipment in the statement of financial position as at 31
December 20X4 using fair value?
 $32,868
 $43,500
 $44,000
 $44,500
December 20X4 using current cost?
 $70,313
 $75,000
 $84,375
 $101,250
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December 20X4 using the value in use method?
 $32,868
 $43,500
 $83,740
 $84,240
7 IAS 1 Presentation of Financial Statements

IAS 1 (para. 15) states that in order to achieve fair presentation, an entity must present
information in accordance with the principles in the Conceptual Framework and apply IFRS
Standards, which include all IFRS Standards, International Accounting Standards (IASs) and IFRIC
Interpretations originated by the IFRS Interpretations Committee.
Applying the requirements of IFRS Standards is presumed to result in a fair presentation.
IAS 1 (para. 17) clarifies that a fair presentation also requires an entity to:
(a) Select and apply appropriate accounting policies;
(b) Present information, including accounting policies, in a manner that provides relevant,
reliable, comparable and understandable information; and
(c) Provide additional disclosures when compliance with the specific requirements of IFRS
Standards is insufficient to enable users to understand the impact of particular transactions,
and other events and conditions on the entity’s financial position and financial performance.
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Chapter summary
The Conceptual Framework
What is a The IASB’s The objective of

conceptual Conceptual general purpose
framework? Framework financial reporting
A statement of generally Purpose To provide financial information

accepted theoretical principles, • To help develop IFRS Standards about the reporting entity that is
which form the frame of which are based on consistent useful to existing and potential
reference for financial reporting concepts investors, lenders and other
• To assist preparers where no creditors in making decisions
IFRS Standard applies about providing resources to the
Advantages entity
• Accounting standards
developed on same principles, Status
using a consistent approach Accrual accounting
• Not an IFRS Standard
• Development of accounting • Compliance required by IAS 1 The effects of transactions and
standards less subject to other events are recognised
political pressure when they occur, even if the
• Avoids need for large volume of Contents resultant cash receipts/payments
rules occur in a different period
• The objective of general
purpose financial reporting
• The qualitative characteristics
Disadvantages Going concern
of useful financial information
• Not clear that single • Financial statements and the The financial statements are
conceptual framework will suit reporting entity normally prepared on the
all users • The elements of financial assumption that the entity is a
• May be a need for a variety of statements going concern and will continue
accounting standards, each • Recognition and derecognition in operation for the foreseeable
produced for a different • Measurement future
purpose (and with different • Presentation and disclosure
concepts as a basis) • The concepts of capital and
• Not clear that a conceptual capital maintenance
framework makes the task of
preparing and then
implementing standards any
easier than without a
framework
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Qualitative The elements Recognition
characteristics of useful of financial and
financial information statements derecognition
Fundamental qualitative Asset Recognition criteria

characteristics Present economic resource • Meets the definition of an
• Relevance: controlled by the entity as a element
– Capable of making a result of past events • Provides information that is
difference in the decisions relevant and a faithful
made by users representation
– Predictive and/or Liability • At a cost that does not
confirmatory value A present obligation of an entity outweigh the benefit
– Materiality to transfer an economic resource
• Faithful representation: as a result of past events
– Represents economic Derecognition
phenomena in words and • When control of all/part of an
numbers Equity asset is lost
– Reflects substance The residual interest in the assets • When there is no longer a
– Complete of an entity after deducting all present obligation in respect of
– Neutral its liabilities all/part of a liability
– Free from error
Income and expenses

Enhancing qualitative
• Income: Increases in assets or
characteristics
decreases in liabilities that
• Comparability: About other result in increases in equity,
entities and other periods other than those relating to
• Verifiability: Information must contributions from holders of
be capable of being verified equity claims
• Timeliness: Information must • Expenses: Decreases in assets
be available in time to or increases in liabilities that
influence decision making result in decreases in equity,
• Understandability: Information other than those relating to
must be classified and distributions to holders of
presented in a clear and equity claims
concise manner
The cost constraint

The benefits of reporting
financial information must justify
the costs incurred to provide and
use it
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Measurement
Historical cost
• Most common
• Measured at the transaction
date and not subsequently
updated
• Asset: Cost of acquisition/
creation of asset plus
transaction costs
• Liability: Value to incur/take on
the liability less transaction
costs
Current value
• Information is updated to
reflect changes in value at the
measurement date
• Fair value: Price that would be
received to sell an asset/paid
to transfer a liability in an
orderly transaction between
market participants at the
measurement date
• Value in use (assets)/fulfilment
value (liabilities)
– Value in use – present value
of the cash flows expected to
be derived from the asset
– Fulfilment value – present
value of the cash flows
expected to be obliged to
transfer to fulfil the liability
• Current cost: Cost of an
equivalent asset/consideration
that would be received for an
equivalent liability at the
measurement date
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Knowledge diagnostic
1. What is a conceptual framework?

A conceptual framework for financial reporting is a statement of generally accepted theoretical
principles, which form the frame of reference for financial reporting.
There are advantages and disadvantages to having a conceptual framework.
2. The IASB’s Conceptual Framework

The Conceptual Framework establishes the objectives and principles underlying financial
statements and underlies the development of new standards.
The Conceptual Framework states that the objective of general purpose financial reporting is to
provide financial information about the reporting entity that is useful to existing and potential
investors, lenders and other creditors in making decisions about providing resources to the entity.
3. Qualitative characteristics of useful financial information

Useful information is information that is relevant and a faithful representation of what it purports
to represent.
The usefulness of information is enhanced if these characteristics are maximised:
• Comparability
• Verifiability
• Timeliness
• Understandability
4. The elements of the financial statements

The elements of financial statements are assets, liabilities, equity, income and expenses.
5. Recognition of the elements of financial statements

An element should be recognised in the financial statements when:
(a) It meets the definition of an element
(b) It provides relevant information that is a faithful representation at a cost that does not
outweigh benefits
A recognised element should be derecognised when:
• Control of an asset is lost
• There is no longer a present obligation for a liability
6. Measurement
Using the historical cost basis is an objective and readily understood method, but overstates
profits and return on capital employed in times of inflation.
Using the current value basis attempts to solve this problem. Current value includes:
• Fair value
• Value in use/Fulfilment value
• Current cost
7. IAS 1 Presentation of Financial Statements

In order to achieve fair presentation, an entity must comply with International Financial Reporting
Standards (IFRS Standards, IASs and IFRIC Interpretations).
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Further study guidance
Question practice
Now try the following from the Further question practice bank (available in the digital edition of
the Workbook):
Section A Q1
Section C Q23 Conceptual framework
Further reading
You should make time to read this article, which is available in the study support resources section
of the ACCA website:
Extreme makeover – IASB edition
www.accaglobal.com
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Activity answers
Activity 1: Qualitative characteristics

The correct answer is: Similar items within a single set of financial statements should be given
similar accounting treatment.
Using accrual accounting, the effects of transactions should be reflected in the financial
statements for the accounting period in which they occur and not in the period where any cash
involved is received or paid. Information is relevant if it has a predictive and/or confirmatory value.
Providing information in time to be capable of influencing decisions describes the qualitative
characteristics of timeliness.
Activity 2: Asset or liability?

1 Asset. PAT Co has an intangible asset. The purchase of the licence is a past event. The licence
gives PAT Co control over the manufacturing process and this will bring PAT Co economic
benefits (by generating future cost savings).
2 Neither asset nor liability. The $10,000 gifted to Don Brennan cannot be classified as an
asset. The payment is a past event. However, BAW Co has no obvious control over the car
repair shop and it is difficult to determine whether this will bring economic benefits to BAW Co
(other than the potential that repairs to their cars will be prioritised).
3 Liability. The fact that DOW Co provides a warranty on every car sold constitutes a liability.
Upon sale of a car (past event) DOW Co is immediately responsible (present obligation) to
make good any deficiencies covered by the warranty. The liability is recognised when the
warranty is issued, rather than when a claim is made.
Activity 3: Recognition
Recognition in the financial statements:
(1) First, it is necessary to consider whether the amounts spent on training should be recognised
as an asset or an expense. To be an asset, there must be:
- Present economic resource
- Control
- A past event
Whilst it is clear that there is a past event (the provision of training) and the training is a
resource that has the potential to produce economic benefits (the staff that will be able to do
a better job), the staff are not personally controlled by the company and thus the increased
capability to do their jobs is not under the control of the company.
(2) The issue here is whether the dividend should be recognised as a liability or not at the year
end. A liability exists only where three criteria are met at the year end:
- A present obligation
- (As a result of) a past event
- Expected to result in a transfer of economic resources.
A present obligation is one that exists at the year end. As the dividend payment has not been
communicated outside the company at the year end, there is no obligation for it to be paid:
the directors could change their mind as to how much or whether a dividend should be paid
without any consequences.
A present obligation does not therefore exist at the year end and no liability can be
recognised for proposed dividends. It is declaration of a dividend externally that creates an
obligation for it to be paid, and this has not happened at the year end. A liability would be
recognised from 10 February, even if the dividend has not been legally approved by
shareholders, as a constructive obligation is sufficient to generate a liability under IFRS
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Standards; ie the creation of a valid expectation in those affected that a payment will be
made.
When the dividend is recognised, it will be recognised as a reduction in equity, rather than as
an expense as it is a distribution to equity participants in the business.
Activity 4: Measurement
The correct answer is: Historical cost: $200,000; Current cost: $240,000
Historical cost: $250,000 × 80% = $200,000 carrying amount
Current cost: $300,000 × 80% = $240,000 carrying amount
Activity 5: Asset carrying amounts

1
1 The correct answer is: $78,750
Working
Historical cost carrying amount
Historical cost
$
1.1.X3 b/d 140,000
1.1.X3–31.12.X3 Dep’n @ 25% (35,000)
31.12.X3 Carrying amount 105,000
1.1.X4–31.12.X4 Dep’n @ 25% (26,250)

Fair value is the price that would be received to sell an asset in an orderly transaction between
market participants at the measurement date. The costs of making the sale should not be
deducted.
3
Working
Current cost carrying amount
Current cost
(restated)
$
150,000
1.1.X3 b/d (180,000 × 100%/120%)
1.1.X3-31.12.X3 Dep’n @ 25% (37,500)
1.1.X4-31.12.X4 Dep’n @ 25% (28,125)
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Working
Value in use
Cash flow Discount factor Present value

Annual cash flow $ $
20X3 20,000 4.212 84,240
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The regulatory
2 framework
Learning objectives
Explain why a regulatory framework is needed including the A3(a)

advantages and disadvantages of IFRS Standards over a national
regulatory framework.
Explain why IFRS Standards on their own are not a complete A3(b)
Distinguish between a principles based and a rules based A3(c)

framework and discuss whether they can be complementary.
Describe the standard setting process of the International A3(d)

Accounting Standards Board (IASB®) including revisions to and
interpretations of Standards.
Explain the relationship of national standard setters to the IASB in A3(e)

respect of the standard setting process.
2
Exam context
Building on your basic knowledge of the IFRS Standards introduced in your earlier studies, the FR
exam expands your knowledge of the standards and their application. It is important to
understand why we have IFRS Standards and to recognise the key aims of the IASB. This chapter
also looks at the impact of IFRS Standards worldwide and their interaction with local accounting
standards.
This is an area that is most likely to be tested as part of a Section A objective test question (OTQ).
However, it is important to understand the basis for setting IFRS Standards and the reasons for
making changes to IFRS Standards for your future studies at the Strategic Professional level.
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2
Chapter overview
The Regulatory Framework
Need for regulatory framework Principles vs Rules
Advantages
Disadvantages
IASB IASB and national standard setters
Definition
Advantages
Disadvantages
Objectives of IFRS Standards
Due process of IASB Criticisms of the IASB
Standard setting Accounting standards and choice
Coordination with national standard setters Advantages
Interpretation of accounting standards Disadvantages
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1 The need for a regulatory framework
A regulatory framework for accounting is needed for two principal reasons:
(a) To act as a central source of reference of generally accepted accounting practice (GAAP) in
a given market; and
(b) To designate a system of enforcement of that GAAP to ensure consistency between
companies in practice.
The aim of a regulatory framework is to narrow the areas of difference and choice in financial
reporting and to improve comparability. This is even more important when we consider how
different financial reporting can be around the world.
Compliance with IFRS Standards cannot be required without their adoption in national or regional
law.
2 Principles-based versus rules-based approach

IFRS Standards are developed using a ‘principles-based’ approach. This means that they are
written based on the definitions of the elements of the financial statements, and the recognition
and measurement principles as set out in the Conceptual Framework for Financial Reporting.
The principles-based approach adopted by IFRS Standards means the IFRS Standards cover a
wide variety of scenarios without the need for very detailed scenario by scenario guidance as far
as possible.
Other GAAP, for example US GAAP, are ‘rules based’, which means that accounting standards
contain rules that apply to specific scenarios.
2.1 Advantages and disadvantages of a principles-based approach

Advantages
(a) A principles-based approach based on a single conceptual framework ensures standards are
consistent with each other.
(b) Rules can be broken and ‘loopholes’ found. Principles offer a ‘catch all’ scenario.
(c) Principles reduce the need for excessive detail in standards.
Disadvantages
(a) Principles can become out of date as practices (eg the current move towards greater use of
‘fair values’) change.
(b) Principles can be overly flexible and subject to manipulation.
3 The IFRS Foundation and the International Accounting

Standards Board (IASB)
The IFRS Foundation is responsible for developing a single set of high-quality global accounting
standards, known as IFRS Standards. IFRS Standards are set by the IASB. The IASB is an
independent accounting standard setter established in April 2001. It is based in London, UK. Its
predecessor, the International Accounting Standards Committee (IASC), was founded in 1973.
At the IASB’s first meeting, it adopted the International Accounting Standards (IAS) issued by the
IASC.
3.1 Advantages and disadvantages of IFRS Standards over a national

framework
Advantages
(a) Greater international consistency and comparability of financial statements
(b) Reduced cost of maintaining a national regulatory framework
(c) Reduced cost of finance and increased investment opportunities for companies
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2: The regulatory framework 25

(d) Greater control over, and understanding of, foreign operations
(e) Consolidation of foreign operations using IFRS Standards is easier
Disadvantages
(a) IFRS Standards may not meet local needs
(b) Loss of control and independence
(c) Interference and conflicts with national and regional law
(d) Language, translation and interpretation issues
Tutorial Note
You must keep up to date with the IASB’s progress and the problems it encounters in the financial
press. You should also be able to discuss:
• Use and application of IFRS Standards
• Due process of the IASB
• The IASB’s relationship with other standard setters which looks at current and future work of
the IASB
• Criticisms of the IASB
3.2 Objectives of the IASB

The three formal objectives of the IASB are:
(a) To develop, in the public interest, a single set of high quality, understandable and enforceable
global accounting standards that require high quality, transparent and comparable
information in the financial statements and other financial reporting to help participants in
the world’s capital markets and other users make economic decisions;
(b) To promote the use and rigorous application of those standards; and
(c) To bring about convergence of national accounting standards and IFRS Standards to high
quality solutions.
4 The IASB’s relationship with other standard setters

As of September 2021, 144 countries required IFRS Standards for all, or most, companies. A further
12 countries permitted companies to use IFRS Standards. However, only 15 of the G20 economies
currently require the use of IFRS Standards, with some of the largest global economies such as
China and the USA not currently permitting use of IFRS Standards.
4.1 Working with other national standard setters

The IASB has worked with local country standard setters in a number of projects to harmonise
accounting standards worldwide.
The IASB concentrated on essentials when producing IFRS Standards. They tried not to make IFRS
Standards too complex, because otherwise they would be impossible to apply on a worldwide
basis.
The IASB maintains a policy of dialogue with other key standard setters around the world, in the
interest of harmonising standards around the globe.
Partner standard setters are often involved in the development of Discussion Papers and Exposure
Drafts on new areas.
There are annual conferences for the world’s financial standard setters which discuss, amongst
specific issues, the increased convergence and adoption of IFRS Standards, as well as providing
feedback on current issues.
IFRS Foundation and the World Bank announced a cooperation agreement in 2017 to assist
emerging economies to adopt IFRS Standards.
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Activity 1: Barriers to international harmonisation
Provide reasons why there may be barriers to increasing international harmonisation of

accounting standards.
Solution
4.2 US Financial Accounting Standards Board (FASB)

The IASB and the FASB have worked together significantly in the past, most notably with the
commencement in 2002, of the Norwalk Agreement, which brought the FASB and IASB together to
increase convergence with their differing accounting standards. This resulted in the publication of
several similar US GAAP and IFRS Standards.
However, in recent years, the work between these two bodies has slowed, with no significant
projects planned for the foreseeable future. Indeed, in 2017, the SEC issued a statement which
stated that the two sets of accounting standards were to ‘continue to co-exist…for the foreseeable
future’ (US Securities and Exchange Commission, 2017) implying that increasing convergence or a
move from the US to IFRS Standards was unlikely in the near future.
4.3 The European Union

In 2002, the European Union adopted IFRS Standards as the required financial reporting
standards for the consolidated financial statements of all EU members whose debt or equity
securities trade in a regulated market in Europe, effective in 2005.
France, for example, requires IFRS Standards for listed companies and it is permitted for their
subsidiary companies. However, all individual financial accounts should follow the French Plan
Comptable Général (PCG), a specific set of reporting codes, which is more prescriptive in nature
than IFRS Standards.
The Russian Federation requires all listed companies to use IFRS Standards.
Norway is currently in the process of revising its national standards for consistency with IFRS for
SMEs.
4.4 The UK and other European countries not within the EU

UK legislation provides that all IFRS Standards that were endorsed by the EU on or before 31
December 2020 would become UK-endorsed from 1 January 2021. Any new or amended IFRS
Standards will require to be separately endorsed by the UK prior to their implementation by UK
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Companies. UK companies preparing their financial statements under IFRS Standards will do so
using UK-adopted IFRS Standards from 1 January 2021.
Switzerland permits rather than requires the use of IFRS Standards.
4.5 Asia-Oceania
China, Japan and Australia are all significant economies with differing levels of convergence.
Australia requires the use of IFRS Standards for ‘reporting entities’ (mainly those entities which are
publicly traded). Japan permits, but does not require, the use of IFRS Standards alongside its
three other permitted reporting frameworks, with increasing adoption by Japanese companies
each year.
China’s national standards are substantially converged with IFRS Standards. However, the
implementation of IFRS Standards themselves has no current timetable. In 2015, the IASB and the
Chinese Ministry of Finance announced the formation of a joint working group for a possible
implementation of IFRS Standards within China.
Thailand is in the process of adopting IFRS Standards in full; Indonesia is in the process of
converging its national standards substantially with IFRS Standards; whereas India uses national
standards.
4.6 Africa
In 2021, 36 countries in Africa have adopted IFRS Standards for listed companies and other public
companies. These included the Republic of Congo, Senegal and Cameroon.
4.7 South America

IFRS Standards are required in Brazil, Chile, Argentina (apart from banks) and across the
continent with the exception of Bolivia and French Guiana.
4.8 Other bodies

IFRS Foundation and the World Bank announced a cooperation agreement in 2017 to assist
emerging economies to adopt IFRS Standards.
5 Due process of the IASB

IFRS Standards are developed through a formal system of due process and broad international
consultation involving accountants, financial analysts and other users and regulatory bodies from
around the world.
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5.1 Standard setting process
The following summarises the key steps in the standard-setting process:
IASB staff prepare an issues paper including studying

Issues paper
the approach of national standard setters.
The IFRS Advisory Council is consulted about the

advisability of adding the topic to the IASB's agenda.
Discussion Paper A Discussion Paper may be published for public comment.
Exposure Draft An Exposure Draft is published for public comment.
After considering all comments received, an IFRS is approved by

International Financial
a majority of the IASB. The final standard includes both a
Reporting Standard
basis for conclusions and any dissenting opinions.
The period of exposure for public comment is normally 120 days. However, in exceptional
circumstances, proposals may be issued with a comment period of no less than 30 days. Draft
IFRS Interpretations are exposed for a 60-day comment period (IFRS Foundation Due Process
Handbook: para. 6.7).
5.2 Coordination with national standard setters

Close coordination between IASB due process and due process of national standard setters is
important to the success of the IASB’s mandate.
The IASB continues to explore ways in which to integrate its due process more closely with
national due process, including:
• IASB and national standard setters aim to try and coordinate their work plans. There is an
annual IASB Conference, which enables discussion on key issues to facilitate this process. IASB
has liaison members who work with national standard setters. They help to promote
convergence or the full adoption of IFRS Standards.
• The IASB would continue to publish its own Exposure Drafts and other documents for public
comment. Local standard setters can issue their own Exposure Draft, including any
divergencies or amendments.
• National standards setters would not be required to vote for the IASB’s preferred solution in
their national standards. This gives the local territory the flexibility to adapt all, or make
amendments to, their local region if required.
• National standard setters would follow their own full due process, which they would ideally
choose to integrate with the IASB’s due process.
5.3 Interpretation of accounting standards

The IASB has developed a procedure for issuing interpretations of its standards using the IFRS
Interpretations Committee.
The duties of the IFRS Interpretations Committee are:
(a) To interpret the application of International Financial Reporting Standards and provide
timely guidance on financial reporting issues not specifically addressed in IFRS Standards.
(b) To have regard to the Board’s objective of working actively with national standard setters to
bring about convergence of national accounting standards and IFRS Standards to high
quality solutions.
(c) To review on a timely basis, any newly identified financial reporting issues not already
addressed in existing IFRS Standards.
This is made up of 14 members with significant technical expertise who can offer guidance on the
application of IFRS Standards. This is often as a result of a question to the Committee who then
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consider whether this requires further investigation based on the extent of the work required (is it
specific enough to be answered efficiently?).
An agenda decision will then decide whether further explanatory material is to be added to the
standard (such as in an appendix) or whether an actual amendment (‘Narrow Scope’ standard
setting).
Activity 2: Roles of the IASB
Which of the following bodies is responsible for reviewing new financial reporting issues and
issuing guidance on the application of IFRS Standards?
 The International Accounting Standards Board
 The IFRS Foundation
 The IFRS Interpretations Committee
 The IFRS Advisory Council
6 Criticisms of the IASB

6.1 Accounting standards and choice
It is sometimes argued that companies should be given a choice in matters of financial reporting.
6.2 Advantages
In favour of accounting standards (both national and international), the following points can be
made.
• They reduce, even eliminate, confusing variations in the methods used to prepare accounts.
• They provide a focal point for debate and discussions about accounting practice.
• They oblige companies to disclose the accounting policies used in the preparation of accounts.
• They are a less rigid alternative to enforcing conformity by means of legislation.
• They have obliged companies to disclose more accounting information than they would
otherwise have done if accounting standards did not exist. For example, IAS 33 Earnings per
Share.
6.3 Disadvantages
Many companies are reluctant to disclose information that is not required by national legislation,
with some arguing against standardisation and in favour of choice.
• One method of preparing accounts might be inappropriate in some circumstances.
• Standards may be subject to lobbying or government pressure (in the case of national
standards).
• Many national standards are not based on a conceptual framework of accounting, although
this is the basis for IFRS Standards.
• There may be a trend towards rigidity.
• There are also political problems, as any international body, whatever its purpose or activity,
faces difficulties in attempting to gain international consensus and the IASB is no exception to
this. It is complex for the IASB to reconcile the financial reporting situation between economies
as diverse as developing countries and sophisticated first-world industrial powers.
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Activity 3: Interpretation of IFRS Standards
Which of the following bodies provides strategic support and advice to the IFRS Foundation?
 IFRS Advisory Council
 IFRS Interpretations Committee
 Global Preparers Forum
 Accounting Standards Advisory Forum
Activity 4: Objectives of the IASB
Which TWO of the following are objectives of the IASB?

 To ensure the convergence of IFRS Standards within local national territories
 To develop a set of understandable global accounting standards
 To develop financial reporting standards which aim to provide comparable information in the
 To provide a set of rules in the form of accounting standards which will be used by worldwide
preparers of financial statements
PER alert
One of the competences you require to fulfil Performance Objective 7 of the PER is the ability
to prepare drafts or review primary financial statements in accordance with relevant
accounting standards and policies and legislation. The information in this chapter will give you
knowledge to help you demonstrate this competence.
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Chapter summary
The Regulatory Framework
Need for regulatory framework Principles vs Rules
• To act as a central source of reference • Principles = guidance

• Designate a system of enforcement to • Rules = specific
ensure consistency
Advantages
• Single framework ensuring consistency
across standards
• Principles avoid requirement of excessive detail
in standards
• Rules can be broken and loopholes found
Disadvantages
• Practices may change leading to outdated principles
• Principles may be overly flexible
IASB IASB and national standard setters
Definition • Working to harmonise accounting standards across

'Independent standard setter made up of the global economies
representatives from differing global economies' • Use of Discussion Papers and Exposure Drafts
• Annual IASB Conference to encourage debate and
discussion on key issues
Advantages • IASB works with both national standard setters
• Greater international consistency of financial and other global bodies, such as World Bank
statements • USA – FASB, some convergence and projects
• Reduced costs of running an international, (Norwalk, IFRS 15 and IFRS 16), however, no
centralised reporting framework than a national current plans
reporting framework
• Europe – EU Commission aiming to build fully
• Greater control over and understanding of foreign
integrated market, including recent harmonisation
operations, including their consolidation, as using
of company law (including non-EU entities)
one international recognised set of standards
• UK – FRS 100-105 based on IFRS. Company law
updates in 2017
Disadvantages
• Japan – increased convergence, with further local
• IFRS may not meet local needs adoption of IFRS Standards
• Loss of control at national level in respect of • China – national standards increasingly converged,
accounting standards but no plans to fully adopt IFRS Standards
• Language, translation and interpretation issues
• Africa – significant adoption of IFRS Standards
• May conflict with national law
across African continent
• South America – required across majority of the
Objectives of IFRS Standards continent
• To develop, in the public interest, a single set of high
quality, understandable and enforceable global
accounting standards
• To promote the use and rigorous application of those
standards
• To bring about convergence of national accounting
standards and IFRS
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Due process of IASB Criticisms of the IASB
Standard setting Accounting standards and choice

• Issues paper and consultation with IFRS Advisory Too much choice and variation in interpretation?
Council
• Discussion Paper
• Exposure Draft Advantages
• IFRS Standard • Reduce variations in accounting methods
• Focal point for debate and discussion on
accounting matters
Coordination with national standard setters • Companies must disclose their accounting policies
• Coordination of work plans • Increased conformity
• Power to local standard setters regarding issuance • Increased information available to the users of the
of Exposure Drafts financial statements
• National standard setters set the process regarding
integration and due process
Disadvantages
• 'One-size fits all' not always appropriate, especially
Interpretation of accounting standards across different industries and territories
• IFRS Interpretations Committee • May be subject to influence and pressure by
– Question resulting in discussion and consideration larger economies
by the Committee • Trend towards rigidity
• Resulting in either • Not all national standards have a conceptual
– Additional illustrative material added to existing framework of accounting
standard; or
– Amendment to the Standard (narrow scope
standard setting)
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1. The need for a regulatory framework

• A regulatory framework is necessary to ensure a central source of reference and enforcement
procedures for generally accepted accounting practice.
• There are advantages and disadvantages of using IFRS Standards versus a national
2. Principles-based versus rules-based approach

• A principles-based approach results in shorter ‘catch-all’ standards consistent with a
conceptual framework.
• A rules-based approach can be more prescriptive, but loopholes can often be identified.
3. IASB
The IASB issues and revises IFRS Standards and is an independent standard setter made up of
representatives from different global economies.
4. The IASB’s relationship with other standard setters

• Working to harmonize accounting standards across global economies
• The IASB works with partner national standard setters on joint projects
• Increasing convergence and/or adoption of IFRS Standards on a global scale
• Annual IASB Conference to encourage debate and discussion on key issues
5. Due process of IASB

• Standard setting: A Discussion Paper is issued first to identify the issues, followed by a draft
standard, an Exposure Draft and finally a new or revised IFRS Standard
• Coordination with national standard setters, including the coordination of work plans and
giving local standard setters a degree of autonomy in the final decisions to be made locally
• IFRS Interpretations Committee to clarify and where necessary make amendments to existing
standards
6. Advantages and criticisms of the IASB

• Advantages including better conformity and comparison across different regions and
industries.
• IASB is a focus point for accounting discussion and development.
• However, there may be issues regarding the adoption of standards on a local basis due to the
nature of the local economy, language as well as interpretation issues.
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Question practice
the Workbook):
Section C Q24 Regulators
Section C Q25(a) Standard setters
Further reading
IASB publishes its workplan and future projects, including details of current and proposed
changes. The website also looks at the IFRS Standards adoption process on a global basis.
www.ifrs.org
The IASB has significant information on its website about the ongoing consideration and adoption
of IFRS Standards on a global basis:
https://www.ifrs.org/use-around-the-world/
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Activity answers
Activity 1: Barriers to international harmonisation

Barriers to harmonisation
(1) Different purposes of financial reporting. In some countries, the purpose is solely for tax
assessment, while in others, it is for investor decision making.
(2) Different legal systems. These prevent the development of certain accounting practices and
restrict the options available.
(3) Different user groups. Countries have different ideas about who the relevant user groups are
and their respective importance. In the USA, investor and creditor groups are given
prominence, while in Europe, employees enjoy a higher profile.
(4) Needs of developing countries. Many countries are developing their standard setting process
and they use IFRS Standards to develop their local standards and principles to ensure
comparability with other countries. They do not need to establish large bodies of committees
when the key principles are already in place and consistent with other, more established
economies.
(5) Nationalism is demonstrated in an unwillingness to accept another country’s standard.
(6) Cultural differences result in objectives for accounting systems differing from country to
country.
(7) Unique circumstances. Some countries may be experiencing unusual circumstances which
affect all aspects of everyday life and impinge on the ability of companies to produce proper
reports. For example, hyperinflation, civil war, currency restriction and so on.
(8) The lack of strong accountancy bodies. Many countries do not have strong independent
accountancy or business bodies that would press for better standards and greater
harmonisation.
Activity 2: Roles of the IASB

The correct answer is: The IFRS Interpretations Committee
The role of the IFRS Interpretations Committee is to interpret the application of IFRS Standards
and provide guidance on financial reporting issues not specifically addressed in IFRS Standards.
Activity 3: Interpretation of IFRS Standards

The correct answer is: IFRS Advisory Council
IFRS Advisory Council is the formal advisory body to the IFRS Foundation.
The IFRS Interpretations Committee aids users’ interpretations of IFRS Standards. The Accounting
Standards Advisory Forum consists of national standard setters and contributes to the setting of
new standards. The Global Preparers Forum is a standing consultative group and is independent
of the IASB.
Activity 4: Objectives of the IASB

The correct answers are:
• To develop a set of understandable global accounting standards
• To develop financial reporting standards which aim to provide comparable information in
the financial statements
The convergence of national accounting standards with IFRS Standards is promoted but not
insisted upon by the IASB. IFRS Standards are a principles-based, not a rules-based set of
accounting standards.
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Tangible non-current
3 assets
Learning objectives
Define and compute the initial measurement of a non-current B1(a)

asset (including borrowing costs and an asset that has been self-
constructed).
Identify subsequent expenditure that may be capitalised, B1(b)

distinguishing between capital and revenue items.
Discuss the requirements of relevant IFRS Standards in relation to B1(c)

the revaluation of non-current assets.
Account for revaluation and disposal gains and losses for non- B1(d)
current assets.
Compute depreciation based on the cost and revaluation models B1(e)

and on assets that have two or more significant parts.
Discuss why the treatment of investment properties should differ B1(f)

from other properties.
Apply the requirements of relevant IFRS Standards to an B1(g)

investment property.
3
Exam context
Property, plant and equipment is an important area of the Financial Reporting syllabus. You can
almost guarantee that in every exam you will be required to account for property, plant and
equipment at least once and it can feature as an OT Question in Section A or B, or as an
adjustment when preparing primary financial statements in Section C. This chapter builds on the
knowledge of IAS 16 Property, Plant and Equipment that you have already gained from your
earlier studies and also introduces IAS 23 Borrowing Costs and IAS 40 Investment Property.
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3
Chapter overview
Tangible non-current assets
Property, plant and Investment property Borrowing costs

equipment (IAS 16) (IAS 40) (IAS 23)
Accounting for PPE Definitions Accounting treatment
Accounting for revaluations Recognition Borrowing costs eligible

for capitalisation
Revaluation of Initial measurement

depreciated assets Commencement, suspension
and cessation
Subsequent measurement
Complex assets
Transfers
Disposals
Disclosure
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1 Property, Plant and Equipment (IAS 16)
1.1 Accounting for property, plant and equipment (PPE)
You should recall IAS 16 Property, Plant and Equipment from your previous studies. This chapter
builds on the knowledge you already have and therefore it is important that you recap on the key
topics. A high-level overview of those key topics is included below; however, you should refer to the
Essential reading discussed at the end of this section for a more detailed recap.
1.2 Definitions
Property, plant and equipment: Tangible assets that:

KEY
TERM • Are held for use in the production or supply of goods or services, for rental to others, or for
administrative purposes
• Are expected to be used during more than one period
Cost: The amount of cash or cash equivalents paid or the fair value of the other consideration
given to acquire an asset at the time of its acquisition or construction.
Residual value: The net amount which the entity expects to obtain for an asset at the end of its
useful life after deducting the expected costs of disposal.
Fair value: The price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date.
Depreciation: The result of systematic allocation of the depreciable amount of an asset over
its estimated useful life. Depreciation for the accounting period is charged to net profit or loss
for the period, either directly or indirectly.
Depreciable amount: The depreciable amount of an asset is the historical cost or other
amount substituted for cost in the financial statements, less its estimated residual value. (IAS
16: paras. 50–54)
Useful life: One of two things:
• The period over which a depreciable asset is expected to be used by the entity, or
• The number of production or similar units expected to be obtained from the asset by the
entity.
Carrying amount: The amount at which an asset is recognised in the statement of financial
position after deducting any accumulated depreciation and accumulated impairment losses.
1.3 Recognition
The recognition of property, plant and equipment depends on two criteria:
It is probable that future economic benefits The cost of the asset to the entity
and
associated with the asset will flow to the entity can be measured reliably
(IAS 16: para. 7)
The degree of certainty attached to the flow It is generally easy to measure the cost of an
of future economic benefits must be assessed. asset as the transfer amount on purchase, ie
This should be based on the evidence what was paid for it.
available at the date of initial recognition Self-constructed assets can also be measured
(usually the date of purchase). easily by adding together the purchase price
of all the constituent parts (labour, material
etc) paid.
See Section 1.6 below
The recognition criteria applies to subsequent expenditure as well as costs incurred initially. There
are no separate criteria for recognising subsequent expenditure. For example, if a shop building is
extended to include a new café as a revenue source, then this meets the criteria of probable
future economic benefits, and so should be recognised as property, plant and equipment.
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3: Tangible non-current assets 39

1.4 Initial measurement
Once an item of property, plant and equipment qualifies for recognition as an asset, it will initially
be measured at cost (IAS 16: para. 15).
1.4.1 Components of cost

The standard lists the components of the cost of an item of property, plant and equipment.
Directly attributable costs Finance costs:

Purchase price, less
+ of bringing the asset to working + capitalised for qualifying
trade discount/rebate
condition for intended use assets (IAS 23)
Including Including See Chapter 3, Section 3

• Import duties • Employee benefit costs of the main workbook
• Non-refundable • Site preparation
purchase taxes • Initial delivery and handling costs
• Installation and assembly costs
• Professional fees
• Costs of testing
• Site restoration provision (IAS 37),
where not included in cost of
inventories produced
(IAS 16: paras.16 & 17)
The following costs will not be part of the cost of property, plant or equipment:
• The costs of opening a new facility
• The costs of introducing a new product or service
• The costs of conducting business in a new location or with a new class of customer
• Administration and other general overheads costs
(IAS 16: para. 19)
The recognition of costs in the carrying amount of PPE ceases when the item is in the location and
condition necessary for its use. Therefore, the costs incurred in using or redeploying PPE are not
capitalised. The following costs are therefore not included in the carrying amount of PPE:
• Costs incurred when an item capable of operating has not yet been brought into use or is
being used at less than full capacity
• Initial operating losses
• Costs of relocating or reorganising part of entity’s business
(IAS 16: para. 20)
Note that IAS 16 was amended in May 2020 to make it clear that if a company incurs costs of
testing whether an asset is functioning properly before it is brought into use, the costs of testing
may be capitalised as part of the cost of the PPE, but any proceeds earned by the company in
selling any items produced as a result of that testing should be accounted for in profit or loss.
1.5 Subsequent measurement

The standard offers an accounting policy choice, essentially a choice between:
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Cost model or Revaluation model
Carry the asset at its historic cost less Carry the asset at a revalued amount, being its fair
• depreciation and value at the date of the revaluation less
• any accumulated impairment loss • depreciation and
• any accumulated impairment loss
The IAS 16 makes clear that the revaluation model is
available only if the fair value of the item can be
measured reliably.
1.5.1 Depreciation
IAS 16 requires the depreciable amount of an asset to be allocated on a systematic basis to each
accounting period during the useful life of the asset. Every part of an item of property, plant and
equipment with a cost that is significant in relation to the total cost of the item must be
depreciated separately. (IAS 16: para. 44)
Activity 1: Depreciation
A lorry bought for Titan Co cost $17,000. It is expected to last for five years and then be sold for
scrap for $2,000. Usage over the five years is expected to be:
Year 1 200 days
Year 2 100 days
Year 3 100 days
Year 4 150 days
Year 5 40 days
Required
Calculate the depreciation to be charged each year under:
(1) The straight-line method
(2) The reducing balance method (using a rate of 35%)
(3) The machine hour method
Solution
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Essential reading
Chapter 3, Section 1 of the Essential reading provides more detailed revision on the important
definitions, recognition and measurement principles, basic revaluation, disposals and disclosure.
Chapter 3, Section 2 of the Essential reading provides revision of depreciation. It is essential that
you are comfortable with this material before continuing with this chapter.
The Essential reading is available as an Appendix of the digital edition of the Workbook.
1.6 Accounting for revaluations

If the revaluation model is applied:
(a) The frequency of revaluations depends upon the changes in fair values of the PPE being
revalued. Items of PPE that are volatile to changing prices will be subject to an annual
revaluation, whereas less frequent valuations may be suitable for items less subject to
change.
(b) The asset should be revalued to fair value in accordance with IFRS 13 Fair Value
Measurement.
(c) If one asset is revalued, so must be the whole of the rest of the class of assets, either at the
same time or on a rolling basis.
(d) An increase in value is credited to the other comprehensive income (and presented in equity).
(e) A decrease is an expense in profit or loss after cancelling a previous revaluation surplus.
1.6.1 Revaluation surpluses

A revaluation exercise will normally result in an increase in the value of the asset. IAS 16 requires
the increase to be credited to other comprehensive income and accumulated in a revaluation
surplus (ie part of owners’ equity), unless there was previously a decrease on the revaluation of
the same asset.
DEBIT Carrying amount (statement of financial position) X

CREDIT Other comprehensive income (revaluation surplus) X
Illustration 1: Revaluation surplus
Binkie Co has a year end of 30 June 20X3. On 1 July 20X2, it purchased land at a cost of
$120,000 and incurred legal fees totalling $5,000 relating to the purchase. Due to a surge in land
prices in the year, the land has been independently assessed as having a fair value of $150,000
at 30 June 20X3.
Required
Calculate the revaluation surplus on the land at 30 June 20X3 and prepare the journal entry to
record the increase.
Solution
The difference between the initial measurement of the land on acquisition and the fair value at the
year end date is recorded in other comprehensive income and accumulated in a revaluation
surplus.
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$’000
Purchase price 120
Legal fees 5
Initial cost 125
Fair value at 30 June 20X3 150
Revaluation surplus 25
The journal entry to record the surplus is:
$’000 $’000
DEBIT Land carrying amount (statement of financial
position) 25
CREDIT Other comprehensive income (revaluation
surplus) 25
1.6.2 Revaluation decreases

Any decrease in value should be recognised as an expense in profit or loss, except where it offsets
a previous increase taken as a revaluation surplus in owners’ equity. Any decrease that exceeds
the amount of the revaluation surplus must be taken as an expense in the profit or loss.
1.6.3 Reversing a previous decrease in value

If the asset has previously suffered a decrease in value that was charged to profit or loss, any
increase in value on a subsequent revaluation should be recognised in profit or loss to the extent
that it reverses the previous decrease (IAS 16: para. 39). Any excess increase is then recognised in
other comprehensive income and accumulated in a revaluation surplus.
Illustration 2: Reversing a revaluation decrease
Continuing the information from Illustration 1, Binkie Co has a year end of 30 June 20X6. There
has been a decline in the value of the land at 30 June 20X6.
Required
Account for the revaluation in the current year, assuming that:
1 The fair value at 30 June 20X6 is $130,000.
2 The fair value at 30 June 20X6 is $120,000.
Solution
1 The value of the land has decreased by $20,000 (from $150,000 at 30 June 20X3 to $130,000
at 30 June 20X6). The decrease in value is less than the amount accumulated in revaluation
surplus and therefore the amount can be debited to other comprehensive income (revaluation
surplus).
The double entry is:
$’000 $’000
DEBIT Other comprehensive income (revaluation surplus) 20
CREDIT Land carrying amount (statement of financial position) 20
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2 The value of the land has decreased by $30,000 (from $150,000 at 30 June 20X3 to $120,000
at 30 June 20X6). The decrease in value is more than the amount accumulated in revaluation
surplus and therefore the excess decrease must be accounted for as an expense in profit or
loss.
The double entry is:
$’000 $’000
DEBIT Other comprehensive income (revaluation surplus) 25
DEBIT Expenses (statement of profit or loss) 5
CREDIT Land carrying amount (statement of financial position) 30
1.7 Revaluation of depreciated assets

1.7.1 Timing of the revaluation
When a revaluation has taken place in the year, we must be careful as to how to calculate
depreciation.
Revaluation at Revaluation at Revaluation mid-way

the start of the year the end of the year through the year
Depreciation for the year is Depreciation for the year is Two separate depreciation
based on the revalued amount. based on the cost or valuation calculations are required:
brought forward at the start of • Pro rata on the brought
the year. Depreciation for the forward cost or valuation to
year must be deducted in arrive at carrying amount at
arriving at the carrying the date of valuation
amount of the asset at the • Pro rata on the revalued
date of valuation. amount
Exam focus point

The ACCA Financial Reporting examining team has also emphasised the importance of noting
the date that the revaluation takes place, requiring the approach described above to be
applied. Review the article on the ACCA website (www.accaglobal.com) Property, plant and
equipment – Part 2: Revaluation and derecognition, which has a section on the treatment of
accounting for a revaluation.
1.7.2 Depreciation and the revaluation surplus

There is a further complication when a revalued asset is being depreciated. A revaluation surplus
normally means that the depreciation charge will increase. Normally, a revaluation surplus is only
realised when the asset is sold. However, when it is being depreciated, part of that surplus is being
realised as the asset is used.
The amount of the surplus realised is the difference between depreciation charged on the
revalued amount and the (lower) depreciation, which would have been charged on the asset’s
original cost. This amount can be transferred to retained earnings but NOT through profit or loss.
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Exam focus point
The ACCA Financial Reporting examining team has stated that in the exam, a reserves
transfer is only required if the examiner indicates that it is company policy to make a transfer
to realised profits in respect of excess depreciation on revalued assets. If this is not the case,
then a reserves transfer is not necessary. For more information on this, refer to the Accounting
for property, plant and equipment article on the ACCA webpage (www.accaglobal.com).
Example: Transfer of revaluation surplus to retained earnings

If an asset is revalued from $100,000 to $140,000 and has a remaining useful life of 40 years at
that date, a revaluation surplus of $40,000 is recognised. The revaluation surplus can then be
transferred to retained earnings over the remaining useful life to represent the depreciation
difference as a result of the asset being revalued. It can be calculated as either:
Revaluation surplus $40,000 / 40 year remaining useful life = $1,000 per annum
OR
Depreciation per annum if value of asset is $100,000 / 40 years = $2,500 per annum
Depreciation per annum if value of asset is $140,000 / 40 years = $3,500 per annum
Therefore, additional depreciation of $1,000 can be transferred from the revaluation surplus to
retained earnings.
The following entry can be made annually over the remaining life of the asset:
Debit Revaluation surplus $1,000

Credit Retained earnings $1,000
If this entry is not made the full $40,000 is transferred to retained earnings when the asset is
disposed of/retired.
Activity 2: Revaluation and depreciation
Crinkle prepares its financial statements to 31 December each year. It bought an asset that had a
useful life of five years for $10,000 in January 20X6. On 1 January 20X8, the asset was revalued
to $12,000. The expected useful life has remained unchanged (ie three years remain). It is the
policy of Crinkle to make a reserve transfer for excess depreciation.
Required
Account for the revaluation and state the treatment for depreciation from 20X8 onwards.
Solution
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Activity 3: Property, plant and equipment
$
List price of machine 8,550
Trade discount (855)
Delivery costs 105
Set-up costs incurred internally 356
8,156
Notes.
1 The machine was purchased on 1 October 20X4 when it was expected to have a useful life of
12 years and a residual value of $2,000.
2 Xavier’s accounting policy is to charge a full year’s depreciation in the year of purchase and
no depreciation is the year of retirement or sale.
3 Xavier has a policy of keeping all equipment at revalued amounts. No revaluations had been
necessary until 30 September 20X8 when one of the major suppliers of such machines went
bankrupt, causing a rise in prices. A specific market value for Xavier’s machine was not
available, but an equivalent brand-new machine would now cost $15,200 (including relevant
disbursements). Xavier treats revaluation surpluses as being realised through use of the asset
and transfers them to retained earnings over the life of the asset. The remaining useful life and
residual value of the machine remained the same.
4 Xavier’s year end is 30 September.
Required
1 What is the carrying amount of plant and equipment at 30 September 20X5?
 $7,200
 $7,317
 $7,643
 $8,427
2 What is the carrying amount of the plant and equipment at 30 September 20X8?
 $10,800
 $11,900
 $13,200
 $15,200
3 Which TWO of the following statements are correct when revaluing property, plant and
equipment?
 All property, plant and equipment should be revalued
 The revaluation should take place every three to five years
 The revalued asset continues to be depreciated
 The asset should be revalued to fair value if available
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4 What is the balance on the revaluation surplus at 30 September 20X8?
 $2,052
 $4,696
 $5,439
 $6,104
5 How much of the revaluation surplus is transferred to retained earnings in the year to 30
September 20X9?
$
Exam focus point

The July 2020 Examiner’s Report noted disappointing performance from candidates in respect
of the disposal of revalued assets. The report included the following comments:
Candidates appeared to struggle with the disposal of a revalued asset, and how that is shown
in the statement of changes in equity. Many were able to produce a reserve transfer for the
additional depreciation on a revalued asset, but relatively few knew to release a revaluation
surplus upon the disposal of a revalued asset.
1.8 Assets with two or more significant parts

1.8.1 Depreciation of assets with two or more significant parts
Large and complex assets are often made up of a number of components, known as significant
parts, which each have different useful lives and wear out at different rates. For example, a
building may have a useful life of 50 years but the lift within that building may be expected to last
for 15 years. IAS 16, para. 43 requires that the component parts of such assets are capitalised and
depreciated separately.
Illustration 3: Depreciation of assets with two or more significant parts
An aircraft could be considered as having the following components.
Cost Useful life

$’000
Fuselage 20,000 20 years
Undercarriage 5,000 500 landings
Engines 8,000 1,600 flying hours
Required
Calculate the depreciation for the year.
Solution
Depreciation at the end of the first year, in which 150 flights totalling 400 hours were made would
then be:
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$’000
Fuselage (20,000 / 20 years) 1,000
Undercarriage (5,000 × 150/500 landings) 1,500
Engines (8,000 × 400/1,600 hours) 2,000
4,500
1.8.2 Replacements and Overhauls

Parts of some items of property, plant and equipment may require replacement at regular
intervals, often as a legal requirement. IAS 16 gives examples of a furnace that may require
relining after a specified number of hours or aircraft interiors which may require replacement
several times during the life of the aircraft.
The cost of the replacement parts should be recognised in full when it is incurred and added to
the carrying amount of the asset. It should be depreciated over its useful life, which may be
different from the useful life of the other components of the asset. The carrying amount of the
item being replaced, such as the old furnace lining, should be derecognised when the
replacement takes place (IAS 16: para. 13).
Illustration 4: Cost of overhaul
Following Illustration Depreciation of assets with two or more significant parts above, an overhaul
of the aircraft was required at the end of year 3 and every third year thereafter at a cost of $1.2
million.
Required
Explain how the overhaul would be accounted for.
Solution
The cost of the overhaul would be capitalised as a separate component. $1.2 million would be
added to the cost and the depreciation (assuming 150 flights again) would therefore be:
$’000
Total as above 4,500
Overhaul ($1,200,000/3) 400
4,900
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2 Investment property (IAS 40)
Investment property: Property (land or a building – or part of a building – or both) held (by
KEY
TERM the owner or by the lessee as a right-of-use asset) to earn rentals or for capital appreciation or
both, rather than for:
(a) Use in the production or supply of goods or services or for administrative purposes, or
(b) Sale in the ordinary course of business.
Owner-occupied property: Property held by the owner for use in the production or supply of
goods or services or for administrative purposes.
Cost: The amount of cash or cash equivalents paid or the fair value of other consideration
Carrying amount: The amount at which an asset is recognised in the statement of financial
position.
2.1 Recognition
Consistent with the recognition criteria under IAS 16, IAS 40 requires that an investment property
is recognised when, and only when:
It is probable that future economic

The cost of the investment property to
benefits associated with the investment and
the entity can be measured reliably
property will flow to the entity
(IAS 40: para. 16)

Investment property is measured initially at cost.
Cost includes purchase price and any directly attributable expenditure such as professional fees
for legal services, property transfer taxes and other transaction costs.
For self-constructed investment properties, cost is the cost at the date when the construction or
development is complete.

An entity can choose whether to use:
Cost model (=IAS 16) Fair value model
Carry the asset at its historic cost less • Investment property is measured at fair value
• Depreciation and at the end of the reporting period
• Any accumulated impairment loss • Any resulting gain or loss is included in profit
or loss for the period
• The investment property is not depreciated
The model chosen should be applied to all investment property.

It is important to note from the above that if the fair value model is applied, the gain or loss is
reported in profit or loss. This is in contrast to the revaluation model in IAS 16 where the revaluation
surplus is utilised.
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Activity 4: Investment property
On 1 October 20X9 Propex has the following properties. It uses the fair value model to measure
investment property:
(1) Tennant House which cost $150,000 on 1 October 20X4. The property is freehold and is
rented to private individuals for six-monthly periods. The current fair value of the property is
$175,000.
(2) Stowe Place which cost $75,000. This is used by Propex as its headquarters. The building was
acquired on 1 October 20W9. The current fair value is $120,000.
Propex depreciates its buildings at 2% per annum on cost.
Required
What is the carrying amount of each property in the statement of financial position at 1 October
20X9?
Tennant House ▼

Stowe Place ▼
Pull down list

• $120,000
• $135,000
• $175,000
• $60,000
Essential reading
Chapter 3, Section 3 of the Essential reading provides further detail on the fair value and cost
models for investment property.
2.4 Transfers
Transfers to or from investment property should only be made when there is a change in use. For
example, owner occupation commences so the investment property will be treated under IAS 16 as
an owner-occupied property.
2.4.1 Investment property to PPE/Inventory
Transfer from investment property

to owner-occupied or inventories
• Cost for subsequent accounting is fair value

at date of change of use
• Apply IAS 16 or IAS 2 as appropriate after
date of change of use
Consider the situation in which an investment property becomes owner-occupied on 1 July 20X6:
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1 Jan X6 1 Jul X6 31 Dec X6
Date of transfer
Determine FV
Account for as IP. No depreciation Account for as PPE. Fair value at

and gain/loss to profit or loss. transfer is initial measurement.
Depreciation commences.
Cost or valuation model per IAS 16.
2.4.2 PPE to Investment property
Transfer from owner-occupied

to investment property
• Apply IAS 16 up to date of change of use

• At date of change, property revalued to fair value
• At date of change, any difference between the
carrying amount under IAS 16 and its fair value is
treated as a revaluation under IAS 16
(IAS 40: paras. 57–65)
Exam focus point

The July 2020 exam included the transfer of PPE to an investment property. The Examiner’s
Report noted the following:
‘The adjustments relating to non-current assets proved the most challenging. These were
technical adjustments, but performance still tended to disappoint a little. The most common
mistake related to a change in use relating to property, moving from PPE to investment
property. This needed to be revalued under IAS 16 before being then held under the fair value
model per IAS 40 for investment properties. Very few knew the steps for dealing with this,
which was disappointing as this is the kind of topic which provides a bridge towards Strategic
Business Reporting.’
Activity 5: Transfer of PPE to investment property
Kapital owns a building which it has been using as a head office. In order to reduce costs, on 30
June 20X9 it moved its head office functions to one of its production centres and is now letting out
its head office. Company policy is to use the fair value model for investment property.
The building had an original cost on 1 January 20X0 of $250,000 and was being depreciated over
50 years. At 30 June 20X9, its fair value was judged to be $350,000. At 31 December 20X9, its fair
value had fallen to $320,000.
Required
Explain how the building will be accounted for in the financial statements of Kapital Co at 31
December 20X9.
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Solution
2.5 Disposals
Derecognise (eliminate from the statement of financial position) an investment property on
disposal or when it is permanently withdrawn from use and no future economic benefits are
expected from its disposal.
Any gain or loss on disposal is the difference between the net disposal proceeds and the carrying
amount of the asset. It should generally be recognised as income or expense in profit or loss.
Compensation from third parties for investment property that was impaired, lost or given up shall
be recognised in profit or loss when the compensation becomes receivable (IAS 40: paras. 66–69).
2.6 Disclosure requirements

These relate to:
• Choice of fair value model or cost model
• Criteria for classification as investment property
• Assumptions in determining fair value
• Use of independent professional valuer (encouraged but not required)
• Rental income and expenses
• Any restrictions or obligations (IAS 40: paras. 74–79)
2.6.1 Fair value model – additional disclosures

An entity that adopts this must also disclose a reconciliation of the carrying amount of the
investment property at the beginning and end of the period (IAS 40: paras. 77–78).
2.6.2 Cost model – additional disclosures

These relate mainly to the depreciation method. In addition, an entity which adopts the cost
model must disclose the fair value of the investment property (IAS 40: para. 79).
3 Borrowing costs (IAS 23)

3.1 Accounting treatment
Borrowing costs that directly relate to the acquisition, construction or production of a qualifying
asset must be capitalised as a part of the cost of that asset (IAS 23: para. 26).
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A qualifying asset is an asset that necessarily takes a substantial period of time to be ready for its
intended use or sale (IAS 23: para. 5).
3.2 Borrowing costs eligible for capitalisation
Funds borrowed Capitalise actual borrowing costs incurred less investment

specifically for a income on temporary investment of the funds (IAS 23: para.
qualifying asset 12)
Funds borrowed Weighted average of borrowing costs outstanding during the

generally period (excluding borrowings specifically for a qualifying
asset) multiplied by expenditure on qualifying asset. The
amount capitalised should not exceed total borrowing costs
incurred in the period (IAS 23: para. 14).
3.3 Commencement, suspension and cessation

3.3.1 Commencement
Commencement of capitalisation begins when:
(a) Expenditures for the asset are being incurred;
(b) Borrowing costs are being incurred; and
(c) Activities that are necessary to prepare the asset for its intended use or sale are in progress.
(IAS 23: para. 17)
3.3.2 Suspension
Capitalisation is suspended during extended periods when development is interrupted. (IAS 23:
para. 20)
3.3.3 Cessation
Capitalisation ceases when substantially all the activities necessary to prepare the qualifying
asset for its intended use or sale are complete (IAS 23: para. 22).
The capitalisation of borrowing costs should be calculated pro-rata if the commencement or
cessation occurs within the period, or there has been a suspension within the period.
Essential reading
Chapter 3, Section 4 of the Essential reading provides more detail on the commencement,
suspension and cessation of capitalisation.
Illustration 5: Borrowing costs
On 1 January 20X6, Stremans Co borrowed $1.5 million to finance the production of two assets,
both of which were expected to take a year to build. Work started during 20X6. The loan facility
was drawn down and incurred on 1 January 20X6, and was utilised as follows, with the remaining
funds invested temporarily.
Asset Alpha Asset Bravo

$’000 $’000
1 January 20X6 250 500
1 July 20X6 250 500
The loan rate was 9% and Stremans Co can invest surplus funds at 7%.
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Required
Ignoring compound interest, calculate the borrowing costs that may be capitalised for each of the
assets and consequently, the cost of each asset as at 31 December 20X6.
Solution
Asset Alpha Asset Bravo

$ $
Borrowing costs
To 31 December 20X6 $500,000/$1,000,000 × 9% 45,000 90,000
Less investment income (8,750) (17,500)
To 30 June 20X6 $250,000/$500,000 × 7% × 6/12 36,250 72,500
Cost of assets
Expenditure incurred 500,00 1,000,000
Borrowing costs 36,250 72,500
536,250 1,072,500
Activity 6: Capitalisation of borrowing costs
Acruni Co had the following loans in place at the beginning and end of 20X6.
1 January 20X6 31 December 20X6

$m $m
10% Bank loan repayable
20X8 120 120
9.5% Bank loan repayable 80 80
On 1 January 20X6, Acruni Co began construction of a qualifying asset, a piece of machinery for
a hydro-electric plant, using existing borrowings. Expenditure drawn down for the construction
was: $30 million on 1 January 20X6, $20 million on 1 October 20X6.
Required
Calculate the borrowing costs that can be capitalised for the hydro-electric plant machinery.
Solution
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HB2022

Chapter summary
Tangible non-current assets
Property, plant and Investment property (IAS 40)

equipment (IAS 16)
Accounting for PPE Definitions Subsequent measurement

Assumed knowledge – • Investment property – is • Cost model (IAS 16)
recognition, measurement, property held to earn rentals • Fair value model
depreciation, disposals, or for capital appreciation – Measure fair value at end of
disclosure • Owner-occupied – property each reporting period
held by the owner for use in – Gain or loss to p/l
the production or supply of – No depreciation
Accounting for revaluations goods or services or for
• Revaluation surpluses in OCI administrative purposes
and revaluation surplus (SFP) • Fair value – price that would Transfers
– Unless reverses previous be received to sell an asset in • Investment property to
decrease in which case P/L an orderly transaction at the PPE/Inventory
to cancel previous loss then measurement date – Per IAS 40 to the date of
OCI • Cost – cash or cash transfer, fair value becomes
equivalents paid or the fair cost of PPE/inventory
• Revaluation decreases to P/L
value of other consideration
– Unless reverses previous • PPE to Investment property
given to acquire an asset
surplus in which case loss to – Per IAS 16 to date of transfer,
• Carrying amount – amount at
OCI then P/L then IAS 40
which an asset is recognised
in the statement of financial
Revaluation of depreciated position. Disposals
assets Gain or loss recognised in p/l
• All assets depreciated for year Recognition
– If revaluation at the start of
• Probably economic benefits Disclosure
the year, revalue then
will flow to the entity
depreciate • Choice of fair value model or
• Cost can be reliably measured
– If revaluation at the end of cost model
the year, depreciate on • Criteria for classification as
b/fwd cost/valuation to find investment property
Initial measurement
CA then revalue • Assumptions in determining
– If revaluation mid-year, Cost per IAS 16
fair value
pro-rate calculations • Use of independent
• Revalution surplus may be professional valuer
released to retained earnings (encouraged but not required)
• Rental income and expenses
• Any restrictions or obligations
Complex assets
• Components of complex assets
depreciated separately
• Cost of replacement parts/
overhauls capitalised if
recognition criteria satisfied
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Borrowing costs (IAS 23)
Accounting treatment
• Borrowing costs relating to a qualifying
asset must be capitalised as part of the
cost of that asset
– A qualifying asset is one that
necessarily takes a long period of
time to be ready for its intended use
or sale
Borrowing costs eligible for

capitalisation
• Funds specifically borrowed – at actual
borrowing rate less any income
• General funds – weighted average of
borrowing costs in period
– Amount capitalised should not
exceed actual cost
Commencement, suspension and

cessation
• Commence capitalisation when:
– Expenditure incurred
– Borrowing costs incurred
– Activities to get the asset ready for
use/sale are in progress
• Suspend capitalisation when
development is interrupted
• Cease capitalisation when activities to
get the asset ready for use/sale are
complete
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1. Property, plant and equipment (IAS 16)

Property, plant and equipment can be accounted for under the cost model (historic cost less
accumulated depreciation an impairment losses) or revaluation model (valuation less depreciation
and impairment losses). Revaluation surpluses are reported in other comprehensive income and
the revaluation surplus unless they reverse previous revaluation losses.
Significant parts of complex assets require to be depreciated separately. The costs of overhauls/
replacement parts may be capitalised if recognition criteria are satisfied.
2. Investment property (IAS 40)

Investment property can be accounted for under the cost model or the fair value model (not
depreciated, gains and losses reported in profit or loss).
Transfers from investment property to PPE/inventories are accounted for under IAS 40 to the date
of transfer. The fair value at transfer becomes the cost of the asset which is then accounted for
under IAS 16 or IAS 2.
Transfers from PPE to investment property are accounted for under IAS 16 to the date of transfer
then IAS 40 applies.
3. Borrowing costs (IAS 23)

Borrowing costs relating to qualifying assets (those which necessarily take a substantial period of
time to be ready for use/sale) must be capitalised. This includes both specific and general
borrowings of the company.
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Question practice
You should attempt the following question from the Further question practice bank (available in
the digital edition of the Workbook):
Section A Q4
Section B Q22(a)
Section C Q27 Gains Co
Further reading
Property, plant and equipment – part 1: Measurement and depreciation
Property, plant and equipment – part 2: Revaluation and derecognition
Property, plant and equipment – part 3: Summary and detailed examples
www.accaglobal.com
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Activity answers
Activity 1: Depreciation
Under the straight-line method, depreciation for each of the five years is:
Annual depreciation = $(17,000 – 2,000)/5 = $3,000
Under the reducing balance method, depreciation for each of the five years is:
Year Depreciation
1 35% × $17,000 $5,950
2 35% × ($17,000 – $5,950) = 35% × $11,050 $3,868
3 35% × ($11,050 – $3,868) = 35% × $7,182 $2,514
4 35% × ($7,182 – $2,514) = 35% × $4,668 $1,634
Balance to bring carrying amount down to $2,000 = $4,668 – $1,634 –
5 $2,000 $1,034
Under the machine hour method, depreciation for each of the five years is calculated as follows:
Total usage (days) = 200 + 100 + 100 + 150 + 40 = 590 days
Depreciation per day = $(17,000 – 2,000)/ 590 = $25.42
Year Usage Depreciation ($)

(days) (days × $25.42)
1 200 5,084.00
2 100 2,542.00
3 100 2,542.00
4 150 3,813.00
5 40 1,016.80
14,997.80
Activity 2: Revaluation and depreciation

On 1 January 20X8 the carrying amount of the asset is $10,000 – (2 × $10,000 / 5) = $6,000. For
the revaluation:
DEBIT Accumulated depreciation $4,000

DEBIT Carrying amount $2,000
CREDIT Other comprehensive income (revaluation surplus) $6,000
The depreciation for each of the next three years will be $12,000 / 3 = $4,000, compared to
depreciation on cost of $10,000 / 5 = $2,000. So each year, the extra $2,000 can be treated as
part of the surplus that has become realised (this can also be calculated by taking the revaluation
surplus of $6,000 over the remaining useful life of three years):
DEBIT Other comprehensive income (revaluation surplus) $2,000

CREDIT Retained earnings $2,000
This is a movement on owners’ equity only and it will be shown in the statement of changes in
equity. It is not an item in profit or loss.
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Activity 3: Property, plant and equipment
AT 30 SEPTEMBER 20X5
Working
Property, plant and equipment
$
Cost (8,550 – 855 + 105 + 356) 8,156
Accumulated depreciation (8,156 – 2,000)/12 years (513)
7,643

AT 30 SEPTEMBER 20X8
Workings
1 Plant and equipment
$
Revalued amount (W) 10,800
Accumulated depreciation (0)
10,800
2 Revalued amount (depreciated replacement cost)
$
Gross replacement cost 15,200
Depreciation (15,200 – 2,000) × 4/12 (4,400)
Depreciated replacement cost 10,800
3 The correct answers are:

• The revalued asset continues to be depreciated
• The asset should be revalued to fair value if available
There is no requirement for all property, plant and equipment to be revalued, but if an asset is
revalued, the entire class to which that asset belongs should be revalued (IAS 16: para. 36). The
frequency of revaluations depends on the changes in fair value of assets and is not restricted
to every three to five years (IAS 16: para. 34).
Revaluation surplus (10,800 (W1) – 6,104 (W2))
Workings
1 Revalued amount (depreciated replacement cost)
$
Gross replacement cost 15,200
Depreciation (15,200 – 2,000) × 4/12 (4,400)
Depreciated replacement cost 10,800
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2 Carrying amount before revaluation
$
Cost 8,156
Accumulated depreciation (8,156 – 2,000) × 4/12 (2,052)
6,104
5
5 $ 587
Working
Revaluation surplus
$
Depreciation on new revalued amount (10,800 – 2,000)/8-year remaining life 1,100
Depreciation on historic cost (6,014 – 2,000)/8 years (513)
Difference transferred to retained earnings each year 587
or $
Balance on revaluation surplus at 30.9.X8 (4,696/8 years) 587
Activity 4: Investment property
Tennant House $175,000
Stowe Place $60,000
(1) Tennant House

- Held for its investment potential and not for use by Propex
- Treat as investment property in accordance with IAS 40
- Rental income to profit or loss
- Revalue to market value of $175,000, the difference of $25,000 credited to profit or loss
(2) Stowe Place
- Held for use by Propex
- Depreciate over useful life 75,000 × 2% = 1,500 per annum to profit or loss
- Carrying amount 75,000 – (1,500 × 10) = 60,000 to be shown in SOFP
Activity 5: Transfer of PPE to investment property

The building is PPE up to the point of transfer and will be depreciated up to 30 June 20X9. At that
date, the increase in value will be accounted for in other comprehensive income and accumulated
in a revaluation surplus. The PPE will then be transferred to investment property at its fair value at
the date of transfer.
$
Original cost 250,000
Depreciation 1.1.X0 – 1.1.X9 (250/50 × 9) (45,000)
Depreciation to 30.6.X9 (250/50 × 6/12) (2,500)
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$
Carrying amount immediately prior to transfer 202,500
Fair value at the date of transfer 350,000
Revaluation surplus 147,500
After the date of transfer, the building is accounted for as an investment property and will be
subjected to a fair value exercise at each year end. At 31 December 20X9, the fair value has fallen
and the loss will be recognised in profit or loss.
$
Fair value at 30.6.X9 350,000
Fair value at 31.12.X9 320,000
Decrease in value (profit or loss) 30,000
The investment property is not depreciated under the fair value model.
Activity 6: Capitalisation of borrowing costs

Capitalisation rate = weighted average rate = (10% × 120 / (120 + 80)) + (9.5% × 80 / (120 + 80)) =
9.8%
Borrowing costs = ($30m × 9.8%) + ($20m × 9.8% × 3/12) = $3.43m
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HB2022

Intangible assets
4
4
Learning objectives
Discuss the nature and accounting treatment of internally B2(a)

generated and purchased intangible assets.
Distinguish between goodwill and other intangible assets B2(b)
Describe the criteria for the initial recognition and measurement B2(c)
of intangible assets.
Describe the subsequent accounting treatment of intangible B2(d)

assets.
Describe and apply the requirements of relevant IFRS Standards B2(f)

to research and development expenditure.
4
Exam context
Intangible assets are increasingly important in modern business where the trend is away from
investment in property, plant and equipment and inventory and towards building businesses
around brands, data intelligence, software or workforce talent. IAS 38 considers how intangible
assets can be recognised and measured in an entity’s financial statements, although there is
some criticism as to whether the standard reflects the true value of modern businesses. In the
Financial Reporting exam, intangible assets could feature as an objective test question in Section
A or B, or as an adjustment in an accounts’ preparation question in Section C. The March/June
2021 hybrid exam included a case study (Section B) question which focused on intangible assets.
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4
Chapter overview
Intangible assets
Definitions Recognition and categories of intangible asset
Intangible assets Recognition criteria
Identifiable
Monetary assets
Acquired intangible assets Internally generated intangible assets
Recognition criteria Definitions
Goodwill Recognition criteria
Initial measurement Subsequent measurement
Cost model or revaluation model
Revaluation model
Amortisation/Impairment Derecognition
Point of derecognition
Gain or loss on derecognition
Revaluation model
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1 Definitions
Intangible asset: ‘An identifiable non-monetary asset without physical substance.’ (IAS 38:
KEY
TERM para. 8)
1.1 Identifiable
An asset is identifiable if either:
It is separable – capable of being OR It arises from contractual or other legal

separated / divided from the entity and rights (regardless of whether those rights
sold / transferred / licensed / rented / exchanged are transferable or separable from the entity
• Individually; or or other rights / obligations)
• With a related contract or identifiable
asset or liability
regardless of whether the entity intends to
do so.
(IAS 38: para. 12)
1.2 Monetary vs non-monetary assets

Monetary assets are defined as:
Monetary assets: ‘Money held and assets to be received in fixed or determinable amounts of
KEY
TERM money.’ (IAS 38: para. 8)
• Cash and receivables are both examples of monetary assets and therefore do not meet the
definition of an intangible asset.
• Property, plant and equipment and inventories are examples of non-monetary assets.
However, they have physical substance and therefore also do not meet the definition of
intangible assets.
• Computer software, brands, licences and patents are all examples of intangible assets.
2 Recognition and categories of intangible asset

2.1 Recognition
An intangible asset may be recognised in the financial statements if it meets:
(a) The definition of an intangible asset; and
(b) The recognition criteria
(IAS 38: para. 18)
The recognition criteria set by IAS 38 are:
It is probable that future economic

The cost of the asset to the
benefits associated with the asset and
entity can be measured reliably
will flow to the entity
(IAS 38: para. 21)
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4: Intangible assets 67

Essential reading
Chapter 4, Section 1 of the Essential reading discusses the recognition criteria in more detail. You
will find that it is generally consistent with that covered for tangible non-current assets in Chapter
3.
Activity 1: Recognition criteria
Which THREE of the following are likely to meet the recognition criteria of IAS 38 Intangible Assets?
(Tick the correct answers.)
 Expenditure of $300,000 on increasing the skills of staff
 $250,000 acquiring a licence to operate in a new geographical location
 $28,000 spend on advertising a new product which is expected to generate economic benefits
for the entity
 $100,000 on computer software acquired from a supplier
 A brand, valued at $500,000 acquired as part of the purchase of a new subsidiary
 An internally developed brand name, estimated to be worth $100,000
2.2 Categories of intangible assets

IAS 38 breaks down intangible assets into the following categories:
• Acquired intangible assets, which can be either:
- Separately acquired; or
- Acquired as part of a business combination;
• Internally generated intangible assets.
3 Acquired intangible assets

3.1 Recognition criteria
The recognition criteria are always presumed to have been met for intangible assets that are
acquired separately or acquired as part of a business combination.
Acquired separately Acquired as part of a business combination
Recognise as an Recognise as intangible assets separately

intangible asset from goodwill in the group accounts
(irrespective of whether recognised by
acquiree before the business combination).
If only separable together with a related
contract, identifiable asset or liability,
group together with related item.
(IAS 38: paras. 25, 26, 33, 34, 35 & 36)
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3.1.1 Business combination
A business combination is defined by IFRS 3 Business Combinations as:
Business combination: ‘A transaction or other event in which an acquirer obtains control of

KEY
TERM one or more businesses.’ (IFRS 3: Appendix A)
A business combination usually results in the need to prepare group accounts, as covered in
Chapters 7–10 of this Workbook.
3.2 Goodwill
Goodwill reflects an entity’s value over and above its recorded value in the financial statements.
It is often referred to as representing the reputation of a business.
There are two types of goodwill:
Internally generated goodwill Goodwill arising as the result of a

business combination
Do not recognise as an intangible Recognise positive goodwill as

asset as it is not identifiable an intangible asset in the
(not separable nor arising from group accounts
contractual / legal rights) and
cannot be measured reliably
(IAS 38: paras. 48 & 49; IFRS 3: para. 32)

Goodwill arising at the result of a business combination will be covered in more detail in Chapters
7–10 of this Workbook which cover group accounting.
4 Internally generated intangible assets

4.1 Definitions
Research: ‘Original and planned investigation undertaken with the prospect of gaining new
KEY
TERM scientific or technical knowledge and understanding.’ (IAS 38: para. 8)
Development: ‘Application of research findings to a plan or design for the production of new or
substantially improved materials, products, processes, systems or services before the start of
commercial production or use.’ (IAS 38: para. 8)
4.2 Recognition criteria

To assess whether an internally generated intangible asset meets the IAS 38 recognition criteria,
an entity classifies expenditure into:
(a) A research phase; and
(b) A development phase.
Essential reading
You should be familiar with the research and development phases and the PIRATE criteria from
your previous studies. A recap has been included in Chapter 4, Section 2 of the Essential reading.
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Internally generated
intangible assets
Research Development
'original and planned investigation 'application of research findings to a
undertaken with the prospect of plan or design for the production of
gaining new scientific or technical new or substantially improved
knowledge and understanding' materials, products, processes,
systems or services before the start of
commercial production or use'
Meets all of the 'PIRATE' criteria?

Probable future economic benefits will
be generated by the asset
Intention to complete and use / sell asset
Resources (technical, financial, other)
adequate to complete asset
Ability to use/sell asset
Technical feasibility of completing asset
Expenditure can be measured reliably
NO YES
Not recognised as an Recognise as an

intangible asset intangible asset
Recognise as an
expense in the statement
of profit or loss
(IAS 8: para. 8)
4.2.1 Expenditure specifically excluded from recognition

The standard states that expenditure on internally generated brands, mastheads, publishing
titles, customer lists and items similar in substance are not recognised as intangible assets
(because they cannot be distinguished from the cost of developing the business as a whole).
Similarly, start-up, training, advertising, promotional, relocation and reorganisation costs are all
recognised as expenses.
(IAS 38: paras. 63 & 67)
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5 Initial measurement
Intangible asset Intangible asset acquired Internally generated
acquired separately as part of a business intangible asset
combination
Measure at cost: Measure at fair value: Measure at cost:

• Purchase price • Defined by IFRS 13 • Sum of expenditure
(include import duties as 'the price that incurred from date
and non-refundable would be received to intangible asset first
purchase taxes; sell an asset or paid meets the recognition
deduct trade discounts to transfer a liability criteria ('PIRATE')
and rebates) in an orderly • Directly attributable
• Any directly transaction between costs necessary to
attributable costs in market participants at create, produce and
preparing asset for its the measurement date' prepare asset to be
intended use (eg cost (IFRS 13: Appendix A) capable of operating in
of employee benefits manner intended by
directly arising from management (eg costs
bringing the asset to of materials and
its working condition, services, costs of
professional fees and employee benefits, fee
costs of testing to register a legal right
whether asset is and amortisation of
functioning properly) patents / licences used to
generate the asset)
(IAS 38: paras. 27, 33, 65 & 66)
Activity 2: Initial measurement of a separately acquired intangible asset
Apricot Co purchases an operating licence from an overseas supplier for $180,000 plus non-
refundable purchase taxes of $18,000. The supplier’s normal list price is $200,000 but it has
awarded Apricot Co a 10% trade discount. Apricot Co has to pay import duties on the purchase of
this licence of $20,000.
As part of the purchase process, Apricot Co seeks advice from a lawyer and incurs legal fees of
$15,000.
Required
Calculate the initial cost of the intangible asset that Apricot Co should recognise in relation to this
licence.
Solution
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Activity 3: Initial measurement of an internally generated intangible asset
Dopper Co is developing a new production process. During 20X3, expenditure incurred was
$100,000, of which $90,000 was incurred before 1 December 20X3 and $10,000 between 1
December 20X3 and 31 December 20X3. Dopper Co can demonstrate that, at 1 December 20X3,
the production process met the criteria for recognition as an intangible asset. The recoverable
amount of the know-how embodied in the process is estimated to be $50,000.
Required
Explain how the expenditure should be treated in Dopper Co’s financial statements for the year
ended 31 December 20X3.
Solution
6 Subsequent measurement
After initial recognition, an intangible asset can either be measured using the cost or the
revaluation model.
6.1 Cost model

The carrying amount of an intangible asset measured using the cost model is cost less
accumulated amortisation and impairment losses (IAS 38: para. 74).
6.2 Revaluation model

The carrying amount of an intangible asset measured using the revaluation model is its fair value
at the date of the revaluation less subsequent accumulated amortisation and impairment losses
(IAS 38: para. 75).
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6.2.1 Active market
If the revaluation model is followed, fair value shall be measured by reference to an active market.
All other assets in the same class must also be accounted for using the revaluation model unless
there is no active market for them in which case the cost model is used for those assets.
Active market: ‘A market in which transactions for the asset or liability take place with
KEY
TERM sufficient frequency and volume to provide pricing information on an ongoing basis.’ (IFRS 13:
Appendix A)
It is uncommon for an active market to exist for intangible assets, although this may happen for
some intangible assets, eg freely transferable taxi licences or nut production quotas.
6.2.2 Frequency of revaluations

Revaluations must be made with such regularity that the carrying amount does not differ
materially from its fair value at the end of the reporting period.
6.2.3 Accounting for revaluations

Revaluation increases and decreases for intangible assets are accounted for in the same way as
for tangible non-current assets, as covered in Chapter 3.
Increase in value Decrease in value

Recognise in other comprehensive income* (a) Recognise in other comprehensive
(and accumulate in equity under the heading income to the extent of any credit
‘revaluation surplus’) balance in the revaluation surplus in
* or in profit or loss to the extent it reverses a respect of that asset (and reduce the
revaluation decrease of the same asset revaluation surplus in equity)
previously recognised in profit or loss (b) Recognise any excess in profit or loss
DEBIT Asset (carrying amount) DEBIT Other comprehensive income (and

CREDIT Other comprehensive income (and reduce revaluation surplus)
accumulate in revaluation surplus) DEBIT Profit or loss
CREDIT Asset (carrying amount)
The revaluation surplus may be amortised to retained earnings if the entity has a policy of making
such a reserves transfer.
7 Amortisation/impairment tests
An entity shall assess whether the useful life of an intangible asset is finite or indefinite. (IAS 38:
paras. 88, 97, 99-100, 104, 107-109)
Finite useful life Indefinite useful life
• Amortise asset on a systematic • Do not amortise asset

basis over its useful life • Conduct impairment reviews:
• Usually recognise amortisation in – Annually; and
profit or loss (unless part of the – Where indication of
cost of another asset) possible impairment
• Residual value is normally zero • Review useful life at least annually
• Amortisation begins when asset is to determine if events and
available for use circumstances still support an
• Review useful life and amortisation indefinite useful life assessment
method at least each year end and
adjust where necessary
HB2022

Activity 4: Intangible assets
Stauffer plc has a year end of 30 September 20X6. The following transactions occurred during the
year:
(1) The Stauffer brand has become well known and has developed a lot of customer loyalty since
the company was set up eight years ago. Recently, valuation consultants valued the brand
for sale purposes at $14.6 million. Stauffer’s directors are delighted and plan to recognise the
brand as an intangible asset in the financial statements. They plan to report the gain in the
revaluation surplus as they feel that crediting it to profit or loss would be imprudent.
(2) The company undertook an expensive, but successful, advertising campaign during the year
to promote a new product. The campaign cost $1 million, but the directors believe that the
extra sales generated by the campaign will be $3.6 million over its four-year expected useful
life.
(3) Stauffer owns a 30-year patent that it acquired on 1 April 20X4 for $8 million, which is being
amortised over its remaining useful life of 16 years from acquisition. The product sold is
performing much better than expected. Stauffer’s valuation consultants have valued its
current market price at $14 million.
(4) Stauffer has been developing a new piece of technology over the past 18 months. Costs
incurred and expensed in the year ended 30 September 20X5 were $1.6 million; further costs
of $0.4 million were incurred up to 31 December 20X5 when the project met the criteria for
capitalisation. Costs incurred after 1 January 20X6 were $0.9 million.
Required
1 In accordance with IAS 38, which of the following is the correct treatment of the brand?
 Recognise an intangible asset of $14.6m with the gain to the profit or loss
 Recognise an intangible asset of $14.6m with the gain to other comprehensive income
 Recognise an intangible asset of $14.6m with the gain direct to the revaluation surplus
 Do not recognise the brand
2 What is the carrying amount of the advertising campaign in the statement of financial
position at 30 September 20X9?
 Nil
 $750,000
 $1,000,000
 $3,600,000
3 Which TWO of the following are TRUE regarding revaluing intangibles?
 Revaluations should be carried out with reference to an active market
 Revaluations should take place every three to five years
 All assets in the same class should be revalued
 Active markets are very common for intangible assets
4 What is the carrying amount of the patent in the statement of financial position at 30
September 20X6?
 $6.5m
 $6.75m
 $8m
 $14m
5 What amount should be capitalised as an intangible asset for the development project?
$ million
HB2022

8 Derecognition
8.1 Point of derecognition
An intangible asset is derecognised:
(a) On disposal; or
(b) When no future economic benefits are expected from its use or disposal.
(IAS 38: para. 112)
8.2 Gain or loss on derecognition

The gain or loss on derecognition is calculated as:
$
Net disposal proceeds (proceeds less selling costs) X
Less: Carrying amount of intangible asset (X)
Gain/loss on derecognition (recognise in profit or loss) X/(X)
The accounting entry required on derecognition is:
DEBIT (↑) Cash (if any)

CREDIT (↓) Intangible asset
CREDIT/DEBIT Profit or loss (balancing figure)
8.3 Revaluation model

On derecognition, if the intangible asset has been held under the revaluation model, any balance
on the revaluation surplus may be transferred to retained earnings (IAS 38: para. 87):
DEBIT (↓) Other comprehensive income (revaluation surplus)

CREDIT (↑) Retained earnings
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Chapter summary
Intangible assets
Definitions Recognition and categories of intangible asset
Intangible assets Recognition criteria

• Identifiable Recognise intangible asset if it meets:
• Non-monetary asset • Definition of an intangible asset
• Without physical substance • Recognition criteria
– Probable future economic benefits
– Cost can be measured reliably
Identifiable
• Separable:
– Capable of being separated/divided from entity
and sold/transferred/licensed/exchanged; or
• Arises from contractual or other legal rights
Monetary assets
• Money held
• Assets to be received in fixed/determinable
amounts of money
Acquired intangible assets Internally generated intangible assets
Recognition criteria Definitions

• Assumed to be satisfied • Research – original and planned investigation to
• Separately acquired recognised at purchase gain new knowledge/understanding
• Acquired as part of a business combination • Development – application of research to
– Recognise separately from goodwill develop/enhance products
Goodwill Recognition criteria

• Internally generated – do not recognise • Research expenditure
• As a result of a business combination – recognise – Recognise as an expense in P/L
positive goodwill as an intangible asset in the • Development expenditure:
group accounts – Capitalise as an intangible asset if all of the
following are met:
◦ Probable future economic benefits
◦ Intention to complete and use/sell
◦ Resources available to complete asset
◦ Ability to use/sell asset
◦ Technical feasibility of completing asset
◦ Expenditure can be measured reliably
• Recognition as an intangible asset
prohibited for:
– Brands
– Mastheads
– Publishing titles
– Customer lists
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Initial measurement Subsequent measurement
• Acquired separately: Measure at cost Cost model or revaluation model

– Purchase price (include import duties and • Cost model:
non-refundable purchase taxes; deduct trade
Cost X
discounts and rebates)
Accumulated amortisation (X)
– Directly attributable costs
Accumulated impairment (X)
• Acquired as part of a business combination:
Measure at fair value Carrying amount X
• Internally generated: Measure at cost • Revaluation model:
– Sum of expenditure incurred from date Fair value (at revaluation date) X
intangible asset first meets recognition criteria Subsequent accumulated amortisation (X)
– Directly attributable costs
Subsequent accumulated impairment (X)
Carrying amount X
Revaluation model
• Revalue to fair value by reference to an
active market
• Revalue all assets of that class unless no
active market
• Revalue sufficiently often that carrying amount
does not differ materially from fair value
• Increase in value: to OCI (unless reverses
previous revaluation loss in P/L)
• Decrease in value: (1) to OCI (2) to P/L
Amortisation/Impairment Derecognition
• Finite useful life Point of derecognition

– Amortise on systematic basis over useful life Derecognise an intangible asset:
– Usually recognise in P/L • On disposal; or
– Residual value normally zero • When no future economic benefits are expected
– Begins when asset is available for use from its use or disposal
– Review useful life and amortisation method at
least every year end
• Indefinite useful life: Gain or loss on derecognition
– Do not amortise asset
Net disposal proceeds X
– Conduct impairment reviews:
Less: Carrying amount (X)
◦ Annually; and
◦ Where indication of possible impairment Gain/(loss) on derecognition X
• Review useful life at least annually • Recognise gain/loss in P/L
• Accounting entry:
DEBIT Cash (if any)
CREDIT Intangible asset
CREDIT/DEBIT Profit or loss (balancing figure)
Revaluation model
Balance on revaluation surplus transferred to
retained earnings
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1. Definitions
‘An intangible asset is an identifiable non-monetary asset without physical substance.’ (IAS 38:
para. 8)
2. Recognition and categories of intangible asset

IAS 38 recognition criteria is:
• Probable that future economic benefits will flow to the entity; and
• Cost can be measured reliably.
Intangible assets can be acquired (separately or as part of a business combination) or internally
generated. (IAS 38, para. 21)
3. Acquired intangible assets

Separate acquired intangible assets meet the recognition criteria and can be capitalised at the
date of purchase.
Intangible assets acquired as part of a business combination should be recognised separately
from goodwill in the group accounts.
4. Internally generated intangible assets

Research expenditure should be written off as an expense to profit or loss.
Development expenditure must be capitalised if the PIRATE criteria are satisfied:
• Probable future economic benefits will be generated by the asset
• Intention to complete and use/sell asset
• Resources (technical, financial, other) adequate to complete asset
• Ability to use/sell asset
• Technical feasibility of completing asset
• Expenditure can be measured reliably
5. Initial measurement
(a) Intangible assets separately acquired – purchase price plus directly attributable costs
(b) Intangible assets acquired as part of a business combination – at fair value (IFRS 13)
(c) Internally generated – at expenditure incurred after criteria satisfied plus directly attributable
costs
6. Subsequent measurement
Cost model or revaluation model: Revaluation model only permitted if an active market exists for
the asset, eg licences, quota.
7. Amortisation/impairment
If the intangible asset has a finite useful life, it should be amortised on a systematic basis across
that useful life.
8. Derecognition
Intangible asset should be derecognised on disposal or when no further benefits are expected. A
gain or loss on disposal should be calculated by comparing proceeds on disposal with the
carrying amount of the asset. Any revaluation surplus should be released to retained earnings.
HB2022

Question practice
You should attempt the following from the Further question practice (available in the digital
edition of the Workbook):
Section C Q28 Biogenics Co
Further reading
For further reading on the treatment of intangible assets, there are two useful technical articles
available on the ACCA website:
Intangible assets – can’t touch this
(available as an article and a podcast within Financial Reporting Technical Articles)
Reporting on intangibles is all a bit of a muddle
(available on the CPD area of the ACCA website)
www.accaglobal.com
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Activity answers
Activity 1: Recognition criteria

• $250,000 acquiring a licence to operate in a new geographical location
• $100,000 on computer software acquired from a supplier
• A brand, valued at $500,000 acquired as part of the purchase of a new subsidiary
The licence is an acquired intangible asset. Therefore, according to IAS 38, the recognition criteria
are presumed to have been met.
Computer software is an acquired intangible asset. Therefore, according to IAS 38, the
recognition criteria are presumed to have been met.
A brand is an intangible asset acquired as part of a business combination. Therefore, according
to IAS 38, the recognition criteria are presumed to have been met and the brand should be
recognised as an intangible asset in the group accounts separately from goodwill.
Activity 2: Initial measurement of a separately acquired intangible asset

$233,000
$
Purchase price:
Purchase price (net of trade discount) 180,000
Non-refundable purchase taxes 18,000
Import duties 20,000
Directly attributable costs:

Legal fees 15,000
233,000
Activity 3: Initial measurement of an internally generated intangible asset

The recognition criteria were satisfied at 1 December 20X3. Any costs incurred after this date can
be capitalised, therefore for the year ended 31 December 20X3, the production process is
recognised as an intangible asset at a cost of $10,000. The $90,000 expenditure incurred before 1
December 20X3 is expensed in profit or loss, because the recognition criteria were not met. It will
never form part of the cost of the production process recognised in the statement of financial
position.
Activity 4: Intangible assets

1 The correct answer is: Do not recognise the brand
The Stauffer brand is an ‘internally generated’ intangible asset rather than a purchased one.
IAS 38 specifically prohibits the recognition of internally generated brands, on the grounds
that they cannot be reliably measured in the absence of a commercial transaction. Stauffer
will not therefore be able to recognise the brand in its statement of financial position.
2 The correct answer is: Nil
The advertising campaign is treated as an expense. Advertising expenditure cannot be
capitalised under IAS 38, as the economic benefits it generates cannot be clearly identified so
no intangible asset is created.
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3 The correct answers are:
• Revaluations should be carried out with reference to an active market
• All assets in the same class should be revalued
Revaluations should take place with reference to an active market and all assets in the same
class should be revalued.
There is not often an active market for intangible assets as they are not frequently traded. IAS
38 does not specify a three- to five-year time frame for revaluations, but instead says that
‘revaluations should be carried out with sufficient regularity to ensure that the carrying
amount does not differ materiality from its fair value’. (IAS 38, para. 75)
4 The correct answer is: $6.75m
The patent is amortised to a nil residual value at $500,000 per annum based on its acquisition
cost of $8m and remaining useful life of 16 years.
The patent cannot be revalued under the IAS 38 rules as there is no active market as a patent
is unique. IAS 38 does not permit revaluation without an active market, as the value cannot be
reliably measured in the absence of a commercial transaction.
5 $ 0.9 million
All costs prior to the project meeting the criteria for capitalisation should be expensed through
the profit or loss.
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HB2022

Impairment of assets
5
5
Learning objectives
Define, calculate and account for an impairment loss, including B3(a)

the principle of impairment tests in relation to goodwill.
Account for the reversal of an impairment loss on an individual B3(b)

asset.
Identify the circumstances that may indicate impairments to B3(c)

assets.
Describe what is meant by a cash-generating unit. B3(d)
State the basis on which impairment losses should be allocated, B3(e)

and allocate an impairment loss to the assets of a cash-
generating unit.
5
Exam context
It is important that assets are not carried in the financial statements at more than the value of the
benefits they are expected to generate. An impairment arises when the carrying amount of an
asset exceeds its value to an entity. Entities must consider whether there have been any internal
events or external factors that would indicate that the carrying amount of assets is too high.
Impairment is an important concept and applies mainly to non-current tangible and intangible
assets. It is frequently examined as an objective test question in Section A and B of the Financial
Reporting exam, and could be an adjustment you are required to make when preparing the
primary financial statements in Section C.
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5
Chapter overview
Principle of impairment Impairment

indicators
Basic principle Recoverable amount Examples of impairment indicators
Definitions Impairment loss
Cash generating Recognition of After the

units impairment losses impairment review
Assets within CGU Recognition of impairment losses Depreciation and amortisation

in the financial statements
Reversal of impairment loss

Allocation of impairment
losses for CGU
Maximum value
Minimum value
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1 Principle of impairment
1.1 Basic principle
There is an established principle that assets should not be carried above their recoverable
amount. IAS 36 Impairment of Assets requires an entity to write down the carrying amount of an
asset to its recoverable amount if the carrying amount of an asset is not recoverable in full. (IAS
36: paras. 18–24)
Note that assets in this case include all tangible and intangible assets. It does not include assets
such as inventories, deferred tax assets, assets arising under IAS 19 Employee Benefits and
financial assets within the scope of IFRS 9 Financial Instruments as these standards already have
rules for recognising and measuring impairment. Note also that IAS 36 does not apply to non-
current assets held for sale, which are dealt with under IFRS 5 Non-current Assets held for Sale
and Discontinued Operations.
1.2 Definitions
Impairment loss: The amount by which the carrying amount of an asset or a cash-generating
KEY
TERM unit exceeds its recoverable amount.
Carrying amount: The amount at which the asset is recognised after deducting accumulated
depreciation and any impairment losses in the statement of financial position.
Recoverable amount: The higher of the fair value less costs of disposal of an asset (or cash-
generating unit) and its value in use.
Cash-generating unit: The smallest identifiable group of assets that generates cash inflows
that are largely independent of the cash inflows from other assets or groups of assets.
Fair value less costs of disposal: The price that would be received to sell the asset in an
orderly transaction between market participants at the measurement date (IFRS 13 Fair Value
Measurement), less the direct incremental costs attributable to the disposal of the asset.
Value in use of an asset: The present value of estimated future cash flows expected to be
derived from the use of an asset.
(IAS 36: para. 6)
1.3 Recoverable amount

It is important that you can apply the definition of recoverable amount to information you are
provided with in a question:
Recoverable amount =
Higher of
Fair value less costs of disposal Value in use
Illustration 1: Recoverable amount
Henry Co holds an item of machinery which it believes is impaired. The following information is
relevant:
• The fair value of the machinery is $10,000, the cost of selling is $500.
• The value in use of the machinery is estimated to be $9,000.
It is the company’s intention to continue to use the asset for the remainder of its useful life.
Required
Determine the recoverable amount of the machinery.
HB2022
5: Impairment of assets 85

Solution
Recoverable amount =
Higher of
Fair value less costs of disposal Value in use

$10,000 – $500 = $9,500 $9,000
Therefore, the recoverable amount is $9,500. Note that the company’s intention to continue to use
the asset is not a relevant factor.
Essential reading
Chapter 5, Section 1 of the Essential reading provides detail on measuring the recoverable amount
of an asset.
1.4 Impairment loss

If there is any indication that an asset may be impaired, the entity should compare its carrying
amount with its recoverable amount.
greater than carrying amount No impairment
Recoverable amount
less than carrying amount Impairment loss
An impairment loss is the amount by which the carrying amount of an asset or cash-generating
unit exceeds its recoverable amount.
Illustration 2: Impairment loss
Following on from Illustration 1, further information has been provided about the carrying amount
of the asset:
• The machinery is held at historical cost
• The carrying amount of the machinery is $10,500
Required
Using the recoverable amount determined in Illustration 1, calculate the impairment loss.
Solution
The carrying amount of the machinery must be compared to its recoverable amount.
The recoverable amount was determined in Illustration 1 as $9,500.
The carrying amount of the machinery is therefore greater than its recoverable amount, so the
machinery is impaired.
The impairment loss charged is: $10,500 – $9,500 = $1,000.
Section 4 of this chapter will consider how to account for the impairment.
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2 Impairment indicators
An entity must assess at the end of each reporting period whether there is any indication that an
asset may be impaired.
2.1 Examples of events indicating impairment

2.1.1 External sources
• Observable indications that the value of the asset has declined during the period significantly
more than expected due to the passage of time or normal use
• Significant changes with an adverse effect on the entity in the technological, market,
economic or legal environment in which the entity operates
• Increased market interest rates or other market rates of return affecting discount rates and
thus reducing value in use
• Carrying amount of net assets of the entity exceeds market capitalisation
2.1.2 Internal sources

• Evidence of obsolescence or physical damage
• Significant changes with an adverse effect on the entity (including the asset becoming idle,
plans to discontinue or restructure an operation to which the asset belongs or to dispose of it
earlier than expected and reassessing the useful life of an asset as finite rather than indefinite)
• Internal evidence available that asset performance will be worse than expected
3 Cash-generating units (CGUs)

It may not be possible to estimate the recoverable amount of an individual asset. An entity must
therefore determine the recoverable amount of the CGU to which the asset belongs.
3.1 Assets within a CGU

If an active market exists for the output produced by the asset or a group of assets, this asset or
group should be identified as a cash-generating unit, even if some or all of the output is used
internally. (IAS 36: para. 70)
Cash-generating units should be identified consistently from period to period for the same type of
asset, unless a change is justified. (IAS 36: para. 72)
The group of net assets less liabilities that are considered for impairment should be the same as
those considered in the calculation of the recoverable amount. (IAS 36: para. 75)
Goodwill (and corporate assets eg head office assets – or a portion of them – that can be
allocated on a reasonable and consistent basis) are allocated to a CGU (or group of CGUs) when
determining carrying amount and recoverable amount.
Activity 1: Cash-generating units
Minimart Co belongs to a retail store chain, Magnus Co. Minimart Co makes all its retail
purchases through Magnus Co’s purchasing centre. Pricing, marketing, advertising and human
resources policies (except for hiring Minimart Co’s cashiers and salesmen) are decided by Magnus
Co. Magnus Co also owns five other stores in the same city as Minimart Co (although in different
neighbourhoods) and 20 other stores in other cities. All stores are managed in the same way as
Minimart Co. Minimart Co and four other stores were purchased five years ago and goodwill was
recognised.
Required
What is the cash-generating unit for Magnus Co?
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Solution
4 Recognition of impairment losses

4.1 Recognition of impairment losses in the financial statements
4.1.1 Impairment losses for individual assets
Impairment losses are treated in the following way:
Assets carried at historical cost Revalued assets
The impairment loss is recognised The impairment loss is accounted

as an expense in profit or loss. for under the appropriate rules of
the applicable IFRS Standards.
For example under IAS 16 the

impairment loss is charged:
1. First to other comprehensive
income (reducing any
revaluation surplus relating to
the particular asset); and
2. Any remainder as an expense in
profit or loss.
Activity 2: Impairment of a revalued asset
Brix Co owns a building which it uses as its offices, warehouse and garage. The land is carried as
a separate non-current tangible asset in the statement of financial position.
Brix Co has a policy of regularly revaluing its non-current tangible assets. The original cost of the
building in October 20X2 was $1,000,000; it was assumed to have a remaining useful life of 20
years at that date, with no residual value. The building was revalued on 30 September 20X4 by a
professional valuer at $1,800,000. Brix Co does not make transfers between revaluation surplus
and retained earnings. The economic climate had deteriorated during 20X5, causing Brix Co to
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carry out an impairment review of its assets at 30 September 20X5. Brix Co’s recoverable amount
was calculated as $1,500,000 on 30 September 20X5.
Required
At 30 September 20X5, what is the impairment loss AND where in the financial statements should
it be presented?
1 What is the amount of the impairment loss?
 $200,000
 $300,000
2 Where is the impairment loss presented in the financial statements?
 Other comprehensive income
 Profit or loss
4.2 Allocation of impairment losses for a CGU

The impairment loss is allocated to reduce the carrying amount of the assets of the unit in the
following order:
(a) To any goodwill allocated to the CGU;
(b) To the other assets of the unit on a pro-rata basis based on the carrying amount of each
asset in the unit.
Illustration 3: Allocation of impairment loss for CGU
A cash-generating unit comprises the following:
$m
Building 30
Plant and equipment 6
Goodwill 10
Current assets 20
66
Following a recession, an impairment review has estimated the recoverable amount of the cash-
generating unit to be $50 million.
Required
Allocate the impairment loss to the assets in the CGU.
Solution
There is an impairment of $16 million as the recoverable amount of $50 million is less than the
carrying amount of $66 million.
$10 million of the impairment is allocated to goodwill. The remaining $6 million will be allocated to
the other non-current assets on a pro-rata basis based on their carrying amounts.
• Impairment allocated to building is 30/36 × $6 million
• Impairment allocated to plant and equipment is 6/36 × $6 million
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Plant and Current
Building equipment Goodwill assets Total
$m $m $m $m $m
Carrying amount 30 6 10 20 66
Impairment – goodwill — — (10) — (10)
30 6 — 20 56
Impairment – other assets (5) (1) — — (6)
Carrying amount after
impairment 25 5 — 20 50
4.3 Minimum value

In allocating an impairment loss, the carrying amount of an asset should not be reduced below
the highest of:
• Its fair value less costs of disposal
• Its value in use (if determinable)
• Zero
Any remaining amount of the impairment loss should be recognised as a liability if required by
other standards. (IAS 36: paras. 104–108)
Activity 3: Calculation and allocation of impairment loss
On 31 December 20X1, Invest Co purchased all the shares of Mash Co for $2 million. The net fair
value of the identifiable assets acquired and liabilities assumed of Mash Co at that date was $1.8
million. Mash Co made a loss in the year ended 31 December 20X2 and at 31 December 20X2, the
net assets of Mash Co – based on fair values at 1 January 20X2 – were as follows:
$’000
Property, plant and equipment 1,300
Development expenditure 200
Net current assets 250
1,750
An impairment review on 31 December 20X2 indicated that the recoverable amount of Mash Co at
that date was $1.5 million. The capitalised development expenditure has no ascertainable external
market value and the current fair value less costs of disposal of the property, plant and
equipment is $1,120,000. Value in use could not be determined separately for these two items.
Required
Calculate the impairment loss that would arise in the consolidated financial statements of Invest
as a result of the impairment review of Mash Co at 31 December 20X2 and show how the
impairment loss would be allocated.
HB2022

Solution
Asset values at Allocation of Carrying

31.12.X2 before impairment loss amount after
impairment (W1)/(W2) impairment loss
$’000 $’000 $’000
Goodwill
Property, plant and

equipment
Development expenditure
Net current assets
5 After the impairment review

5.1 Depreciation and amortisation
After the recognition of an impairment loss, the depreciation or amortisation charge for the asset
in future periods should allocate the asset’s revised carrying amount less its residual value over its
remaining useful life. It is often the case that the remaining useful life of an asset will be
reassessed at the date of the impairment review.
5.2 Reversal of an impairment loss

It may be possible that there is a change in the economic or operating conditions for an asset or
CGU that mean a previous impairment loss can now be reversed. An impairment loss recognised
for an asset in prior years should be recovered only if there has been a change in the estimates
used to determine the asset’s recoverable amount since the last impairment loss was recognised.
(IAS 36: para. 114)
If there is a change in estimates that requires an impairment loss to be reversed, the carrying
amount of the asset should be increased to its new recoverable amount:
Assets carried at historical cost Revalued assets
Reversal of the impairment loss Reversal of the impairment loss should be

should be recognised immediately recognised in other comprehensive
in profit or loss income and accumulated as a revaluation
surplus in equity
(IAS 36: para. 119)
5.2.1 Maximum value

The asset cannot be revalued to a carrying amount that is higher than what it would have been if
the asset had not been impaired originally, ie its depreciated carrying amount had the
impairment not taken place.
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5.2.2 Subsequent depreciation and amortisation
Depreciation of the asset should now be based on its new revalued amount, its estimated residual
value (if any) and its estimated remaining useful life.
5.2.3 Goodwill
An exception to the rule above is for goodwill. An impairment loss for goodwill should not be
reversed in a subsequent period. (IAS 36: para. 124)
Exam focus point

The July 2020 exam included the reversal of an impairment of a tangible asset. The Examiner’s
Report noted that many candidates were not aware that the carrying amount of the asset
after the reversal should be restricted to its carrying amount had the asset been measured
using historical cost accounting.
Activity 4: Reversal of impairment loss
A head office building with a carrying amount of $140 million is estimated to have a recoverable
amount of $90 million due to falling property values in the area. An impairment loss of $50 million
is recognised.
After three years, property prices in the area have risen, and the recoverable amount of the
building increases to $120 million. The carrying amount of the building, had the impairment not
occurred, would have been $110 million.
Required
Calculate the reversal of the impairment loss.
Solution
Essential reading
Chapter 5, Section 2 of the Essential reading contains two further activities to allow you to
practise calculating impairment loss for an individual asset and a CGU.
HB2022

PER alert
to record and process transactions and events, using the right accounting treatments for
those transactions and events. The treatment of impairment losses for both assets and cash-
generating units is one that is non-routine, but increasingly important in the current economic
climate. The information in this chapter will give you knowledge to help you demonstrate this
competence.
HB2022

Chapter summary
Principle of impairment Impairment

indicators
Basic principle Recoverable amount Examples of impairment indicators

Assets should not be carried at Higher of: • External
more than their value to an entity • Fair value less costs of disposal – Asset's value declined more
• Value in use than expected due to the
Definitions passage of time or normal use
– Adverse changes in
• Impairment loss – amount by Impairment loss
technological, market,
which carrying amount exceeds • If carrying amount exceeds economic or legal environment
recoverable amount recoverable amount, impairment – Increased market interest rates
• Carrying amount – amount at loss arises – Carrying amount of net assets
which asset is presented in • If carrying amount is less than exceeds market capitalisation
financial statements recoverable amount, no
• Recoverable amount – higher of • Internal
impairment loss – Obsolescence or physical
fair value less costs of disposal
and value in use damage
• Cash generating unit – smallest – Significant changes with an
identifiable group of assets that adverse effect on the entity
generates cash flows – Evidence available that asset
• Fair value less costs of disposal performance will be worse
– price received to sell an asset than expected
less incremental costs to dispose
of the asset
• Value in use – present value of
the net future cash flows
Cash generating Recognition of After the

units impairment losses impairment review
Assets within CGU Recognition of impairment losses Depreciation and amortisation

• Smallest group of assets that in the financial statements Based on revised carrying amount
generates cash flows Losses for individual assets: over estimated remaining useful life
• Net of associated liabilities • If at historic cost – in profit/loss
• Goodwill and corporate assets • If revalued assets – rules per Reversal of impairment loss
should be allocated relevant IFRS Standard • Only if change in circumstances
• Asset at historic cost –
Allocation of impairment losses for immediately in profit/loss
CGU • Revalued asset – as a
Allocate first to goodwill, then to revaluation surplus
other assets pro-rata • Impairment of goodwill cannot
be reversed
Minimum value
Maximum value
No asset below:
• Its fair value less costs of Asset not above carrying amount
disposal had no impairment occurred
• Its value in use (if determinable)
• Zero
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1. Principle of impairment
Assets should not be measured at more than their value to an entity. An asset’s recoverable
amount is the higher of value in use (net cash flows) and fair value less costs of disposal.
Impairment losses occur where the carrying amount of an asset is above its recoverable amount.
2. Impairment indicators
An entity must do an impairment test when there are impairment indicators. These can be
internal, such as physical damage to an asset or external, such as significant technological
advances.
3. Cash generating units

Where the cash flows of individual assets cannot be measured separately, the recoverable
amount is calculated by reference to the CGU.
4. Recognition of impairment losses

Impairment losses are charged first to other comprehensive income (re: any revaluation surplus
relating to the asset) and then to profit or loss.
In the case of a CGU, the credit is allocated first against any goodwill and then pro-rata over the
other assets of the CGU.
5. After the impairment review

After the impairment review, depreciation/amortisation is allocated over the asset’s revised
remaining useful life.
Impairment losses can be reversed in subsequent periods, provided there is a change in the
circumstances that gave rise to the impairment. Reversals are up to a maximum of what the asset
would have been carried at, had no impairment occurred.
Impairment of goodwill cannot be reversed.
HB2022

Question practice
Now try the following from the Further question practice bank available in the digital edition of the
workbook:
Section A Q6
Section B Q22
Section C Q29 Multiplex Co
HB2022

Activity answers
Activity 1: Cash-generating units

In identifying Minimart Co’s cash-generating unit, an entity considers whether, for example:
(1) Internal management reporting is organised to measure performance on a store-by-store
basis.
(2) The business is run on a store-by-store profit basis or on a region/city basis.
All Magnus Co’s stores are in different neighbourhoods and probably have different customer
bases. So, although Minimart Co is managed at a corporate level, Minimart Co generates cash
inflows that are largely independent from those of Magnus Co’s other stores. Therefore, it is likely
that Minimart Co is a cash-generating unit.
Activity 2: Impairment of a revalued asset

At 30 September 20X4, the building was revalued upwards and a revaluation surplus was
recorded as follows:
$
Carrying amount at 1 October 20X2 1,000,000
Accumulated depreciation 20X2 to 20X4
(1,000,000 × 2/20 years) (100,000)
Carrying amount 900,000

Valuation 1,800,000
The revaluation surplus would be presented in other comprehensive income.

At 30 September 20X5, the building was revalued downwards as follows:
$
Valuation at 30 September 20X4 1,800,000
Depreciation 20X5 (1,800,000/18 years) (100,000)
Carrying amount 1,700,000
Recoverable amount at 30 September 20X5 1,500,000
Impairment loss 200,000
2 The correct answer is: Other comprehensive income

As there is a sufficient revaluation surplus, the impairment loss of $200,000 will be charged to
other comprehensive income.
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Activity 3: Calculation and allocation of impairment loss
Asset values at Allocation of Carrying

31.12.X2 before impairment loss amount after
impairment (W1)/(W2) impairment loss
$’000 $’000 $’000
Goodwill (2,000 – 1,800) 200 (200) –
Property, plant and

equipment 1,300 (180) 1,120
Development expenditure 200 (70) 130
Net current assets 250 – 250
1,950 (450) 1,500
Workings
1 Impairment loss
$’000
Recoverable amount 1,500
Impairment loss 450
Amount to allocate against goodwill 200

Amount to allocate pro-rata against other assets 250
2 Allocation of the impairment losses on pro-rata basis
Carrying
amount if Actual
Initial Impairment fully loss Impaired
value pro-rated allocated Reallocation allocated value
$’000 $’000 $’000 $’000 $’000 $’000
PPE (250 ×
1,300/
1,500) 1,300 217 1,083 (37) 180 1,120
Dev. exp
(250 ×
200/
1,500) 200 33 167 37 70 130
The amount not allocated to the PPE because the assets cannot be taken below their
recoverable amount is allocated to other remaining assets pro-rata, in this case all against the
development expenditure.
Hence the development expenditure is reduced by a further $37,000 (217,000 – 180,000),
making the total impairment $70,000 (33,000 + 37,000).
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The net current assets are not included when pro-rating the impairment loss. As current assets
are not intended to be held as assets in future periods, they are more likely to be measured at
their recoverable amount and therefore are less likely to be impaired.
Activity 4: Reversal of impairment loss

The reversal of the impairment loss is recognised to the extent that it increases the carrying
amount of the building to what it would have been, had the impairment not taken place, ie a
reversal of impairment loss of $20 million is recognised and the building written back to $110
million.
HB2022

HB2022

Skills checkpoint 1
Approach to objective test
(OT) questions
Chapter overview
cess skills
Exam suc
Answer planning
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Man
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skills skills
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Approach
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Effective writing
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Introduction
Sections A and B of the FR exam consist of objective test (OT) questions.
The OT questions in Section A are single, short questions that are auto-marked and worth two
marks each. You must answer the whole question correctly to earn the two marks. There are no
partial marks.
The OT questions in Section A aim for a broad coverage of the syllabus, and so all areas of the
syllabus need to be carefully studied. You need to work through as many practice OT questions as
possible, reviewing the answers carefully to understand how the correct answers are derived.
The OT questions in Section B are a series of short questions that relate to a common scenario, or
case. Section B questions are also auto-marked and must be answered correctly to gain the
credit. There are no partial marks.
The types of OT question and approach to answering the questions is the same in both Section A
and Section B.
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The following types of OT question commonly appear in the Financial Reporting exam:
Question type Explanation

Multiple choice You need to choose one correct answer from four given response
(MCQ) options.
Multiple response These are a kind of multiple choice question, except you need to select
(MRQ) more than one answer from a number of given options. The question will
specify how many answers need to be selected, but the system won’t
stop you from selecting more answers than this. It is important to read
the requirement carefully.
Fill in the blank (FIB) This question type requires you to type a numerical answer into a box.
The unit of measurement (eg $) will sit outside the box, and if there are
specific rounding requirements these will be displayed.
Enhanced matching Enhanced matching (sometimes referred to as ‘drag and drop’)

questions involve you dragging an answer and dropping it into the
correct place. Some questions could involve matching more than one
answer to a response area and some questions may have more answer
choices than response areas, which means not all available answer
choices need to be used.
Pull down list This question type requires you to select one answer from a pull down
list. Some of these questions may contain more than one pull down list
and an answer has to be selected from each one.
Hot spot For hot spot questions, you are required to select one point on an image
as your answer. When the cursor is hovered over the image, it will
display as an ‘X’. To answer, place the X on the appropriate point on the
diagram.
Hot area These are like hot spot questions, but instead of selecting a specific
point you are required to select one or more areas in an image.
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Approach to OT questions
A step-by-step technique for approaching OT questions is outlined below. Each step will be
explained in more detail in the following sections as we work through a range of OT questions.
STEP 1: Answer the questions you know first.

If you’re having difficulty answering a question, move on and come back to tackle it
once you’ve answered all the questions you know.
It is often quicker to answer discursive style OT questions first, leaving more time
for calculations.
STEP 2: Answer all questions.

There is no penalty for an incorrect answer in ACCA exams; there is nothing to be
gained by leaving an OT question unanswered. If you are stuck on a question, as a
last resort, it is worth selecting the option you consider most likely to be correct
and moving on. Flag the question, so if you have time after you have answered the
rest of the questions, you can revisit it.
STEP 3: Read the requirement first!

The requirement will be stated in bold text in the exam. Identify what you are
being asked to do, any technical knowledge required and what type of OT
question you are dealing with. Look for key words in the requirement such as
"Which TWO of the following," or "Which of the following is NOT".
STEP 4: Apply your technical knowledge to the data presented in the question.
through each response option and eliminate those you know are incorrect
Exam success skills

The following questions are examples of the types of OT questions you may come across in the
exam. This does not cover all of the styles, but focuses on the trickier ones which you may face on
the day.
In looking at these OT questions, we will also focus on the following exam success skills:
• Managing information. It is easy for the amount of information contained in an OT question to
feel a little overwhelming. This is particularly true in Section B due to the volume of information
within the case scenario. Active reading is a useful technique to help avoid this. This involves
focusing on the requirement first, on the basis that until you have done this the detail in the
question will have little meaning and will seem more intimidating as a result.
Focus on the requirement, highlighting key verbs to ensure you understand the requirement
properly and correctly identify what type of OT question you are dealing with. Then read the
rest of the scenario, highlighting important and relevant information, and using your scratch
pad if necessary to make notes of any relevant technical information you think you will need.
• Correct interpretation of requirements. Identify from the requirement the different types of OT
question. This is especially important with multiple response questions to ensure you select the
correct number of response options.
• Good time management. Complete all OT questions in the time available. Each OT question is
worth 2 marks and should be allocated 3.6 minutes (based on 1.8 minutes per mark).
HB2022
Skills Checkpoint 1: Approach to objective test (OT) questions 103

Skill activity
1. Which TWO of the following are acceptable methods of accounting for a government grant
relating to an asset in accordance with IAS 20 Accounting for Government Grants and
Disclosure of Government Assistance?
Note. This is a multiple response question (MRQ) requiring you to select two valid statements. IAS
20 is being examined here.
• Set up the grant as deferred income
• Credit the full amount received to profit or loss
• Deduct the grant from the carrying amount of the asset
• Add the grant to the carrying amount of the asset
(2 marks)
2. Which of the following would be recognised as an investment property under IAS 40

Investment Property in the consolidated financial statements of Build Co?
Note. This is a multiple choice question (MCQ) requiring you to select one valid statement. You will
note that the requirement does not specify one. You should assume that you select one statement
unless you are told otherwise.
• A property intended for sale in the ordinary course of business
• A property being constructed for a customer
• A property held by Build Co as a right-of-use asset and leased out under a six-month lease
• A property owned by Build Co and leased out to a subsidiary
(2 marks)
3. Lichen Ltd owns a machine that has a carrying amount of $85,000 at the year end of 31
March 20X9. The market value of the machine at 31 March 20X9 is $78,000 and costs of disposal
are estimated at $2,500. Lichen Ltd has calculated that the value in use of the asset is $77,000.
Note. This is a fill in the blank (FIB) question. This is testing your knowledge of impairment and a
calculation of the loss to be recognised on the machine.
What is the impairment loss on the machine to be recognised in the financial statements at 31
March 20X9? (provide you answer to the nearest $000)
$_______’000
(2 marks)
4. Springthorpe Co entered into a three-year contract on 1 January 20X2 to construct a factory

on a client’s land. The client gains control of the asset as the construction takes place.
Springthorpe Co does not have an alternative use for the factory and has an enforceable right to
payment for performance completed to date. Springthorpe Co has determined that performance
obligations are satisfied over time, with progress measured according to certificates issued by a
surveyor. At 31 December 20X2 details of the contract were as follows:
$m
Total contract price 12
Costs incurred to date 4
Amounts invoiced to date 4
Certified as complete by surveyor 40%
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Identify, by clicking on the relevant boxes below, whether a contract asset or contract liability
should be recognised and at what carrying amount in the statement of financial position of
Springthorpe Co as at 31 December 20X2?
Note. This is a hot area question. You should click to select whether this is a contract asset or
liability and the appropriate carrying amount.
Asset or liability Carrying amount

Contract asset $200,000
Contract liability $800,000
$1,000,000
(2 marks)
5. On 1 September 20X7, Jack Co entered into a contract for the right to use a machine for a
period of five years from that date. The contract meets the definition of a lease under IFRS 16
Leases. The machinery has a useful life of eight years. Jack Co incurred costs of $4,000 to
arrange the lease. Under the terms of the lease, Jack Co was required to pay $100,000 on
commencement of the lease followed by five annual payments of $200,000 commencing 31
August 20X8. The present value of the future lease payments has been correctly calculated as
$790,000 on the commencement date. The rate of interest implicit in the lease is 8.4%.
Using the pull down list provided, what should be the carrying amount of the machine following
at 31 August 20X8?
Note. This is a pull down list question, it is very similar to an MCQ except the selection is taken
from a list.
Pull down list
$894,000
$715,200
$656,360
$782,250
STEP 1 Answer the questions you know first.
If you’re having difficulty answering a question, move on and come back to tackle it once you’ve answered
all the questions you know. It is often quicker to answer discursive style OT questions first, leaving more time
for calculations.
Questions 1 and 2 are discursive style questions. It would make sense to answer these questions
first as it is likely that you will be able to complete them comfortably within the 3.6 minutes per
question allocated to them. Any time saved could then be spent on the more complex calculations
required to answer Questions 3, 4 and 5.
STEP 2 Answer all questions.
There is no penalty for an incorrect answer in ACCA exams, there is nothing to be gained by leaving an OT
question unanswered. If you are stuck on a question, as a last resort, it is worth selecting the option you
consider most likely to be correct and moving on. Use your scratch pad or the ‘flag for review’ option within
the exam software to make a note of the question, so if you have time after you have answered the rest of
the questions, you can revisit it.
Of the questions here, you could have a guess for four out of five questions as there are
alternative answers given. With an MCQ or pull down list question, you have a 25% chance of
getting the question correct so don’t leave any unanswered. It is obviously more difficult to get a
fill in the blank question (like Question 3) correct by guessing.
STEP 3 Read the requirement first!
The requirement will be stated in bold text in the exam. Identify what you are being asked to do, any
technical knowledge required and what type of OT question you are dealing with. Look for key words in the
requirement such as “Which TWO of the following” and “ Which of the following is NOT” etc.
HB2022

Questions 1 and 2 ask you to identify which statements are correct. Read through each statement
carefully knowing that you are looking to identify the statement that is correct.
Question 3 is a FIB question, you need to follow the instructions carefully and provide your answer
in $000 as requested.
Question 4 is a hot area question, which ask you to click on the image to identify whether there is
a contract asset or liability and the carrying amount. Ensure you answer both parts of the
requirement.
Question 5 is a pull down list. You need to be careful to ensure you scroll through the options to
get to your intended answer.
STEP 4 Apply your technical knowledge to the data presented in the question.
Work through calculations taking your time and read through each answer option with care. OT questions
are designed so that each answer option is plausible. Work through each response option and eliminate
those you know are incorrect.
Let’s look at the questions in turn:
Question 1
The question is testing your knowledge of IAS 20 and the

permissible ways of accounting for a grant.
As no application of the standard is required, it is a

relatively simple knowledge exercise requiring two
statements to be selected. It is important that you
remember to select two statements in order to gain the
marks (partial marks are not available, you must get
both statements correct).
The correct answer is:
• Set up the grant as deferred income; and
• Deduct the grant from the carrying amount of the

asset
Both of these are options available stated within the

standard. The second statement would not meet the
criteria of accruals accounting as the costs of the asset
(depreciation expense) would not be matched to the
income included wholly in year 1. The last statement
would be the correct treatment if a requirement to
repay the grant was necessary.
Question 2 works in a similar way, again testing the

knowledge rather than the application of the standard.
A property held by Build Co as a right-of-use asset and

leased out under a six-month lease.
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The property intended for sale and the property being
constructed would be classified as inventory and WIP.
The property leased out to a subsidiary would be
regarded as an investment property in the single entity
financial statements of Build Co but is treated as owner
occupied in the consolidated financial statements (as it
is occupied by a subsidiary not a third party).
Question 3 is a calculation question requiring

knowledge of the impairment of assets (IAS 36) and the
application of that knowledge.
This is quite a time-consuming question if you not

confident with the treatment of impairment of assets.
You should start by pulling out the key data from the
question:
Lichen Ltd owns a machine that has a carrying amount

1
of $85,0001 at the year end of 31 March 20X9. Its Carrying amount $85,000
2 2
market value is $78,000 and costs of disposal are Fair value $78,000
estimated at $2,500. Lichen Ltd has calculated that the

3
value in use of the asset is $77,0003. Value in use
What is the impairment loss on the machine to be

recognised in the financial statements at 31 March
20X9?
What information do we need?
Impairment occurs when the carrying amount of the

asset exceeds the recoverable amount, so we need to
know what the carrying amount and the recoverable
amounts are.
The carrying amount is $85,000.
The recoverable amount of an asset should be

measured as the higher of:
(a) The asset’s fair value less costs of disposal =

$75,500 ($78,000 market value less $2,500 costs of
disposal)
(b) The value in use = $77,000
The recoverable amount is the higher of the fair value

less costs of disposal $75,500 and the value in use
£77,000. The recoverable amount is therefore $77,000.
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The calculation of the impairment is $85,000 – $77,000
= $8,000.
Because the requirement asks you to enter your answer

to the nearest $000, you should type 8 in the fill in the
blank box. If you typed 8,000, your answer would be
marked as incorrect.
Question 4 contains a calculation question, with a

narrative element. In this case however, there are three
potential numerical answers, and you have to select
whether there is a contract asset or a contract liability
to be recognised. You need to correct identify both
whether there is an asset or liability and the correct
carrying amount to score credit. Once again, you need
to pull the relevant data out of the question and apply it
to your knowledge of IFRS 15.
This style of question works better on software as you

will click on the correct answers.
Asset or liability Carrying amount

Contract asset $800,000
Working
A contract asset represents an entity’s right to receive

consideration in respect of goods or services transferred
to a customer.
A contract liability represents an entity’s obligation to

transfer goods or services to a customer for which it has
already received consideration.
This is determined by reference to the revenue that can

be recognised to date and the amount invoiced to date.
$
Revenue recognised ($12m × 40%) 4.8
Amounts invoiced (4.0)
Contract asset 0.8
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A contract asset arises as the entity has transferred
goods or services to the customer with a value of $4.8
million but has only charged $4 million to date for those
goods or services.
Question 5 is another numerical question, requiring

knowledge of IFRS 16.
The question asks what the carrying amount of the

machine at 31 August 20X8, which is the end of the first
year. There is a lot of information in this question. You
need to be clear when reading the requirements that
you are interested in the carrying amount of the right of
use asset at 31 August 20X8. To arrive at that balance,
you need to calculate the following:
(i) the initial carrying amount of the right of use asset
$
Present value of future lease payments 790,000
Direct costs 4,000
Payments made on commencement of lease 100,000
894,000
$
Initial measurement of right of use asset 894,000
Depreciation (over 5 years) (178,800)
Carrying amount at 31 August 20X8 715,200
Exam success skills diagnostic

Every time you complete a question, use the diagnostic below to assess how effectively you
demonstrated the exam success skills in answering the question. The table below allows you to
perform a check for the OT questions you undertake in timed conditions to give you an idea of
how to complete the diagnostic.
Exam success skills Your reflections/observations

Managing information Some questions are longer than others, so
prioritise the topics which you feel more
confident with. Ensure you are familiar with
the time period in the question, and what data
is required in order to answer the question, eg
calculation of the depreciation in order to give
the required answer of the carrying amount of
an asset.
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Correct interpretation of requirements Ensure you read the question requirement
carefully so that you answer the question
being asked (not the one you think or hope is
being asked!)
Good time management Remember that each OT question is worth two

marks, regardless of how hard it is or how long
it takes you to answer. You are aiming for to
spend 3.6 minutes on each question (180
minutes/100 marks × 2 marks).
Some questions will be quicker than others,
due to their nature (narrative) or how
confident you are on a certain topic.
Ensure you don’t overrun, but equally, don’t
rush your answers and make mistakes.
Most important action points to apply to your next question – Read the scenario and
requirement carefully.
Summary
60% of the FR exam consist of OT questions. Key skills to focus on throughout your studies will
therefore include:
• Always read the requirements first to identify what you are being asked to do and what type of
OT question you are dealing with.
• Actively read the scenario highlighting key data needed to answer each requirement.
• Answer OT questions in a sensible order dealing with any easier discursive style questions first.
HB2022

Revenue and government
6 grants
Learning objectives
Explain and apply the principles of recognition of revenue: B10(a)

• Identification of contracts
- Identification of performance obligations
- Determination of transaction price
- Allocation of the price to performance obligations
- Recognition of revenue when/as performance obligations are
satisfied
Explain and apply the criteria for recognising revenue generated B10(b)
from contracts where performance obligations are satisfied over
time or at a point in time
Describe the acceptable methods for measuring progress towards B10(c)

complete satisfaction of a performance obligation
Explain and apply the criteria for the recognition of contract costs B10(d)
Apply the principles of recognition of revenue, and specifically B10(e)

account for the following types of transaction:
• principal versus agent
• repurchase agreements
• bill and hold arrangements
• consignment arrangements
Prepare financial statement extracts for contracts where B10(f)

performance obligations are satisfied over time
Apply the provisions of relevant IFRS Standards in relation to B11(a)

accounting for government grants
6
Exam context
Revenue is usually the single largest figure in a statement of profit or loss, so it is important that it
is recognised in the financial statements at the correct point in time and is measured correctly.
Understanding the rules of revenue recognition using IFRS 15, Revenue from Contracts with
Customers, is vital in your Financial Reporting studies, as it can be examined across all parts of
the exam.
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This chapter also covers IAS 20, Government Grants and Disclosure of Government Assistance. It
is most likely to be examined in Section A, and if it is included in a Section B case objective test
question, it is likely to sit alongside the related topics of revenue or the acquisition of tangible non-
current assets.
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6
Chapter overview
Revenue and government grants
Revenue IFRS 15 Revenue from

recognition Contracts with Customers
IFRS 15 five steps to recognition of revenue Common types of transaction
1. Identify contract Principal vs agent
2. Identify performance obligations Repurchase agreement
3. Determine transaction price Sales with a right of return
4. Allocate transaction price Consignment arrangements

to performance obligations
Bill and hold arrangements

5. Recognise revenue when (or as)
performance obligation is satisfied
Warranties
Performance IAS 20 Accounting for

obligations Government Grants and Disclosure
of Government Assistance
Performance obligations satisfied over time Grants relating to income
Methods of measuring performance Grants relating to assets
Repayment of grants
HB2022
6: Revenue and government grants 113

1 Revenue recognition
Revenue is normally the main component of a company’s income.
Income
Revenue Interest and Other gains or

(profit or loss) dividend income losses on assets
(profit or loss)
Refer to
Chapter 12,
Definition Financial Revaluation of Revaluation of other
Income arising in the Instruments investments non-current assets
course of an entity's (Profit or loss) (Other comprehensive
ordinary activities Refer to income)
(IFRS 15: App A) Chapter 12, Refer to Chapter 3,
Financial Tangible non-current
Instruments assets, Chapter 5,
Examples Impairment of assets
• Sale of goods
• Rendering of services
• Contracts to
construct an asset
Revenue does not include sales taxes, value added taxes or goods and service taxes which are
only collected for third parties, because these do not represent an economic benefit flowing to the
entity.
2 IFRS 15 Revenue from Contracts with Customers

2.1 Definitions
Contract: An agreement between two or more parties that creates enforceable rights and
KEY
TERM obligations.
Performance obligation: A promise in a contract with a customer to transfer to the customer
either:
(a) A good or service (or a bundle of goods or services) that is distinct; or
(b) A series of distinct goods or services that are substantially the same ad that have the
same pattern of transfer to the customer.
Transaction price: The amount of consideration to which an entity expects to be entitled in
exchange for transferring promised goods or services to a customer, excluding amounts
collected on behalf of third parties.
(IFRS 15: Appendix A)
2.2 Principle of revenue recognition

The core principle of IFRS 15 is that an entity recognises revenue to depict the transfer of goods or
services to customers in an amount that reflects the consideration to which the entity expects to
be entitled in exchange for those goods or services.
Revenue is recognised when there is transfer of control to the customer from the entity supplying
the goods or services.
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Some indicators of the transfer of control are:
(a) The entity has a present right to payment for the asset.
(b) The customer has legal title to the asset.
(c) The entity has transferred physical possession of the asset.
(d) The significant risks and rewards of ownership have been transferred to the customer.
(IFRS 15: para. 38)
2.3 IFRS 15 – Five steps to recognise and measure revenue

IFRS 15 sets out a series of actions for recognising and measuring revenue. These can be broken
down into five steps.
(1) Identify the A contract is only in scope when:

contract (a) Both parties are committed to carrying it out
(b) Each party’s rights to be transferred can be identified
(c) The payment terms can be identified
(d) The contract has commercial substance
(e) It is probable the entity will collect the consideration
A contract can be written, verbal or implied. (IFRS 15: para. 9)
(2) Identify A performance obligation is a promise to transfer a good or service to

performance a customer. Performance obligations should be accounted for
obligations separately provided the good or service is distinct. Where a promised
good or service is not distinct, it is combined with others until a
distinct bundle of goods or services is identified. (IFRS 15: para. 22)
(3) Determine The amount to which the entity expects to be ‘entitled’

transaction price Probability-weighted expected value or most likely amount used for
variable consideration
Discounting not required where less than one year (IFRS 15: para. 47)
(4) Allocate Multiple deliverables: transaction price allocated to each separate

transaction price performance obligation in proportion to the stand-alone selling price
to performance at contract inception of each performance obligation. (IFRS 15: para.
obligations 73)
(5) Recognise Ie when entity transfers control of a promised good or service to a

revenue when (or customer
as) performance An entity must be able to reasonably measure the outcome of a
obligation is performance obligation before the revenue can be recognised. (IFRS
satisfied 15: para. 31)
3 Identify the contract

A contract with a customer is within the scope of IFRS 15 only when:
(a) The parties have approved the contract and are committed to fulfilling the terms of the
contract
(b) Each party’s rights regarding the goods and services to be transferred can be identified.
(c) Clear identification of the payment terms for the goods and services
(d) The contract has commercial substance.
(e) It is probable that the entity will collect the consideration to which it will be entitled.
(f) The contract can be written, verbal or implied.
(IFRS 15: para. 9–10)
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4 Identify the performance obligations
4.1 Performance obligation
At the start of a contract, the goods or services promised to the customer should be assessed.
Each transfer of a distinct good/service is a performance obligation within the contract. There
may be more than one performance obligation within the same contract.
IFRS 15 states that a good or service that is promised to a customer is distinct if both of the
following criteria are met:
(a) The customer can benefit from the good or service either on its own or together with other
resources that are readily available to the customer (ie the good or service is capable of
being distinct); and
(b) The entity’s promise to transfer the good or service to the customer is separately identifiable
from other promises in the contract (ie the good or service is distinct within the context of the
contract). (IFRS 15: para. 27)
Activity 1: Identifying the separate performance obligation
Office Solutions Co, a limited company, has developed a communications software package
called CommSoft. Office Solutions Co has entered into a contract with Logisticity Co to supply
the following:
(1) Licence to use Commsoft
(2) Installation service; this may require an upgrade to the computer operating system, but the
software package does not need to be customised
(3) Technical support for three years
(4) Three years of updates for Commsoft
Office Solutions Co is not the only company able to install CommSoft, and the technical support
can also be provided by other companies. The software can function without the updates and
technical support.
Required
Explain whether the goods or services provided to Logisticity Co are distinct in accordance with
IFRS 15 Revenue from Contracts with Customers.
Solution
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5 Determine the transaction price
The transaction price is the amount of consideration a company expects to be entitled to from
the customer in exchange for transferring goods or services.
In determining the transaction price, consider the effects of:
• Variable consideration
• The existence of a significant financing component
• Non-cash consideration
• Consideration payable to a customer
5.1 Variable consideration

The transaction price should include variable consideration if it is highly probable that a
significant reverse of cumulative revenue will not occur (IFRS 15: para. 56). The variable
consideration should be included provided that it is highly probable that it will be received.
It should be estimated using one of the following methods. The choice of method will be
dependent on which best predicts the amount of consideration to be received:
• Probability weight expected value (eg reviewing past, similar contracts to assess the likelihood
of receiving the consideration); or
• Most likely amount (eg if there are only two possible outcomes).
5.2 The existence of a significant financing component

In determining the transaction price, an entity must adjust the promised consideration for the
effects of the time value of money if the timing of payments provides the customer or entity with a
significant benefit associated with financing the goods (IFRS 15: para. 60). The objective is to
recognise revenue at the amount the customer would have paid for the goods or services had the
customer paid cash at the date of transfer (IFRS 15: para. 61). The difference between the amount
recognised as revenue and the amount of consideration received is recorded as finance income
over the finance period. Discounting is most likely to be required when consideration is payable
one year or more from the date of the transaction. If the consideration is due from a customer
which is dependent on a significant financing component, then the credit risk should be taken into
account when assessing the consideration expected to be received from the customer.
The discount rate used may be stated in the contract, but it should reflect the credit risk of the
party financing the transaction and represent market terms.
This may result in different consideration amounts being recognised for different customers, even
if the contracts are similar. This is because the customers may be more of a credit risk than others.
Illustration 1: Significant financing component
Cod Co sold goods to Eel Co on 1 January 20X2 for $200,000, payable on 31 December 20X3. Eel
Co cannot return the goods.
The relevant discount rate is 6%.
Required
What amount of revenue and finance income should be recognised in Cod Co’s statement of
profit or loss for the year ended 31 December 20X2?
Solution
Revenue is measured based on the $200,000 payable by Eel Co on 31 December 20X3 as
discounted to its present value at 1 January 20X2.
Revenue = $200,000 × 0.890 (2 year 6% discount rate) = $178,000
Finance income in 20X2 = $178,000 × 6% = $10,680
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5.3 Non-cash consideration
This will be measured at fair value (where this cannot be easily determined, then it will be
compared to the selling price of the goods being sold by the entity).
5.4 Consideration payable to a customer

Examples of this type of consideration include discounts, rebates or refunds on goods or services
provided by the entity. Judgement may need to be applied by management to estimate the
transaction price if there is a degree of variability, such as the consideration being based on
timing or whether deadlines are met.
Activity 2: Determining the transaction price
Taplop Co supplies laptop computers to large businesses. On 1 July 20X5, Taplop Co entered into
a contract with TrillCo, under which TrillCo was to purchase laptops at $500 per unit. The
contract states that if TrillCo purchases more than 500 laptops in a year, the price per unit is
reduced retrospectively to $450 per unit. Taplop’s year end is 30 June.
(1) As at 30 September 20X5, TrillCo had bought 70 laptops from Taplop. Taplop Co therefore
estimated that TrillCo’s purchases would not exceed 500 in the year to 30 June 20X6, and
TrillCo would therefore not be entitled to the volume discount.
(2) During the quarter ended 31 December 20X5, TrillCo expanded rapidly as a result of a
substantial acquisition and purchased an additional 250 laptops from Taplop Co. Taplop Co
then estimated that TrillCo’s purchases would exceed the threshold for the volume discount in
the year to 30 June 20X6.
Required
Calculate the revenue Taplop Co would recognise in:
1 Quarter ended 30 September 20X5
2 Quarter ended 31 December 20X5
Solution
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6 Allocating transaction price to performance obligations
Where a contract contains more than one distinct performance obligation a company allocates
the transaction price to all separate performance obligations in proportion to the stand-alone
selling price of the good or service underlying each performance obligation.
Activity 3: Allocating the transaction price to the performance obligations
A mobile phone company, Deltawave Co, sells mobile phone handsets to customers including two
years’ network services for $980. The phones are sold separately for $600 and the network
services-only contract costs $20 per month.
Required
Calculate the amount of revenue to be recognised in each year of the contract.
Solution
7 Recognising revenue as performance obligations met

Revenue is only recognised when a performance obligation is satisfied.
• A performance obligation is satisfied when the entity transfers a promised good or service (ie
an asset) to a customer.
• An asset is considered transferred when (or as) the customer obtains control of that asset.
• Control of an asset refers to the ability to direct the use of, and obtain substantially all of the
remaining benefits from, the asset. (IFRS 15, paras. 31–33)
A performance obligation can be satisfied at a point in time eg goods being delivered to a
customer, or over a period of time eg construction of an asset for a customer.
7.1 Performance obligations satisfied over time

A performance obligation is satisfied over time if one of the following criteria is met:
• The customer simultaneously receives and consumes the benefits provided as they occur;
• The entity’s performance creates or enhances an asset that the customer controls as the asset
is created or enhanced; or
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• The entity’s performance does not create an asset with an alternative use to the entity and the
entity has an enforceable right to payment for the performance completed to date.
Many service contracts are satisfied over time, for example the provision of streaming services
over a two-year period. There are also examples of contracts for the construction of assets on
behalf of a customer, including, for example, the construction of a:
• Bridge
• Building
• Dam
• Ship
7.1.1 Measurement of revenue

For each performance obligation satisfied over time, revenue should be recognised by measuring
progress towards complete satisfaction of that performance obligation (IFRS 15: para. 39).
Appropriate methods of measuring progress include output methods and input methods.
Method to measure progress of performance obligations
Output methods Input methods

Proportion of the work completed based Proportion of work completed based
on assessing how much of the finished on the inputs (eg costs) incurred to date
product is completed • Resources consumed
• Surveys of performance completed to date • Labour hours expended
• Appraisals of results achieved • Costs incurred
• Time elapsed • Time elapsed
• Units produced or delivered • Machine hours used
7.1.2 Progress of satisfaction of performance obligation cannot be measured

If an entity cannot reasonably measure the outcome of a performance obligation (eg in the early
stages of a contract) but the entity expects to recover the costs incurred in satisfying the
performance obligation, it should recognise revenue only to the extent of costs incurred. This
applies until it can reasonably measure the outcome of the performance obligation (IFRS 15: para.
45).
8 Presentation in the statement of financial position

There are different ways that a contract with a customer may be presented in the statement of
financial position (IFRS 15: para. 105):
Statement of financial position Description

Receivable If an entity’s right to consideration is
unconditional (only the passage of time is
required before payment is due), it should be
recognised as a receivable (IFRS 15: para. 108).
Contract liability If a customer pays consideration or the entity

has a right to an amount of consideration that
is unconditional (ie a receivable) before the
entity transfers the goods or services to the
customer, the entity should present the contract
as a ‘contract liability’ when the payment is
made or falls due (whichever is earlier) (IFRS 15:
para. 106).
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Statement of financial position Description
Contract asset If the entity transfers goods or services before
the customer pays, it should present the
contract as a ‘contract asset’ if the entity’s right
to consideration is conditional on something
other than the passage of time (eg the entity’s
performance) (IFRS 15: para. 107).
Contract asset: A contract asset is recognised when revenue has been earned but not yet
KEY
TERM invoiced (revenue that has been invoiced is a receivable).
Contract asset (presented separately under current assets)

$
Revenue recognised (based on % certified to date) X
Less amounts invoiced to the customer to date (X)
Contract asset/(liability) X/(X)
Contract liability: A customer has paid prior to the entity transferring control of the good or
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TERM service to the customer.
This is calculated as above. However, if the answer is a net amount due to the customer, then this
is included as a contract liability. The amount of revenue the entity is entitled to corresponds to
the amount of performance complete to date.
Activity 4: Contract completed over time
James Co entered into a contract to build an office building for a customer commencing on 1
January 20X5, with an estimated completion date of 31 December 20X6. Control of the asset is
passed to the customer as construction takes place and James Co does not have an alternative
use for the asset. Satisfaction of performance obligations is measured by reference to work
completed to date. In the first year, to 31 December 20X5:
(1) Certificates of work completed have been issued, to the value of $750,000.
(2) The final contract price is $1,500,000.
(3) Amounts invoiced to the customer as at 31 December 20X5 is $625,000.
(4) No payments had been received in respect of the receivable at year end.
Required
What is the amount of revenue recognised in the financial statements of James Co at 31
December 20X5, and what entries would be made for the contract on the statement of financial
position at 31 December 20X5?
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Solution
Activity 5: Recognition in the financial statements
Build Co entered into a three-year contract to build a sports stadium. The customer takes control
of the stadium as construction takes place and Build Co has no alternative view for the stadium.
Details of the contract activity at 31 December 20X1, 20X2 and 20X3 are as follows:
20X1 20X2 20X3

$m $m $m
Total fixed contract price 380 380 380
Percentage of the contract completion as certified at year end 20% 65% 100%
Invoices issued to the customer (cumulative) 70 160 200
Cash received from the customer to date (cumulative) 62 124 170
Company policy is to calculate satisfaction of performance obligations based on certified work.

Required
1 What should be the revenue recognised in the statement of profit or loss of Build Co for the
years ended 31 December 20X1, 20X2 and 20X3?
 20X1: $62m, 20X2: $62m, 20X3: $46m
 20X1: $70m, 20X2: $90m, 20X3: $110m
 20X1: $76m, 20X2: $171m, 20X3: $133m
 20X1: $62m, 20X2: $247m, 20X3: $380m
2 What are the balances to be presented in the statement of financial position for the year
ended 31 December 20X3?
 Trade receivable $30m; Contract asset $93m
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9 Common types of transactions
IFRS 15 has specific guidance on different transactions, here we look at some of the most
common.
• Principal versus agent
• Repurchase arrangements
• Sales with a right of return
• Consignment arrangements
• Bill and hold arrangements
• Warranties
9.1 Principal versus agent

When another party is involved in providing goods or services to a customer, the entity shall
determine whether the nature of its promise is a performance obligation to provide the specified
goods/services itself, or to arrange for those goods or services to be provided to the customer
(IFRS 15: para. B34).
Principal v agent
Entity arranges for goods or services

Entity controls the goods or services
to be provided by the other party
Principal Agent
Revenue = gross revenue Revenue = fee or commission
Indicators that an entity controls the goods or services before transfer and therefore is classified
as a principal include (IFRS 15: para. B37):
(a) The entity is primarily responsible for fulfilling the promise to provide the specified good or
service;
(b) The entity has inventory risk; and
(c) The entity has discretion in establishing the price for the specified good or service.
Activity 6: Principal versus agent
TicketsRUS Co, a ticket agency, sells tickets to a theatre show for $100. TicketsRUS Co is entitled
to a commission of 5% of the ticket price and passes the remainder to the theatre. The tickets are
non-refundable and there is no sales tax.
Required
Calculate the revenue to be recognised for the current financial period.
Solution
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9.2 Repurchase agreement
Under a repurchase agreement an entity sells an asset and promises, or has the option, to
repurchase it. Repurchase agreements generally come in three forms.
(a) An entity has an obligation to repurchase the asset (a forward contract).
(b) An entity has the right to repurchase the asset (a call option).
(c) An entity must repurchase the asset if requested to do so by the customer (a put option).
In the case of a forward or a call option the customer does not obtain control of the asset, even if
the customer has physical possession. The entity will account for the contract as:
• A lease in accordance with IFRS 16, if the repurchase price is below the original selling price; or
• A financing arrangement if the repurchase price is equal to or greater than the original selling
price. In this case the entity will recognise both the asset and a corresponding liability
If the entity is obliged to repurchase at the request of the customer (a put option), it must consider
whether or not the customer is likely to exercise that option.
If the repurchase price is lower than the original selling price and it is considered that the
customer does not therefore have significant economic incentive to exercise the option, the
contract should be accounted for as an outright sale, with a right of return. If the customer is
considered to have a significant economic incentive to exercise the option, the entity should
account for the agreement as a lease in accordance with IFRS 16.
If the repurchase price is greater than or equal to the original selling price and is above the
expected market value of the option, the contract is treated as a financing arrangement.
Illustration 2: Contract with a call option (based on IFRS 15: Illustrative

Examples, Example 62, Case A-Call option: financing, paras. IE316–IE318)
Austria Co enters into a contract with a customer (Belgium Co) for the sale of a tangible asset on 1
January 20X7 for $1 million. The contract includes a call option that gives Austria Co the right to
repurchase the asset for $1.1 million on or before 31 December 20X7.
Required
Explain how A should account for the right to repurchase the asset.
Solution
The existence of the call option means that Belgium Co does not obtain control of the asset, as
Belgium Co is limited in its ability to use and obtain benefit from the asset.
As control has not been transferred, Austria Co accounts for the transaction as a financing
arrangement, because the exercise price is above the original selling price. Austria Co continues
to recognise the asset and recognises the cash received as a financial liability. The difference of
$0.1 million is recognised as interest expense.
If on 31 December 20X7 the option lapses unexercised, Belgium Co now obtains control of the
asset. Austria Co will derecognise the asset and recognise revenue of $1.1 million (the $1 million
already received plus the $0.1 million charged to interest).
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Illustration 3: Contract with a put option (based on IFRS 15: Illustrative
Examples, Example 62 Case B-Put option: lease, paras. IE319–IE321)
Aberdeen Co enters into a contract with a customer (Brighton Co) for the sale of a tangible asset
on 1 January 20X7 for $1 million. The contract includes a put option that obliges Aberdeen Co to
repurchase the asset at Brighton Co’s request for $900,000 on or before 31 December 20X7, at
which time the market value is expected to be $750,000.
Required
Explain how Aberdeen Co should account for the obligation to repurchase the asset.
Solution
In this case Brighton Co has a significant economic incentive to exercise the put option because
the repurchase price exceeds the market value at the repurchase date. This means that control
does not pass to Brighton Co. Since Brighton Co will be exercising the put option, this limits its
ability to use or obtain benefit from the asset.
In this situation Aberdeen Co accounts for the transaction as a lease in accordance with IFRS 16.
The asset has been leased to the customer for the period up to the repurchase and the difference
of $100,000 will be accounted for as payments received under an operating lease.
9.3 Sales with a right of return

In some contracts, a company sells goods to customers and transfers control of that product to
the customer and also grants the customer the right to return the product. The right to return may
be in respect of, for example, dissatisfaction with the products or expected levels of sales being
below expectations. When goods are sold with a right of return, IFRS 15 requires an entity to
recognise all of the following:
(a) Revenue for the transferred products in the amount of consideration to which the entity
expects to be entitled (ie revenue is not recognised for products expected to be returned);
(b) A refund liability (in respect of the products that are expected to be returned); and
(c) An asset (and corresponding adjustment to cost of sales) for the right to recover products
from customers on settling the refund liability.
(IFRS 15: para. B21)
Illustration 4: Sale with a right of return
Quirky Co is an online clothing retailer. Customers are entitled to return items within 28 days of
purchase for a full refund if they do not fit or are otherwise not suitable. In the last week of
December 20X8, Quirky Co sold 200 dresses for $400 each. The dresses cost $250 each. Quirky
Co has an expected average level of returns of 25%. None of the dresses sold in the final week of
December 20X8 have been returned by the end of the month.
Required
What are the accounting entries required to record the sale of the dresses in Quirky Co’s financial
statements for the year ended 31 December 20X8?
Solution
Quirky receives cash of $80,000 (200 dresses × $400).
Quirky should recognise revenue only in respect of the 75% of dresses not expected to be
returned: 200 dresses × 75% × $400 = $60,000.
Quirky should recognise a refund liability for the 25% of dresses expected to be returned: 200
dresses× 25% × $400 = $20,000.
The journal entry to record the sale with the right of return is:
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$ $
DR Cash 80,000
CR Revenue 60,000
CR Refund liability 20,000
The 200 dresses sold had a purchase cost of $50,000 (200 dresses × $250). This amount will be
included in purchases, within cost of sales. As none of these 200 dresses are held at the year end,
none of them will be included in closing inventory. Therefore, the total amount in cost of sales
relating to the dresses is an expense of $50,000.
However, no revenue has been recognised in relation to 25% of the dresses. Therefore, the
purchase expense in relation to the dresses that are expected to be returned that is included
within cost of sales needs to be reversed and an asset should be recognised for the right to
recover the dresses: 200 dresses × 25% × $250 = $12,500.
$ $
DR Asset for right to recover dresses 12,500
CR Cost of sales 12,500
This leaves a correct expense within cost of sales for the 75% of the dresses which are not
expected to be returned: 200 dresses × 75% × $250 = $37,500 which matches against the revenue
to be recognised. This can also be calculated as total purchases of $50,000 less cost of dresses
expected to be returned of $12,500.
9.4 Consignment arrangements

In a consignment arrangement, an entity delivers a product to a third party, such as a dealer or
distributor, for sale to end customers. The entity must evaluate whether the third party takes
control of the product at the point of delivery. If the third party does not take control of the
product transferred, the product is held under a consignment arrangement and therefore:
• Revenue should not be recognised;
• No cost of sales is recognised;
• The inventory remains in the books of the entity.
Activity 7: Consignment arrangements
A wholesaler sells goods to a retailer for $42,000 on credit on 31 December 20X1. The goods were
transferred to the retailer on that date and the wholesaler recognised revenue and derecognised
inventory immediately. The wholesaler sells to the retailer at a mark-up of 20% on cost.
The wholesaler retains control over the goods until they are sold to the final customer. The retailer
does not need to pay the wholesaler for the goods until they are sold to the final customer and
can return any unsold goods for a refund. No goods were sold to the final customer on 31
December 20X1.
Required
What are the adjustments needed to correct the wholesaler’s financial statements for the year
ended 31 December 20X1?
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Solution
9.5 Bill and hold arrangements

Goods are sold but remain in the possession of the seller for a specified period of time. An entity
will need to determine at what point the customer obtains control of the product.
For a customer to have obtained control of a product in a bill and hold arrangement the following
criteria must be met:
(a) The reason for the bill and hold must be substantive.
(b) The product must be separately identified as belonging to the customer.
(c) The product must be ready for physical transfer to the customer.
(d) The entity cannot have the ability to use the product or transfer it to another customer.
9.6 Warranties
Products are often sold with a warranty. IFRS 15 identifies three types of warranty and explains
the required accounting treatment for each:
Standard warranty at no cost to the

Account for warranty in accordance with
customer that typically provides assurance
IAS 37 Provisions, Contingent Liabilities and
that a product will function as intended per
Contingent Assets (see Chapter 5).
agreed-upon specifications
Additional warranty available to the

customer at a cost Account for warranty as an additional
performance obligation in the sales
contract under IFRS 15 Revenue from
Contracts with Customers by allocating it a
Additional warranty at no cost to the portion of the transaction price.
customer that provides an additional
service beyond assurance that the
product will function as intended per
agreed-upon specifications
In assessing whether the warranty is an additional warranty that provides an additional service
beyond the assurance that the product will function as intended, the entity should consider
factors such as:
(a) Whether the warranty is required by law (if so, it is likely to be a standard warranty);
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(b) The length of the warranty coverage period (the longer the cover, the more likely that it is an
additional warranty); and
(c) The nature of the tasks that the entity promises to perform (whether they relate to providing
assurance that the product will function as intended).
Illustration 5: Warranties
Lavender Co sells a machine to a customer on credit for $392,000. The sales contract includes a
standard warranty that provides assurance that the machine complies with agreed-upon
specifications and will operate as promised for one year from the date of purchase. The sales
contract also includes an additional warranty that provides the customer with the right to an
annual service of the machine for four years from the date of purchase. An annual service is
usually charged at $2,000 per annum. However, as this customer represents new business, the
servicing is offered at no additional cost to the customer. Therefore, the provision of servicing is
not reflected in the $392,000 transaction price, which is the normal standalone selling price of the
machine.
Required
Explain how the two warranties and the sale of the machine should be accounted for (ignore the
effect of any discounting).
Solution
Standard warranty
The warranty that provides assurance that the machine complies with agreed-upon specifications
and will operate as promised one year from the date of purchase is a standard warranty at no
cost to the customer.
Therefore, it should be accounted for in accordance with IAS 37 Provisions, Contingent Liabilities
and Contingent Assets. This will be explained in further detail in Chapter 14.
Additional warranty
The additional warranty is provided at no cost to the customer and provides an additional service
(four years of servicing) beyond assurance that the machine will function as intended per the
agreed-upon specifications.
This additional warranty should be treated as a separate performance obligation and revenue will
not be recognised until the performance obligation is satisfied, which will be when the annual
services are performed.
Sale of the machine
The transaction price of $392,000 should be allocated to the two performance obligations in
accordance with their standalone selling prices:
Performance Standalone selling Transaction price

obligation price % Total allocated
$ $
Machine 392,000 98 384,160
Servicing (4 × $2,000) 8,000 2 7,840
Total 400,000 100 392,000
Revenue of $384,160 from the sale of the machine will be recognised when control of the machine
is transferred to the customer which is likely to be on delivery. Revenue from the servicing will be
recognised when each annual service is performed.
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10 IAS 20 Accounting for Government Grants
10.1 Recognition
Grants are not recognised until there is reasonable assurance that the conditions will be complied
with and the grants will be received.
Government grants: Assistance by government in the form of transfers of resources to an

KEY
TERM entity in return for past or future compliance with certain conditions relating to the operating
activities of the entity. They exclude those forms of government assistance which cannot
reasonably have a value placed upon them and transactions with government which cannot
be distinguished from the normal trading transactions of the entity.
Forgivable loans: Loans for which the lender undertakes to waive repayment under certain
prescribed conditions (IAS 20: para. 3).

Grants relating to income
Grants relating to income are shown in profit or loss either separately or as part of ‘other income’
or alternatively deducted from the related expense.
Activity 8: Grants relating to income
Pootle Co received a government grant of $60,000 on 1 September 20X4. The conditions of the
grant state that Pootle Co must employ a local worker on a full-time contract over a five-year
period. The local worker commenced employment on 1 September 20X4 and Pootle Co expects to
meet the conditions of the grant.
The full grant has been recorded as other income for the year ended 31 December 20X4.
Required
What is the adjustment required to correctly account for the grant at 31 December 20X4?
Solution
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Grants related to assets: Government grants whose primary condition is that an entity quali-
KEY
TERM fying for them should purchase, construct or otherwise acquire non-current assets. Subsidiary
conditions may also be attached restricting the type or location of the assets or the periods
during which they are to be acquired or held (IFRS 15: para. 3).
Government grants relating to assets are presented in the statement of financial position either:
(a) As deferred income (Dr Cash, Cr Deferred income), this is then released to the profit or loss
account over the useful life of the asset (effectively over the same period as the asset is being
depreciated); or
(b) By deducting the grant in calculating the carrying amount of the asset.
Grant conditions
In the case of grants for non-depreciable assets, certain obligations may need to be fulfilled, in
which case the grant should be recognised as income over the periods in which the cost of
meeting the obligation is incurred. For example, if a piece of land is granted on condition that a
building is erected on it, then the grant should be recognised as income over the useful life of the
building.
There may be a series of conditions attached to a grant, in the nature of a package of financial
aid. An entity must take care to identify precisely those conditions which give rise to costs that in
turn determine the periods over which the grant will be earned. When appropriate, the grant may
be split and the parts allocated on different bases.
10.3 Repayment of grants

A government grant that becomes repayable is accounted for as a change in accounting estimate
in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.
Repayment of grants relating to income are applied first against any unamortised deferred credit
and then in profit or loss.
Repayments of grants relating to assets are recorded by increasing the carrying amount of the
asset or reducing the deferred income balance. Any resultant cumulative extra depreciation is
recognised in profit or loss immediately.
Activity 9: Recognition of the grant
Maddoc purchased a new item of plant for $800,000 on 1 January 20X2, and expected to use it
for five years with a zero residual value. The Government awarded Maddoc a grant of $300,000
towards the cost of the plant on the same date.
Maddoc treated the grant as deferred income and has a 30 June year end.
Required
How much is recognised in non-current liabilities in respect of the grant as at 30 June 20X2?
 $60,000
 $30,000
 $210,000
 $270,000
Essential reading
There are a number of additional activities to apply your knowledge obtained in this chapter,
which are in addition to the Further question practice bank (available in the digital edition of the
Workbook) and the Practice and Revision Kit. Please see Chapter 6 of the Essential reading.
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Chapter summary
Revenue and government grants
Revenue IFRS 15 Revenue from

recognition Contracts with Customers
Revenue is income arising in the course of an entity’s Revenue is recognised when there is transfer of
ordinary activities (IFRS 15: Appendix A) control to the customer from the entity supplying the
goods or services
IFRS 15 five steps to Common types of transaction

recognition of revenue
1. Identify contract Principal versus agent Sales with a right of return

• Contract: An agreement between Indicators that an entity controls • Goods not expected to be
two or more parties that creates the goods or returned
enforceable rights and obligations. services before transfer and – Recognise revenue and cost
• Contract costs are the incremental therefore is a principal include: of sales as normal
costs of obtaining a contract (such (a) The entity is primarily • Goods expected to be returned
as sale commission) are responsible for fulfilling the – Do not recognise revenue or
recognised as an asset if the entity promise to provide the cost of sales on goods
expects to recover those costs specified good or service; expected to be returned
(b) The entity has inventory risk; – Recognise a refund liability
and and an asset for the right to
2. Identify performance obligations
(c) The entity has discretion in recover goods
• Performance obligations should be establishing the price for the
accounted for separately provided specified good or service.
the good or service is distinct. Consignment arrangements
• Where a promised good or service • The customer does not obtain
is not distinct, it is combined with Repurchase agreement control of the product at the
others until a distinct bundle of 1. Obligation to repurchase delivery date
goods or services is identified (forward) ↓
2. Right to repurchase (call) • The inventory remains in the
3. Repurchase at request of books of the entity and revenue
3. Determine transaction price is not recognised until control
customer (put)
The amount to which the entity – Do not recognise revenue for passes
expects to be 'entitled' forward or call.
– Assess likelihood that
customer will exercise Bill and hold arrangements
4. Allocate transaction price to An entity will need to determine at
option
performance obligations what point the customer obtains
Based on standalone selling prices control of the product
5. Recognise revenue when (or as) Warranties

performance obligation is satisfied • IFRS 15: If separate
When entity transfers control of a performance obligation
promised good or service to a • IAS 37: If legal and constructive
customer obligation
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Performance IAS 20 Accounting for
obligations Government Grants and Disclosure
of Government Assistance
• A contract includes a promise to transfer Grants are not recognised until there is
goods or services to a customer reasonable assurance that the conditions will
• This is the performance obligation within the be complied with and the grants will be received
contract
• An entity must be able to reasonably measure
the outcome of a performance obligation Grants relating to income
before the revenue can be recognised Grants relating to income are shown in profit or
loss either separately or as part of 'other
income' or alternatively deducted from the
Performance obligations satisfied over time related expense
• An entity may transfer a good or service over
time with the revenue being recognised over
time Grants relating to assets
• A performance obligation is satisfied when Government grants relating to assets are
the entity transfers a promised good or presented in the statement of financial position
service (ie an asset) to a customer either:
↓ • As deferred income; or
• An asset is considered transferred when (or • By deducting the grant in calculating the
as) the customer obtains control of that asset carrying amount of the asset
↓ • Any deferred credit is amortised to profit or
• Control of an asset refers to the ability to loss over the asset's useful life
direct the use of, and obtain substantially all
of the remaining benefits from, the asset
Repayment of grants
• A government grant that becomes repayable
Methods of measuring performance is accounted for as a change in accounting
• Output methods estimate in accordance with IAS 8 Accounting
– Units produced Policies, Changes in Accounting Estimates
– Survey of completion to date and Errors
• Input methods • Repayment of grants relating to income are
– Resources consumed applied first against any unamortised
– Costs incurred deferred credit and then in profit or loss
• A contract asset is recognised when revenue • Repayments of grants relating to assets are
has been earned but not yet invoiced (revenue recorded by increasing the carrying amount
that has been invoiced is a receivable) of the asset or reducing the deferred income
• A contract liability is recognised when a balance
customer has paid prior to the entity • Any resultant cumulative extra depreciation is
transferring control of the good or service to recognised in profit or loss immediately
the customer
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1. Revenue recognition
• Revenue is recognised when there is a transfer of control to the customer from the entity
supplying the goods or services.
• Five step model for recognition:
Step 1 Identify the contract with the customer
Step 2 Identify the separate performance obligations
Step 3 Determine the transaction price
Step 4 Allocate the transaction price to the performance obligations
Step 5 Recognise revenue when a performance obligation is satisfied
• Where the outcome cannot be estimated reliably, revenue is only recognised to the extent of
expenses recognised that are recoverable, ie no profit is recognised until the outcome can be
estimated reliably.
• Where performance obligations are satisfied over time, for example with a construction
contract, revenue and costs are recognised by reference to the stage of completion of the
construction contract where its outcome can be estimated reliably. However, any expected
losses are recognised immediately on the grounds of prudence.
• Where the outcome cannot be estimated reliably, revenue is recognised only to the extent of
contract costs incurred that are recoverable, consistent with the treatment of service revenue.
2. Government grants
• An entity should not recognise grant income unless:
(i) The conditions attached to the grant will be complied with; and
(ii) The entity will receive the money
• Grants relating to income are shown in profit or loss either separately or as part of ‘other
income’ or alternatively deducted from the related expense
• Government grants relating to assets are presented in the statement of financial position
either:
(i) As deferred income; or
(ii) By deducting the grant in calculating the carrying amount of the asset.
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Question practice
the Workbook):
Section C Q42 Jenson Co
Section C Q43 Trontacc Co
Further reading
There are articles on the ACCA website, written by the Financial Reporting examining team, which
are relevant to the topics studied in this chapter and which you should read:
Revenue revisited
IFRS 15 – Contract Assets and Contract Liabilities
www.accaglobal.com
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Activity answers
Activity 1: Identifying the separate performance obligation

CommSoft Co was delivered before the other goods or services and remains functional without
the updates and the technical support. It may be concluded that Logisticity Co can benefit from
each of the goods and services either on their own or together with the other goods and services
that are readily available.
The promises to transfer each good and service to the customer are separately identifiable. In
particular, the installation service does not significantly modify the software itself and, as such,
the software and the installation service are separate outputs promised by Office Solutions Co
rather than inputs used to produce a combined output.
In conclusion, the goods and services are distinct and amount to four performance obligations in
the contract under IFRS 15.
Activity 2: Determining the transaction price

1 Applying the requirements of IFRS 15 to TrillCo’s purchasing pattern at 30 September 20X5,
Taplop should conclude that it was highly probable that a significant reversal in the
cumulative amount of revenue recognised ($500 per laptop) would not occur when the
uncertainty was resolved, that is when the total amount of purchases was known.
Consequently, Taplop Co should recognise revenue of 70 × $500 = $35,000 for the first
quarter ended 30 September 20X5.
2 In the quarter ended 31 December 20X5, TrillCo’s purchasing pattern changed such that it
would be reasonable for Taplop Co to conclude that TrillCo’s purchases would exceed the
threshold for the volume discount in the year to 30 June 20X6, and therefore that it was
appropriate to retrospectively reduce the price to $450 per laptop.
Taplop Co should therefore recognise revenue of $109,000 for the quarter ended 31 December
20X5. The amount is calculated from $112,500 (250 laptops × $450) less the change in
transaction price of $3,500 (70 laptops × $50 price reduction) for the reduction of the price of
the laptops sold in the quarter ended 30 September 20X5.
Activity 3: Allocating the transaction price to the performance obligations

Under IFRS 15, revenue must be allocated to the handset because delivery of the handset
constitutes a performance obligation. This will be calculated as follows:
Standalone price
$ %
Handset 600 56
Contract – two years (20 × 24 months) 480 44
Total value 1,080 100
As the total receipts are $980, this is the amount that must be allocated to the separate
performance obligations. Revenue will be recognised as follows (rounded to nearest $).
$
Year 1
Handset (900 × 56%) 544
Contract (980 – 544) × 12/24 month 218
762
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$
Year 2
Contract (as above) 218
Activity 4: Contract completed over time

This is a contract in which the performance obligation is satisfied over time, as the control of the
office building is transferred to the customer throughout the contract period and James Co has
no alternative use for the asset.
Satisfaction of performance obligations is satisfied by reference to certificates of work complete.
In this case the contract is certified as 50% (750,000/1,500,000 = 50%) complete, measuring
progress under the output method.
The (unconditional) receivable is shown separately as a trade receivable, and the (conditional, as
not yet invoiced to the customer) balance of the revenue recognised at year end is recorded as a
contract asset.
$ $
DEBIT Trade receivable 625,000
DEBIT Contract asset (750,000 – 625,000) 125,000
CREDIT Revenue 750,000
Activity 5: Recognition in the financial statements

1
1 The correct answer is: 20X1: $76m, 20X2: $171m, 20X3: $133m
Working
Statement of profit or loss (extract)
20X1 20X2 20X3

Revenue $m $m $m
20X1: $380m × 20% 76
20X2: $380m × (65% – 20%) 171
20X3: $380m × (100% – 65%) 133
2
2 The correct answer is: Trade receivable $30m; Contract asset $180m
Workings
1 Trade receivables
20X3
$m
Amounts billed to the customer 200
Cash received from the customer (170)
Trade receivable 30
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2 Contract asset
20X3
$m
Revenue recognised (cumulative) 380
Less: amounts billed to the customer (200)
Contract asset 180
Activity 6: Principal versus agent

TicketsRUS Co is an agent. It can therefore only recognise the commission of $100 × 5% = $5 as
revenue rather than recognising $100 as revenue and $95 as costs, since the ticket price is
collected as agent on behalf of the theatre.
The remaining $95 received is reported as a liability to the theatre.
Activity 7: Consignment arrangements

Revenue cannot be recognised in the wholesaler’s financial statements as at 31 December 20X1 as
control has not transferred to the buyer (the retailer).
The sales transaction must be reversed in the wholesaler’s financial statements and the closing
inventory balance adjusted:
$ $
DR Revenue 42,000
CR Trade receivables 42,000
and
DR Inventories (42,000 × 100%/120%) 35,000
CR Cost of sales 35,000
Activity 8: Grants relating to income

The grant is intended to cover the cost of employment over the five-year employment contract
period and must therefore be recognised in income over that period. In the four-month period
from 1 September 20X4 to 31 December 20X4, Pootle Co may recognise $4,000 ($60,000 × 4/60
months) of income relating to the grant. The remaining balance of $56,000 ($60,000 – 4,000)
should be recognised as deferred income.
The journal entry to record the adjustment is:
$ $
DR Other income 56,000
CRDeferred income 56,000
(adapted from ACCA March/June 2021 Examiner’s report)
Activity 9: Recognition of the grant

The correct answer is: $210,000
The grant is treated as deferred income:
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$
1 January 20X2 Cash received 300,000
Credited to profit or loss
20X1–20X2 year (300,000/5 × 6/12) (30,000)
30 June 20X2 c/d 270,000
The $27,000 deferred income at 30 June 20X2 must be split into current and non-current
elements.
$
Credited to profit or loss
(300,000/5) = current
20X2–20X3 year amount (60,000)
c/d = non-current amount at

30 June 20X3 30 June 20X2 210,000
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Skills checkpoint 2
Approach to Case OT
questions
Chapter overview
cess skills
Exam suc
Answer planning
c FR skills C
n Specifi o
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rr req
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of
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t i rem
or
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inf
erp ents
ng
reta
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Man
tion
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Go od
skills skills
ana
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Approach
em
to Case
e ri
OTQs
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Effi
Effective writing
and presentation
Introduction
Section B of the FR exam consists of three OT case questions.
Each case contains a group of five OT questions focused on a single scenario (which may
describe two connected themes, such as government grants and revenue recognition). These can
be any combination of the single OT question types and they are auto-marked in the same way
as the single OT questions.
OT cases are worth 10 marks (each of the five OTs within it are worth two marks), and as with the
single OT questions in Section A, candidates will score either two marks or zero marks for those
individual questions). Your skills from practising the Section A questions will be relevant in this
section.
OT cases are written so that there are no dependencies between the individual questions. So, if
you did get the first question in the case wrong, this does not affect your ability to get the other
four correct. The OT case scenario remains on screen so you can see it while answering the
questions.
Each OT case normally consists of a range of numerical (calculation-based) questions and
narrative questions. It is often quicker to tackle the narrative questions first leaving some
additional time to tackle calculations.
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As we saw in Skills Checkpoint 1, the following types of OT question commonly appear in the
Financial Reporting exam:
Question type Explanation

Multiple choice (MCQ) You need to choose one correct answer from four given response
options.
Multiple response (MRQ) You need to select more than one answer from a number of given
options. The question will specify how many answers need to be
selected, but the system won’t stop you from selecting more
answers than this. It is important to read the requirement
carefully.
Fill in the blank (FIB) This question type requires you to type a numerical answer into a
box. The unit of measurement (eg $) will sit outside the box, and if
there are specific rounding requirements these will be displayed.
Enhanced matching Enhanced matching (sometimes referred to as ‘drag and drop’)

questions involve you dragging an answer and dropping it into
place. Some questions could involve matching more than one
answer to a response area and some questions may have more
answer choices than response areas, which means not all
available answer choices need to be used.
Pull down list This question type requires you to select one answer from a pull
down list. Some of these questions may contain more than one
pull down list and an answer has to be selected from each one.
Hot spot For hot spot questions, you are required to select one point on an
image as your answer. When the cursor is hovered over the
image, it will display as an ‘X’. To answer, place the X on the
appropriate point on the diagram.
Hot area These are like hot spot questions, but instead of selecting a
specific point you are required to select one or more areas in an
image.
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Approach to OT case questions
A step-by-step technique for approaching OT case questions is outlined below. Each step will be
explained in more detail in the following sections as the OT case question ‘Dearing Co’ is
answered in stages.
STEP 1: Read the scenario carefully

Read the introduction to the question carefully, ensuring you understand what the
questions are asking you to do. Skimming the questions requirement will help you
to identify whether the questions are narrative or numerical in style.
STEP 2: Start with narrative questions

Attempt the narrative questions first as this will allow you to use any remaining
time to focus on the numerical and calculation questions. The case is usually split
into three narrative questions with two further, calculation based questions.
STEP 3: Work through numerical questions methodically

Apply your technical knowledge to the data presented in the question.
through each response option and eliminate those you know are incorrect.
STEP 4: Be aware of time

Stick to your time carefully, as each question is worth two marks, so spending more
than the allocated time of 18 minutes on each case question is an inefficient use of
your time, as you will need to move onto the Section C questions. If you are
running out of time, or you cannot answer any of the questions, guess the answer
from the options provided. You do not lose marks for incorrect answers.
Exam success skills

The following question is a Section B OT case question from a past exam worth 10 marks.
As we work through this question, we will also focus on the following exam success skills:
• Managing information. It is easy for the amount of information contained in an OT case
questions in Section B to feel a little overwhelming. Active reading is a useful technique to help
avoid this. This involves focusing on the requirements, on the basis that until you have done
this the detail in the question will have little meaning and will seem more intimidating as a
result.
Focus on the requirements, highlighting key verbs to ensure you understand the requirement
properly and correctly identify what type of OT question you are dealing with. Then read the
rest of the scenario, highlighting and using the scratch pad to note any important and relevant
information, and making notes of any relevant technical information you think you will need.
• Correct interpretation of requirements. Identify from the requirement the different types of OT
question. This is especially important with multiple response questions to ensure you select the
correct number of response options.
• Efficient numerical analysis. The key to success here is using the information from the
question and ensuring that you check the detail, such as which period the question is asking
you to conclude upon. Working through the numerical data in a logical manner will ensure
that you stay focused.
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Skills Checkpoint 2: Approach to Case OT questions 141

• Good time management. Complete all OT questions in the time available. Each OT case is
worth 10 marks and should be allocated 18 minutes.
Skill activity
The following scenario relates to questions 1 to 5.
On 1 October 20X5 Dearing Co acquired a machine under the following terms.
$
Cost 1,050,000
Trade discount (applying to cost only) 20%
Freight charges 30,000
Electrical installation cost 28,000
Staff training in use of machine 40,000
Pre-production testing 22,000
Purchase of a three-year maintenance contract 60,000
On 1 October 20X7 Dearing Co decided to upgrade the machine by adding new components at a
cost of $200,000. This upgrade led to a reduction in the production time per unit of the goods
being manufactured using the machine.
1. What amount should be recognised under non-current assets as the initial cost of the
machine? (enter your answer to the nearest $000)
$_____,000
Note. This is FIB question which requires the calculation of the total cost of the machine to be
capitalised under IAS 16 is required.
2. How should the $200,000 worth of new components be accounted for?

Note. This is an MCQ requiring you to select one valid statement.
• Added to the carrying amount of the machine
• Charged to profit or loss
• Capitalised as a separate asset
• Debited to accumulated depreciation
3. Every five years the machine will need a major overhaul in order to keep running. How should
this be accounted for?
Note. This is an MCQ requiring you to select one valid statement.
• Set up a provision at year 1
• Build up the provision over years 1–5 capitalising the cost in year 1 and releasing it over five
years.
• Capitalise the cost when it arises in year 5 and amortising over five years
• Write the overhaul off to maintenance costs in the year they are incurred
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4. By 27 September 20X7 internal evidence had emerged suggesting that Dearing Co’s
machine was impaired. Select whether the following are internal indicators or external
indicators of impairment.
Note. This is a hot area question, requiring you to select the correct responses by clicking on the
box (the software in the exam will shade the box). You need to select whether the statement
represents an internal or an external indicator of impairment.
The performance of the machine had declined Internal indicator External indicator
leading to reduced economic benefits.
There were legal and regulatory changes Internal indicator External indicator
affecting the operating of the machine.
There was an unexpected fall in the market Internal indicator External indicator
value of the machine.
New technological innovations were producing Internal indicator External indicator

more efficient machines.
5. On 30 September 20X7 the impairment review was carried out. The following amounts were
established in respect of the machine:
$
Value in use 760,000
Fair value 840,000
Costs of disposal 30,000
Use the pull down list below to identify the carrying amount of the machine following the
impairment review.
Note. This is a pull down list question, which is similar to an MCQ. Ensure you correctly scroll to
your intended answer in the exam.
Pull down list
$850,000
$760,000
$840,000
$810,000
STEP 1 Read the introduction to the question carefully, ensuring you understand what the questions are asking you
to do. Skimming the questions requirement will help you to identify whether the questions are narrative or
numerical in style.
Question 1 is a FIB question, you need to follow the instructions carefully and ensure you enter
your answer to the nearest $000 as required. Questions 2 and 3 are narrative questions which ask
you to identify which statements are correct. Read through each statement carefully knowing
that you are looking to identify the statement that is correct. Question 4 is a hot area question,
which ask you to select the correct indicator for each statement. Question 5 is a pull down list
question, the approach for which is very similar to an MCQ.
STEP 2 Attempt the narrative questions first as this will allow you to use any remaining time to focus on the
numerical questions. The case will always have some narrative questions.
Questions 2, 3, and 4 are discursive style ‘narrative’ questions that do not require any
calculations. It would make sense to answer these three questions first as it is likely that you will be
able to complete them comfortably within the 10.8 minutes allocated to them. Any time saved
could then be spent on the more complex calculations required to answer Questions 1 and 5.
STEP 3 Apply your technical knowledge to the data presented in the question.
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Work through calculations taking your time and read through each answer option with care. OT questions
are designed so that each answer option is plausible. Work through each response option and eliminate
those you know are incorrect.
To answer Questions 1 and 5 you need to analyse the data given in the question.
Let’s look at Question 1 in detail. The question asks you to calculate the cost of Dearing Co’s asset
based on the information provided. You need to use your knowledge of IAS 16 Property, Plant and
Equipment, to identify which of the costs stated may be capitalised.
IAS 16 specifies the costs which must be included in the capitalised plant:
• Purchase price
• Import duties
• Directly attributable costs (including site

preparation, professional fees and testing costs.
• Any estimates of costs to be incurred for dismantling

the machine at the end of its life.
In summary, these are defined by IAS 16 as those costs which bring ‘the asset to the location and
working conditions necessary for it to be capable of operating in the manner intended by
management’ (IAS 16: para. 16). Even if you cannot remember the list above, then bear the
guidance in mind as to whether the asset would be able to operate without the cost being
incurred.
$ Note
Cost 1,050,000
Trade discount (applying to cost only) 20% 1
Freight charges 30,000 2
Electrical installation cost 28,000 3
Staff training in use of machine 40,000 4
Pre-production testing 22,000 5
Purchase of a three-year maintenance contract 60,000 6
Notes.
1 You will need to calculate the discount value.
2 Freight charges (allowable as part of the initial delivery costs, and capitalised under IAS 16)
3 Electrical costs (allowable as part of the initial delivery costs, and capitalised under IAS 16).
4 These costs should be expensed as the company does not have control over the benefits generated.
5 Testing is specifically allowed, as without it, the asset would not be able to function. Therefore,
allowable capitalised cost.
6 Not allowable, as the asset would be able to function without the maintenance contract (it would be
classed as repairs and maintenance cost, therefore expensed).
Therefore, the cost calculation should look like this:
$
Cost 1,050,000
Trade discount (1,050,000 × 20%) (210,000)
840,000
Freight charges 30,000
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$
Electrical installation cost 28,000
Pre-production testing 22,000
920,000
The correct answer is therefore $920,000, which you should enter in the fill in the blank box as
920 as you are asked to provide your answer to the nearest $000.
Question 5 is the other numerical question, requiring knowledge of impairment recoverable
amounts of an asset. A reminder from IAS 36 Impairment of Assets:
An asset is impaired if its carrying amount ($850,000) exceeds its recoverable amount.
The recoverable amount of an asset should be measured as the higher of:
(a) The asset’s fair value less costs of disposal of

$810,000 ($840,000 fair value less $30,000 costs of
disposal)
(b) The value in use ($760,000)

The recoverable amount is therefore $810,000.
As the carrying amount exceeds the recoverable amount, the asset is impaired. The asset is
therefore carried at $810,000 after impairment.
Question 2 is answered by applying your knowledge of the accounting standards covered in this
question, namely IAS 16.
• Added to the carrying amount of the machine
• Charged to profit or loss
• Capitalised as a separate asset
• Debited to accumulated depreciation

You need to eliminate the responses that are incorrect by referring to the guidance in the
standard.
Added to the carrying amount of the machine.
They should be added to the carrying amount of the machine as they cannot be capitalised as a
separate asset (as per IAS 16: para. 8) they should be capitalised with the relevant PPE to which
they relate). Spare parts will normally be expensed. However, upgrades and major spare parts
that will be used over more than one period should be capitalised. They would not be debited to
accumulated depreciation as they increase the cost of the item, rather than reducing the
depreciation to date.
To answer Question 3 you can start by eliminating the response options that do not correctly
identify the treatment required by IAS 16.
3. Every five years the machine will need a major overhaul in order to keep running. How should
this be accounted for?
• Set up a provision at year 1
• Build up the provision over years 1–5, capitalising the

cost in year 1 and releasing it over five years
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• Capitalise the cost when it arises in year 5 and
amortising over five years
• Write the overhaul off to maintenance costs in the

year they are incurred
In this case, there is no other alternative but to incur the cost otherwise the machine would not be
able to function.
Consider the requirement to apply the principle of accrual accounting. In this respect, writing the
overhaul off to expenditure would be wrong, as the company benefits from the revenues
generated by the asset for five years, and the costs are only incurred in year five. This would be
acceptable for minor repairs. However, a significant overhaul requires capitalisation of the cost.
The options remain of setting up a provision in year one or over five years, or capitalising the cost.
Again, the accruals concept would not be met if the provision was fully set up in year 1.
It is important to read the question information carefully. Although capitalising the cost in year 5
looks correct, it is actually taking the costs incurred in year 5 and then capitalising them (and
amortising them over the next five years). This is not matching the costs of the asset with the
same revenues (revenues are being generated years 1–5, and the costs incurred, capitalised and
amortized years 5–10).
Therefore, building up the provision over the five years is correct. IAS 16 requires the provision to
be capitalised and then released to the profit or loss account over the next five years (in line with
the revenue being generated) as amortisation and finance costs.
Question 4 requires an understanding of the indicators of impairment. In each given scenario,
state whether these are internal or external indicators.
The performance of the machine (Note 1) had declined Internal indicator

leading to reduced economic benefits
There were legal and regulatory changes (Note 2) External

affecting the operating of the machine. indicator
There was an unexpected fall in the market value (Note External

3) of the machine. indicator
New technological innovations (Note 4) were producing External

more efficient machines. indicator
Notes.
1 The machine is used and maintained by the company, it therefore has influence over its use and state of
repair. This is deemed to be an internal factor.
2 The laws are made external to the company.
3 The company cannot dictate market prices, so this is external.
4 There is no indication in the question that the company has R&D costs, so it is assumed that it is ‘general
technological updates’ and therefore external to the company.
STEP 4 Stick to your time carefully, as each question is worth two marks, so spending more than the allocated time
of 3.6 minutes on each individual element of the case question is an inefficient use of your time, as you will
need to move onto the Section C questions. If you are running out of time, or you cannot answer any of the
questions, guess the answer from the options provided. You do not lose marks for incorrect answers.
Be strict with your time keeping, if you feel that you are getting stuck on one question, select an
answer and move onto to the next question. With the exception of the FIB (fill in the box)
questions, all OT question can be attempted by guessing one of the given answers. If your revised
carefully and know the key knowledge areas of the standards, then the statement questions
should be a case of selecting the correct answer. The calculation questions require application of
your knowledge.
Remember each OT question gives you two marks regardless of the style of question. It is
important to practice OT questions as this question practice will develop your skills and improve
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your timekeeping (as you will know, from experience, how long it will take you to complete a style
of question).

demonstrated the exam success skills in answering the question. The table below allows you to
perform a check for the OT activities you undertake in timed conditions to give you an idea of how
to complete the diagnostic.
Exam success skills Your reflection/observations

Managing information Some questions are longer than others.
Prioritise the topics which you feel more
confident with. Ensure you are familiar with
the time period in the question, and what data
is required in order to answer the question, eg
calculation of the depreciation in order to give
the required answer of the carrying amount of
an asset.
Correct interpretation of requirements Ensure you read the question requirement

carefully so that you answer the question
being asked (not the one you think is being
asked by the Examining team).
Good time management Remember that each OT question is worth two

marks, regardless of how hard it is. You are
aiming to spend 3.6 minutes on each question
(180 minutes/100 marks × 2 marks). Some
questions will be quicker than others, due to
their nature (narrative) or how confident you
are on a certain topic. Ensure you don’t
overrun, but equally, don’t rush your answers
and make mistakes.
Most important action points to apply to your next question
Summary
60% of the FR exam consist of OT questions. Key skills to focus on throughout your studies will
therefore include:
• Always read the requirements first to identify what you are being asked to do and what type of
OT question you are dealing with.
• Actively read the scenario highlighting key data needed to answer each requirement.
• Answer OT questions in a sensible order dealing with any easier discursive style questions first.
HB2022

HB2022

Introduction to groups
7
7
Learning objectives
Describe the concept of a group as a single economic unit. A4(a)
Explain and apply the definition of a subsidiary within relevant A4(b)

IFRS Standards.
Using IFRS Standards and other regulation, identify and outline the A4(c)
circumstances in which a group is required to prepare consolidated
financial statements.
Describe the circumstances when a group may claim exemption A4(d)

from the preparation of consolidated financial statements.
Explain why directors may not wish to consolidate a subsidiary A4(e)

and when this is permitted by IFRS Standards and other applicable
regulation.
Explain the need for using coterminous year ends and uniform A4(f)
accounting policies when preparing consolidated financial
statements.
Explain the objective of consolidated financial statements. A4(h)
Prepare a consolidated statement of financial position for a simple D2(a)

group (parent and up to two subsidiaries controlled by the parent
and one associate of the parent) dealing with pre- and post-
acquisition profits, non-controlling interests (at fair value or as a
proportion of net assets at the acquisition date) and consolidated
goodwill.
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Exam context
Companies often expand by acquiring a controlling interest in another entity. The two previously
separate entities then form a group and group accounting needs to be applied.
Group accounting is an important component of the Financial Reporting exam. It may be
examined as an objective test question in Section A or B, but more importantly, the 20-mark
Section C questions will cover the preparation and interpretation of financial statements for either
a single entity or a group. This chapter is an introduction to the preparation of group accounts.
The concepts introduced in this chapter will be developed further in Chapters 8, 9 and 10.
Interpretation of groups will be covered in Chapter 20.
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7
Chapter overview
Introduction and definitions Control
Types of investment Criteria for control
Definitions
Parent's separate financial statements Group financial statements
Parent's statement of financial position Requirement to prepare group financial statements
Important features Features of the consolidated

statement of financial position
Goodwill Non-controlling interest (NCI)
Recognition and initial measurement What is the NCI?
Calculation of goodwill Points to note
Impairment of positive goodwill
Mid-year acquisitions
Net assets of subsidiary
Pre- and post-acquisition reserves
Rules for mid-year acquisition
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7: Introduction to groups 151

1 Introduction and definitions
1.1 Acquisition of another entity
A company may expand or diversify its operations by acquiring another entity. There are different
ways in which an entity might acquire another business:
Acquire sole trade Acquire partnership Acquire company
Acquire individual assets and liabilities Acquire shares
Add assets and liabilities Investment in parent’s accounts represents

to SOFP as now owned ownership of shares which in turn
represents ownership of the net assets of
the acquired company (the subsidiary)
Profits and losses which are generated
by sole trade/partnership assets are
reported in profit or loss After the transaction the subsidiary will
continue to exist as a separate legal entity
Group financial statements

are required if control exists
We will only consider the situation where the entity acquires a company by the acquisition of its
ordinary shares. We can summarise the different types of investment that result from the
acquisition of a company’s shares and the required accounting treatment in the group accounts
as follows:
Investment Criteria Required treatment in group accounts

Subsidiary Control Full consolidation
Associate Significant influence Equity accounting
Investment which is Asset held for As an investment under IFRS 9 Financial

none of the above accretion of wealth Instruments
This chapter, along with Chapters 8, 9 and 10 of this Workbook, consider the accounting
requirements for a subsidiary. Chapter 11 looks at accounting for an associate and Chapter 12,
the accounting for an investment (financial asset).
1.2 Definitions
The following definitions are important for group accounting:
Control: An investor controls an investee when the investor is exposed, or has rights, to variable
KEY
TERM returns from its involvement with the investee and has the ability to affect those returns
through power over the investee.
Power: Existing rights that give the current ability to direct the relevant activities of the
investee.
Subsidiary: An entity that is controlled by another entity.
Parent: An entity that controls one or more subsidiaries.
Group: A parent and all its subsidiaries.
Associate: An entity over which an investor has significant influence and which is neither a
subsidiary nor an interest in a joint venture.
(IFRS 10: App. A)
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Significant influence: The power to participate in the financial and operating policy decisions
of an investee but it is not control or joint control over those policies. (IAS 28: para. 3)
2 Control
We noted above that the acquired company is a subsidiary if control exists. It is important that
you do not simply consider the percentage ownership of the acquired company’s shares to
determine whether a subsidiary exists and instead focus on the criteria for control.
2.1 Criteria for control

A parent (investor) only has control of the potential subsidiary (investee) if it has all of the
following:
Control
Power to Exposure or Ability to use

direct relevant rights to variable power to affect the
activities returns amount of returns
Examples of power: Examples of variable An investor (the parent)

• Voting rights returns: can have the current
• Rights to appoint, reassign • Dividends ability to direct the
or remove key management • Interest from debt
activities of an investee
personnel (the potential subsidiary)
• Changes in value
even if it does not
• Rights to appoint or remove of investment
actively direct the
another entity that directs
activities of the investee
relevant activities
• Decision-making rights
stipulated in a management
contract
Examples of relevant activities:
• Selling and purchasing
goods/services
• Selecting, acquiring,
disposing of assets
• Researching and developing
new products/processes
• Determining funding
decisions
(IFRS 10: paras. 7, B9, B11, B15 & B57)
Activity 1: Control
Alpha acquired 4,000 of the 10,000 equity voting shares and 8,000 of the 10,000 non-voting
preference shares in Crofton.
Alpha acquired 4,000 of the 10,000 equity voting shares in Element and had a signed agreement
giving it the power to appoint or remove all of the directors of Element.
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Required
Which investment would be classified as a subsidiary of Alpha?
 Both Crofton and Element
 Crofton only
 Element only
 Neither Crofton nor Element
3 Parent’s separate financial statements

Before we consider the consolidated financial statements, we must first look at how the investment
in the subsidiary is presented in the parent’s individual financial statements.
3.1 Parent’s statement of financial position

Under IAS 27 Separate Financial Statements, the investment can be recorded in the parent’s
separate financial statements either:
At cost At fair value Using equity accounting method
Assumed in this As a financial asset under Only likely to be adopted for

course/ACCA FR exam IFRS 9 Financial Instruments investments in associates when
the parent does not prepare
consolidated financial statements
(IAS 27: para. 10)
Example: Parent’s statement of financial position

The statements of financial position of Portus Co and Sanus Co at 31 December 20X4 are as
follows:
Portus Co Sanus Co
$’000 $’000
Non-current assets
Property, plant and equipment 56,600 16,200
Investment in Sanus Co (at cost) 13,800 –
70,400 16,200
Current assets
Inventories 2,900 1,200
Trade receivables 3,300 1,100
Cash 1,700 100
7,900 2,400
78,300 18,600
Equity
Share capital ($1 shares) 8,000 2,400
Reserves 54,100 10,600
62,100 13,000
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Portus Co Sanus Co
$’000 $’000
Non-current liabilities
Long-term borrowings 13,200 4,800
Current liabilities
Trade and other payables 3,000 800
78,300 18,600
On 31 December 20X4, Portus Co purchased a 100% holding in Sanus Co for $13.8 million in cash.
It shows investment in Sanus Co at cost. This will remain unchanged from year to year, ie post-
acquisition increases in value are not evident from the parent’s separate statement of financial
position.
The assets and liabilities shown are only those held by the parent (Portus Co) directly.
4 Group financial statements

4.1 Requirement to prepare group financial statements
When a parent acquires a subsidiary, it is required to produce an additional set of financial
statements, known as group or consolidated financial statements, which aim to record the
substance of its relationship with its subsidiary rather than its strict legal form.
Essential reading
Chapter 7 Section 1 of the Essential reading considers the exemptions that are available from
preparing consolidated financial statements.
Exam focus point

In the Financial Reporting exam, you may be asked to prepare group financial statements
containing a parent and up to two subsidiaries and one associate (covered in Chapter 11). You
will not be examined on group situations in which the subsidiaries also hold controlling
interests in or have significant influence over other entities.
4.2 Features of the consolidated statement of financial position

The group, or consolidated, financial statements:
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Present the results and financial position Are issued to the shareholders
of a group of companies as if it was of the parent
a single business entity
Provide information on all companies

Are issued in addition to and not instead controlled by the parent
of the parent's own financial statements
Show share capital of the parent only

Show no investment in subsidiary.
Instead the assets and liabilities of
the subsidiary are included. Show the assets and liabilities
that the group controls, ie
the resources available to the group
Shows the equity owners of the
parent company the consolidated
net assets of the group
5 Goodwill
5.1 Recognition and initial measurement
Essential reading
Chapter 7, Section 2 of the Essential reading discusses goodwill under IFRS 3 Business
Combinations in detail.
Goodwill arises when the:
value of a business as a whole

fair value of
(cost of the investment + any exceeds
net assets acquired
non-controlling share not purchased)
Goodwill is shown as a separate asset in the consolidated statement of financial position,

measured at the acquisition date (under IFRS 3 Business Combinations) as:
$
Consideration transferred (cost of investment) X
Non-controlling interests (NCI) X
Less fair value of identifiable assets acquired and
liabilities assumed at acquisition date (X)
Goodwill X
Note. The fair value of identifiable assets acquired and liabilities assumed at the acquisition date
is commonly referred to as ‘fair value of net assets’ in this Workbook.

Goodwill arising on consolidation is subjected to an annual impairment review and impairment
may be expressed as an amount or as a percentage.
The initial and subsequent measurement of goodwill is considered further in Chapter 8 of this
Workbook.
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Activity 2: Goodwill
At 31 December 20X4, the statements of financial position of Portus Co and Sanus Co were as
follows:
Portus Co Sanus Co
$’000 $’000
Non-current assets
Investment in Sanus (at cost) 13,800 –
70,400 16,200
Current assets
Cash 1,700 100
7,900 2,400
78,300 18,600
Equity
Reserves 54,100 10,600
62,100 13,000
Current liabilities
78,300 18,600
Note. On 31 December 20X4, Portus Co purchased a 100% holding in Sanus Co for $13.8 million in
cash.
Required
Prepare the consolidated statement of financial position of the Portus Group as at 31 December
20X4
Method:
(1) Cancel the investment in Sanus Co in Portus’s books with the shares and reserves (at the date
of acquisition) in Sanus Co’s books. Any difference is goodwill.
(2) Aggregate the two statements of financial position.
Solution
PORTUS GROUP
CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20X4
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$’000
Non-current assets
Goodwill (W1)
Current assets
Inventories
Trade receivables
Cash
Equity attributable to owners of the parent
Share capital ($1 shares)
Reserves (W2)
Long-term borrowings
Current liabilities
Trade and other payables
Workings
1 Group structure
Portus Co
Sanus Co
Pre-acq'n reserves
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2 Goodwill
$’000 $’000
Consideration transferred
Less fair value of identifiable net assets at acquisition:
Share capital
Reserves
Goodwill
3 Consolidated reserves (proof)
Portus Co Sanus Co
$’000 $’000
Per question
Pre-acquisition reserves
Group share of post-acq’n reserves:
Sanus Co
6 Non-controlling interests
6.1 What are non-controlling interests?
Parent (P)
The parent does not

P holds 80% of the ordinary Non-controlling interests
own all of the
shares and has control over S own the remaining 20%
subsidiary – only 80%
Subsidiary (S)
Non-controlling interests are the 'equity in a subsidiary not attributable, directly or indirectly, to a
parent' (IFRS 3: App. A), ie the non-group shareholders' interest in the net assets of the subsidiary
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6.2 Points to note
(a) Remember the parent does not have to own 100% of a company to control it.
(b) The group accounts will need to show the extent to which the assets and liabilities are
controlled by the parent, but are owned by other parties, namely the non-controlling
interests.
7 Mid-year acquisitions
7.1 Net assets of subsidiary
So far, we have considered acquisitions only at the end of a reporting period. Since companies
produce statements of financial position at that date anyway, there has been no special need to
establish the net assets of the acquired company at that date.
With a mid-year acquisition, a statement of financial position will not exist at the date of
acquisition, as required. Accordingly, we have to estimate the net assets at the date of acquisition
using various assumptions. Any profits made after acquisition – post-acquisition reserves – must
be consolidated in the group financial statements.
7.2 Subsidiary profits pre- and post-acquisition

1 Jan 20X5 1 Jul 20X5 31 Dec 20X5
Date of acquisition,
becomes subsidiary of P
Pre-acquistion period. Any profits Post-acquisition period. Any

of S are included in retained profits of S are included in
earnings at date of acquisition. group financial statements.
7.3 Rule for mid-year acquisitions

Assume that profits accrue evenly throughout the year, unless specifically told otherwise.
Activity 3: Mid-year acquisitions
follows:
Portus Co Sanus Co
$’000 $’000
Non-current assets
70,400 16,200
Current assets
Cash 1,700 100
7,900 2,400
78,300 18,600
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Portus Co Sanus Co
$’000 $’000
Equity
Reserves 54,100 10,600
62,100 13,000
Current liabilities
78,300 18,600
Notes.
1 On 1 April 20X4, Portus Co purchased an 80% holding in Sanus Co for $13.8 million in cash.
Sanus Co’s total comprehensive income for the year ended 31 December 20X4 was $2.0
million, accruing evenly over the year. Sanus Co did not pay any dividends in the year.
2 The non-controlling interest in Sanus Co is to be valued at its fair value of $3.2 million at the
date of acquisition.
Required
20X4.
Solution
PORTUS GROUP
$’000
Non-current assets
Goodwill (W2)
Current assets
Inventories
Trade receivables
Cash
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$’000
Reserves (W3)
Non-controlling interests (W4)
Current liabilities
Workings
1 Group structure
Portus Co
Sanus Co
Pre-acq'n reserves
2 Goodwill
$’000 $’000
Non-controlling interests (at fair value)
Share capital
Reserves
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$’000 $’000
Goodwill
3 Consolidated reserves
Portus Co Sanus Co
$’000 $’000
Per question
Sanus Co
$’000
NCI at acquisition (W2)
NCI share of post-acquisition reserves
Essential reading
Chapter 7 Section 3 of the Essential reading considers the accounting policies and year-end date
of the subsidiary.
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Chapter summary
Introduction and definitions Control
Types of investment Criteria for control

• Subsidiary – control – full consolidation • Power to direct relevant activities
• Associate – significant influence – equity accounting • Exposure or rights to variable returns
• Investment – acretion of wealth – financial • Ability to use power to affect returns
instrument • Examples of power:
– Voting rights
– Rights to appoint/remove management
Definitions – Right to appoint/remove entity directing relevant
• Control – investor is exposed, or has rights, to activities
variable returns and has the ability to affect those – Decision-making rights in a management contract
returns • Examples of relevant activities:
• Power – right to direct activities – Selling and purchasing goods/services
• Subsidiary – entity that is controlled by another – Selecting/acquiring/disposing of assets
entity – Research and development
• Parent – entity that controls one or more other – Determining funding decisions
entities • Examples of variable returns:
• Group – parent and all its subsidiaries – Dividends
• Associate – an entity over which an investor has – Interest
significant influence – Changes in value of investment
• Significant influence – power to participate in the • Ability to use power to affect returns:
policy decisions of an investee – Current ability even if entity does not use the
ability
Parent's separate financial statements Group financial statements
Parent's statement of financial position Requirement to prepare group financial statements

Investment held at: cost, fair value, equity method Required to prepare group financial statements which
show substance of relationship
Important features
• Investment remains at cost, unchanged over time Features of the consolidated statement of financial
• Assets and liabilities are those of parent only position
• Present results as single economic entity
• No investment in subsidiary
• Subsidiary assets and liabilities included
• Share capital that of parent only
• Show the assets and liabilities controlled by
the group
• Shows the equity of the owners of the net assets
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Goodwill Non-controlling interest (NCI)
Recognition and initial measurement What is the NCI?

Value of the business exceeds the fair value of its net Shares in a subsidiary not owned by the parent
assets
Points to note
Calculation of goodwill • Don't need to own 100% of S to control it
$ $ • NCI in equity section to reflect ownership
Consideration transferred X
Non-controlling interests X
Less fair value of net assets at acquisition:
Share capital X
Share premium X
Retained earnings X
Revaluation surplus X
(X)
X
Test annually for impairment
Impairment of positive goodwill

For a wholly-owned subsidiary:
DEBIT Expenses (and reduce retained earnings)
CREDIT Goodwill
Mid-year acquisitions
Net assets of subsidiary

• No SOFP at acquisition date
• Need to estimate net assets (= equity)
Pre- and post-acquisition reserves

• Pre-acquisition profits included in reserves (net
assets) at acquisition
• Post-acquisition profits included in group accounts
Rules for mid-year acquisition

Assume profits accrue evenly
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1. Introduction and definitions

A company can acquire another entity by purchasing its shares. If it gains control over the other
entity, it has a subsidiary and group, or consolidated, financial statements should be prepared.
2. Control
Control exists when the acquiring company:
• Has the power to direct relevant activities of the other entity
• Has exposure or the right to variable returns
• Ability to use power to direct the amount of those returns
3. Parent’s separate financial statements

Investment is shown in the statement of financial position, either:
• At cost
• At fair value
• Using the equity accounting method
4. Group financial statements

Required to prepare group financial statements which present the group as a single economic
entity. The group financial statements show:
• No investment in subsidiary
• The assets and liabilities of the parent and subsidiary
• Share capital of the parent only
5. Goodwill
Goodwill arises when the value of a business as a whole exceeds the fair value of the net asset
acquired. It is subsequently tested for impairment annually.
6. Non-controlling interests
Non-controlling interests own any interest in a subsidiary that the parent does not own.
7. Mid-year acquisitions
The net assets of a subsidiary need to be established at the date of acquisition. Any profits
earned by the subsidiary pre-acquisition are included in its retained earnings, and therefore its
net assets, at the date of acquisition. Any post-acquisition profits of the subsidiary are included
within the consolidated financial statements.
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Question practice
As this is an introductory chapter, there are no recommended questions from the Further question
practice bank at this stage. Questions will be recommended in Chapters 8–10 which build on the
concepts covered in this chapter.
Further reading
ACCA have produced a number of technical articles which look at key areas of the FR syllabus.
IFRS 3, Business combinations
www.accaglobal.com
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Activity answers
Activity 1: Control
The correct answer is: Element only
Alpha does not have power over Crofton as the non-voting preference shares do not give it power
and they only own 40% of the voting shares. The agreement regarding Element affords Alpha with
power, thus Element is a subsidiary.
Activity 2: Goodwill
PORTUS GROUP
$’000
Non-current assets
Property, plant and equipment (56,600 + 16,200) 72,800
Goodwill (W1) 800
73,600
Current assets
Inventories (2,900 + 1,200) 4,100
Trade receivables (3,300 + 1,100) 4,400
Cash (1,700 + 100) 1,800
10,300
83,900
Share capital ($1 shares) 8,000
Reserves (W2) 54,100
62,100
Long-term borrowings (13,200 + 4,800) 18,000
Current liabilities
Trade and other payables (3,000 + 800) 3,800
83,900
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Workings
1 Group structure
Portus Co
31.12.X4
100%
Cost $13.8m
Sanus Co
Pre-acq'n reserves $10.6m
2 Goodwill
$’000 $’000
Consideration transferred 13,800
Share capital 2,400
Reserves 10,600
(13,000)
Goodwill 800
3 Consolidated reserves (proof)
Portus Co Sanus Co
$’000 $’000
Per question 54,100 10,600
Pre-acquisition reserves (10,600)
Sanus Co (0 × 100%) 0
54,100
Activity 3: Mid-year acquisitions
PORTUS GROUP
$’000
Non-current assets
Goodwill (W2) 5,500
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$’000
78,300
Current assets
Inventories (2,900 + 1,200) 4,100
Cash (1,700 + 100) 1,800
10,300
88,600
63,300
Non-controlling interests (W4) 3,500
66,800
Current liabilities
88,600
Workings
1 Group structure
Portus Co
31.12.X4
100%
Cost $13.8m
Sanus Co
2 Goodwill
$’000 $’000
Non-controlling interests (at fair value) 3,200
Share capital 2,400
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$’000 $’000
Reserves (10,600 – (2,000 × 9/12)) 9,100
(11,500)
Goodwill 5,500
Portus Co Sanus Co
$’000 $’000
Pre-acquisition reserves (10,600 – (2,000 × 9/12)) (9,100)
1,500
Sanus Co (1,500 × 80%) 1,200
55,300
$’000
NCI at acquisition (W2) 3,200
NCI share of post-acquisition reserves ((W3) 1,500 × 20%) 300
3,500
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The consolidated
8 statement of financial
position
8
Learning objectives
Explain why it is necessary to eliminate intragroup transactions. A4(g)
Explain why it is necessary to use fair values for the consideration A4(i)
for an investment in a subsidiary together with the fair values of a
subsidiary’s identifiable assets and liabilities when preparing
consolidated financial statements.
Distinguish between goodwill and other intangible assets. B2(b)
Describe the subsequent accounting treatment of intangible B2(d)

assets.
Indicate why the value of purchase consideration for an investment B2(e)

may be less than the fair value of the acquired identifiable net
assets and how the difference should be accounted for.

group (parent and up to two subsidiaries controlled by the parent
and one associate of the parent) dealing with pre- and post-
acquisition profits, non-controlling interest (at fair value or as a
proportion of net assets at the acquisition date) and consolidated
goodwill.
Explain and account for other components of equity (eg share D2(c)
premium and revaluation surplus).
Account for the effects in the financial statements of intra-group D2(d)

trading.
Account for the effects of fair value adjustments (including their D2(e)
effect on consolidated goodwill) to:
(a) depreciating and non-depreciating non-current assets
(b) inventory
(c) monetary liabilities
(d) assets and liabilities not included in the subsidiary’s own
statement of financial position, including contingent assets
and liabilities
Account for goodwill impairment. D2(f)
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Describe and apply the required accounting treatment of D2(g)

consolidated goodwill.
8
Exam context
The consolidated statement of financial position is one of the key financial statements you need to
be able to prepare and/or interpret in Section C of the Financial Reporting exam. It is important
that you understand the approach to preparing the consolidated statement of financial position
and that you can apply that approach efficiently in an exam question.
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8
Chapter overview
The consolidated statement of financial position
Approach to the Goodwill

consolidated statement
of financial position
Basic procedure Calculation of goodwill Impairment of positive goodwill
Standard approach Accounting treatment Fair value of

consideration transferred
Fair Pre- and post-acquisition Dividends paid

values profits and other reserves by subsidiary
Definition of fair value Pre- and post-acquisition profits
Measuring NCI at acquisition Other reserves
Fair value of subsidiary’s net

assets at acquisition
Intragroup Unrealised profit on Transfer of

balances transfer of inventory non-current assets
IFRS 10 requirement Cost v NRV Carrying amount

and depreciation
Intragroup payables Method for eliminating

and receivables unrealised profit Method
Reconciliation of
intragroup balances
Method
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8: The consolidated statement of financial position 175

1 Approach to the consolidated statement of financial
position
In Chapter 7, we introduced group accounting, including some of the key features of the
consolidated statement of financial position. This chapter builds on that knowledge by looking in
more detail at the procedures and adjustments required on consolidation.
1.1 Basic procedure

The financial statements of a parent and its subsidiaries are combined on a line-by-line basis by
adding together like items of assets, liabilities, equity, income and expenses.
In respect of the consolidated statement of financial position, the following steps are then taken,
in order that the consolidated financial statements should show financial information about the
group as if it was a single entity.
Approach
• The carrying amount of the parent’s investment in each subsidiary and the equity of each
subsidiary are eliminated or cancelled.
• Goodwill arising on consolidation should be recognised in accordance with IFRS 3 Business
Combinations.
• Non-controlling interests in the net assets of consolidated subsidiaries should be presented
separately in the consolidated statement of financial position.
• Internal transactions such as dividends paid by a subsidiary, intragroup trading, inventories
and non-current assets transfers must be adjusted.
1.2 Standard procedures for the consolidated statement of financial

position
You must be able to work accurately and efficiently if you were required to prepare a statement of
financial position in Section C of the Financial Reporting exam. A high level summary of the key
procedures you will undertake is provided below. Some of these procedures will not make sense to
you at this stage; we will work through the details of these steps as we progress through this
chapter.
Step 1 Read the question and create a short note in your blank spreadsheet workspace, or in
the scratch pad, which shows:
• The group structure
• The percentage owned
• Acquisition date
• Pre-acquisition reserves
Step 2 Enter a proforma statement of financial position into the spreadsheet workspace, which
includes:
• A line for goodwill (in non-current assets)
• A line for non-controlling interests (in equity)
Step 3 Transfer figures from the parent and subsidiary financial statements to the proforma:
• Include the parent plus 100% of the subsidiary’s assets/liabilities controlled at the
year end on a line by line basis
• Include only the parent’s share capital and share premium in the equity section
Step 4 Complete your workings for standard adjustments/line items:
• Goodwill
• Non-controlling interests
• Retained earnings and any other reserves of the subsidiary
• Dividends paid by the subsidiary
• Intragroup trading
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• Inventories transferred within the group
• Non-current assets transferred within the group
Step 5 Transfer your workings to the proforma and complete your answer.
Exam focus point

It is essential that you show all workings in the spreadsheet workspace. You should label your
workings clearly and cross reference on the face of the statement of financial position.
1.3 Goodwill calculation

We noted the basic goodwill calculation in Chapter 7. We will now consider the accounting
treatment for goodwill and the components of the calculation in more detail.
Goodwill
$
Consideration transferred (cost of investment) X
Non-controlling interests (NCI) X
Less the fair value of identifiable assets acquired and liabilities
assumed at the acquisition date (X)
Goodwill X

Goodwill
Purchased (IFRS 3) Internally generated

• Not capitalised (IAS 38: para. 48).
See Chapter 4.
Positive Gain on bargain purchase

• Capitalise as a non-current • Reassess information used
asset (IFRS 3: para. 32) in the calculation
• Test annually for impairment • Credit any gain to profit or
(IAS 36: para. 10(b)) loss attributable to the
parent (IFRS 3: para. 34)
Activity 1: Basic goodwill calculation
Sing Co gained control of Wing Co on 31 March 20X5 when it acquired 80% of its ordinary shares.
The draft statements of financial position of each company were as follows:
SING CO
STATEMENT OF FINANCIAL POSITION AS AT 31 MARCH 20X5
HB2022

$
Assets
Non-current assets
Investment in 40,000 shares of Wing Co at cost 80,000
Current assets 40,000
Total assets 120,000
Equity and liabilities
Equity
Ordinary shares 75,000
Retained earnings 45,000
Total equity and liabilities 120,000
WING CO
$
Current assets 60,000
Equity
50,000 ordinary shares of $1 each 50,000
60,000
The fair value of the non-controlling interest in Wing Co as at 31 March 20X5 has been determined
as $12,500.
Required
Prepare the consolidated statement of financial position of the Sing Group as at 31 March 20X5.
Solution
SING GROUP
CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 MARCH 20X5
Assets
Non-current assets
Goodwill arising on consolidation (W)
Current assets
Total assets
Ordinary shares
HB2022

$
Retained earnings
Non-controlling interests
Total equity and liabilities
1.5 Fair value of consideration transferred

The first component of the goodwill calculation is the consideration transferred (which is the same
as the figure recorded as the cost of the investment in the parent’s separate financial statements).
Consideration may contain several components:
Consideration
Transferred at the Deferred Contingent

date of acquisition consideration consideration
Calculated as the Consideration that is to Contingent consideration

acquisition-date fair values of: be paid in the future (ie a payment dependent
• The assets transferred by should be discounted to on whether specified
the acquirer; present value to future events occur or
• The liabilities incurred by
determine its fair value. conditions are met, eg
a profit target) is
the acquirer (to former
measured at fair value
owners of the acquiree); and
at acquisition date
• Equity interests issued by
the parent.
Any costs involved in the
transaction are charged to
profit or loss.
Illustration 1: Deferred consideration
A liability of $100,000 is to be paid in two years’ time. The discount rate of 6%.
Required
At what amount should the liability be recorded?
Solution
The liability should be recorded at $100,000 × 1/1.062 = $89,000.
Essential reading
Chapter 8, Section 1 of the Essential reading provides more detail on the types of consideration
that may be used to acquire a subsidiary.
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Activity 2: Consideration
ABC acquired 300,000 of DEF’s 400,000 ordinary shares during the year ending 28 February
20X5. DEF was purchased from its directors who will remain in their current roles in the business.
The purchase consideration comprised:
• $250,000 in cash payable at acquisition
• $88,200 payable two years after acquisition
• $100,000 payable in two years’ time if profits exceed $2 million
• New shares issued in ABC at acquisition on a 1 for 3 basis
The consideration payable in two years after acquisition is a tough target for the directors of DEF,
which means its fair value (taking into account the time value of money) has been measured at
only $30,750.
The market value of ABC’s shares on the acquisition date was $7.35.
An appropriate discount rate for use where relevant is 5%.
Required
1 How much is the consideration that has been/will be paid in cash to include in the calculation
of goodwill on acquisition?
$
2 How much is the consideration payable in shares that will be included in the calculation of
goodwill on acquisition?
$
1.6 Impairment testing

Any goodwill arising on a business combination should be tested annually for impairment,
irrespective of whether there are any specific indicators of impairment (IAS 36: para. 10(b)). Any
impairment may be expressed as an amount or as a percentage. The double entry to write off the
impairment is:
DEBIT Group retained earnings

CREDIT Goodwill
However, this is complicated when there is NCI at fair value at the date of acquisition.
When NCI is valued at fair value the goodwill in the statement of financial position includes
goodwill attributable to the NCI. In this case, the double entry will reflect the NCI proportion
based on their shareholding as follows:
DEBIT Group retained earnings

DEBIT Non-controlling interest
CREDIT Goodwill
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Illustration 2: Goodwill impairment
Using the information in Activity 1 above, assume that in the year ending 31 March 20X6, the
goodwill of Wing Co is impaired by 20%.
Required
Prepare the journal entry to record the goodwill impairment of Wing Co in the year ended 31
March 20X6.
Solution
The goodwill impairment is $32,500 × 20% = $6,500.
$5,200 ($6,500 × 80%) of this will be allocated to the group and the remaining $1,300 ($6,500 ×
20%) will be allocated to the NCI.
DEBIT Group retained earnings $5,200

DEBIT Non-controlling interest $1,300
CREDIT Goodwill $6,500
1.7 Gain on bargain purchase

Goodwill arising on consolidation is the difference between the cost of an acquisition and the
value of the subsidiary’s net assets acquired. This difference can be negative: the aggregate of
the fair values of the separable net assets acquired may exceed what the parent company paid
for them. This is often referred to as negative goodwill. IFRS 3 refers to it as a ‘gain on a bargain
purchase’ (para. 34). In this situation:
(a) An entity should first re-assess the amounts at which it has measured both the cost of the
combination and the acquiree’s identifiable net assets. This exercise should identify any
errors.
(b) Any excess remaining should be recognised immediately in profit or loss.
2 Fair values
In order to calculate goodwill, we need to establish
• The fair value of the non-controlling interest; and
• The fair value of the net assets acquired
2.1 Definition
KEY
TERM orderly transaction between market participants at the measurement date (IFRS 13: para. 9).
Essential reading
Chapter 8 Section 2 of the Essential reading provides more detail regarding the interaction of IFRS
3 and IFRS 13.
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2.2 Fair value of non-controlling interests
IFRS 3 allows the non-controlling interests in a subsidiary to be measured at the acquisition date
in one of two ways:
NCI at acquisition
At their fair value (ie how much it At the non-controlling interest's

would cost for the acquirer to proportionate share of the fair value of
acquire the remaining shares). the acquiree's identifiable net assets.
Means that some of the goodwill Measurement of the non-controlling

calculated is attributable to the NCI. interests at proportionate share of the fair
NCI therefore needs to be allocated value of the acquiree's identifiable net
any subsequent impairment losses. assets means that no non-controlling
interest in goodwill is recognised.
Note that a parent can choose which method to use on a transaction by transaction basis.
Important Note
You should note that the term ‘full goodwill’ is sometimes used to refer to measuring NCI at fair
value and the term ‘partial goodwill’ is sometimes used when referring to NCI at proportionate
share of net assets. These terms are not used in IFRS 3 and are not used in this Workbook,
however you may be familiar with them from your workplace.
Illustration 3: Measuring NCI at fair value compared to measuring at

proportionate share of net assets
On 31 December 20X8, Penn acquired four million of the five million $1 ordinary shares of
Sylvania, paying $10 million in cash. On that date, the fair value of Sylvania’s net assets was $7.5
million.
Required
Calculate the goodwill arising on acquisition assuming:
1 Penn has elected to value the non-controlling interest at acquisition at fair value. The market
price of the shares held by the non-controlling shareholders immediately before the
acquisition was $2.00.
2 Penn has elected to value the non-controlling interest at acquisition at its proportionate share
of the fair value of the subsidiary’s identifiable net assets.
Solution
1 NCI at fair value
$’000
Non-controlling interest: 1m × $2 2,000
12,000
Net assets acquired (7,500)
Goodwill 4,500
HB2022

2 NCI at proportion of net assets
$’000
Non-controlling interest: 20% × $7.5m 1,500
11,500
Net assets acquired (7,500)
Goodwill 4,000
You can see from the above illustration that measuring NCI at fair value at acquisition results in an
increased amount of goodwill. The additional amount of goodwill represents goodwill attributable
to the shares held by non-controlling shareholders. It is not necessarily proportionate to the
goodwill attributed to the parent as the parent may have paid more to acquire a controlling
interest.
Exam focus point

The ACCA examining team has stated that candidates need to understand the difference
between the proportionate and fair value methods of measuring non-controlling interest.
Ensure you understand the impact of each method on the initial measurement of goodwill and
on accounting for any subsequent impairment of goodwill.
2.3 Fair value of identifiable assets acquired and liabilities assumed

2.3.1 IFRS 3 requirement
IFRS 3 Business Combinations requires the identifiable assets acquired and liabilities assumed of
subsidiaries to be brought into the consolidated financial statements at their fair value rather
than their carrying amount.
Assets and liabilities in an entity’s own financial statements are often not stated at their fair value,
eg where the subsidiary’s accounting policy is to use the cost model for assets or where a
subsidiary measures a loan using the amortised cost method, which results in a carrying amount
that is different from its fair value. If the fair value of the subsidiary’s asset and liabilities is not
reflected, goodwill would be misstated.
The difference between fair values and carrying amount is a consolidation adjustment made
only for the purposes of the consolidated financial statements.
2.3.2 Restructuring and future operating losses

An acquirer should not recognise liabilities for future losses or other costs expected to be
incurred as a result of the business combination.
IFRS 3 explains that a plan to restructure a subsidiary following an acquisition is not a present
obligation of the acquiree at the acquisition date. Neither does it meet the definition of a
contingent liability. Therefore, an acquirer should not recognise a liability for such a
restructuring plan at the date of acquisition.
2.3.3 Assets and liabilities only recognised on consolidation

Some assets and liabilities are not recognised in the subsidiary’s individual financial statements
but are recognised on consolidation.
Item Valuation basis

Internally generated intangible assets Recognised as non-current assets as the acquiring
company is placing a value on these assets by
HB2022

Item Valuation basis
transferring the consideration.
Contingent liabilities Recognised providing:

• It is a present obligation; and
• Its fair value can be measured reliably (normal
IAS 37 rules do not apply.)
2.3.4 Measurement period

If the initial accounting for a business combination is incomplete by the end of the reporting
period in which the combination occurs, provisional figures for the consideration transferred,
assets acquired and liabilities assumed are used.
Adjustments to the provisional figures may be made up to the point the acquirer receives all the
necessary information (or learns that it is not obtainable), with a corresponding adjustment to
goodwill, but the measurement period cannot exceed one year from the acquisition date.
Thereafter, goodwill is only adjusted for the correction of errors.
Acquisition date Year end End of measurement period
1 May 20X7 31 Dec 20X7 30 April 20X8
Adjustments to provisional figures permitted Only correction

of error permitted
Activity 3: Fair values
follows:
Portus Co Sanus Co
$’000 $’000
Non-current assets
70,400 16,200
Current assets
Cash 1,700 100
7,900 2,400
78,300 18,600
Equity
Reserves 54,100 10,600
62,100 13,000
HB2022

Portus Co Sanus Co
$’000 $’000
Current liabilities
78,300 18,600
Notes.
Sanus Co’s total comprehensive income for the year ending 31 December 20X4 was $2.0
2 At the date of acquisition, the fair value of Sanus Co’s assets was equal to their carrying
amounts with the exception of the items listed below which exceeded their carrying amounts
as follows (see table below). Sanus Co. has not adjusted the carrying amounts as a result of
the fair value exercise. The inventories were sold by Sanus Co before the year end.
date of acquisition. An impairment test conducted at the year-end revealed that the
consolidated goodwill of Sanus Co was impaired by $150,000.
£’000
Inventories 300
Plant and equipment (10-year remaining useful life) 1,200
1,500
Required
1 Prepare the consolidated statement of financial position of the Portus Group as at 31
December 20X4.
2 Show how the goodwill and non-controlling interests would change if the non-controlling
interests were measured at acquisition at the proportionate share of the fair value of the
acquiree’s identifiable net assets.
3 Explain how the goodwill would have been treated if the calculation had resulted in a negative
figure, and how such a negative figure may arise.
Solution
1
PORTUS GROUP
$’000
Non-current assets
HB2022

$’000
Goodwill (W2)
Current assets
Inventories
Trade receivables
Cash
Reserves (W3)
Current liabilities
Workings
1 Group structure
Portus Co
Sanus Co
Pre-acq'n reserves
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2 Goodwill
$’000 $’000
Non-controlling interests (at fair value)
Less fair value of identifiable net assets at

acquisition:
Share capital
Reserves
Fair value adjustments (W5)
Less impairment losses
Portus Co Sanus Co
$’000 $’000
Per question
Fair value movement (W5)
Sanus Co
Less impairment losses: Sanus Co
HB2022

$’000
NCI share of impairment losses
5 Fair value adjustments
At acquisition
date Movement At year end
$’000 $’000 $’000
Inventories
Plant and equipment
Take to
Take to Goodwill CoS/reserves Take to SOFP
2
Changes:
Workings
1 Goodwill
$’000 $’000

acquisition:
Share capital
HB2022

$’000 $’000
Reserves
Less impairment losses
$’000
NCI share of impairment losses
Activity 4: Assets and liabilities only recognised on consolidation
Elderberry Co acquired 750,000 of Apricot Co’s 1,000,000 $1 ordinary shares on 1 January 20X2
for $3,800,000 when Apricot Co’s retained earnings were $4,200,000. Elderberry Co elected to
measure non-controlling interests in Apricot Co at its fair value of $1,600,000 at the date of
acquisition.
At 1 January 20X2, Apricot Co had not recognised the following in its financial statements:
• Apricot Co had a customer list which it had not recognised as an intangible asset because it
was internally generated. However, on acquisition, external experts managed to establish a fair
value for the list of $150,000. Customers are typically retained for an average of 5 years.
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• Apricot Co had a contingent liability with a fair value of $220,000 at the date of acquisition.
There is a present obligation in respect of this contingent liability.
Required
Calculate the goodwill arising on the acquisition of Apricot Co on 1 January 20X2.
Solution
3 Pre- and post-acquisition profits and other components

of equity
3.1 Pre- and post-acquisition profits
Pre- and post-acquisition profits were introduced in Chapter 7.
When a subsidiary is acquired mid-way through the year, for consolidation purposes, it is
necessary to distinguish between:
(a) Profits earned before acquisition (pre-acquisition profits)
(b) Profits earned after acquisition (post acquisition profits)
The assumption can be made that profits accrue evenly whenever it is impracticable to arrive at
an accurate split of pre- and post‑acquisition profits. You should make this assumption in the FR
exam unless you are told otherwise.
3.1.1 Pre-acquisition profits

Once the amount of pre‑acquisition profit has been established by pro-rating the profit for the
year, it should be included in retained earnings in order that the appropriate consolidation
workings can be produced.
3.1.2 Post-acquisition profits

Any profits earned by the subsidiary after the date of acquisition are included in the group profit
for the year.
Essential reading
Chapter 8, Section 3 of the Essential reading is an activity in which a subsidiary is acquired mid-
way through the year.
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3.2 Other components of equity

Exam questions will often include other components of equity (such as share premium or a
revaluation surplus) as well as retained earnings. These other components of equity should be
treated in exactly the same way as retained earnings, which we have already seen.
3.2.1 Pre-acquisition other components of equity

If other components of equity are presented in the statement of financial position pre‑acquisition,
it forms part of the calculation of net assets at the date of acquisition and is therefore used in the
goodwill calculation.
3.2.2 Post-acquisition other components of equity

If other components of equity arise post‑acquisition or there has been some movement in other
components of equity between the date of acquisition and the reporting date, the consolidated
statement of financial position will show the parent’s other components of equity plus its share of
the movement on the subsidiary’s other components of equity.
Activity 5: Other components of equity
Activity 3 included a figure for ‘reserves’ of Portus Co and Sanus Co. We must now more
accurately refer to the component parts of those reserves. The total reserves presented in Activity
3 can be broken down as follows:
Portus Co Sanus Co
$’000 $’000
Equity
Retained earnings 42,700 9,000
Revaluation surplus 11,400 1,600
62,100 13,000
At acquisition, the retained earnings of Sanus Co were $7.8 million and its revaluation surplus
stood at $1.3 million (coming to a total of $9.1 million as before).
Required
Calculate the consolidated retained earnings, consolidated revaluation surplus and non-
controlling interests for the Portus Group as at 31 December 20X4.
Solution
PORTUS GROUP
CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20X4 (EXTRACT)
$’000
Retained earnings (W1)
HB2022

$’000
Revaluation surplus (W2)
Workings
1 Consolidated retained earnings
Portus Co Sanus Co
$’000 $’000
Per question
Pre-acquisition retained earnings
Group share of post-acq’n retained earnings:
Sanus Co (
× 80%)
Less impairment losses: Sanus Co (
× 80%)
2 Consolidated revaluation surplus
Portus Co Sanus Co
$’000 $’000
Per question
Pre-acquisition revaluation surplus
Group share of post-acq’n revaluation surplus:
Sanus Co (
× 80%)
HB2022

$’000
NCI at acquisition (Activity 3 (W2)) 3,200
NCI share of post-acquisition retained earnings ((W1)

(
× 20%))
NCI share of post-acquisition revaluation surplus ((W2)

(
× 20%))
NCI share of impairment losses (Activity 3 (W2) (30)
× 20%)
3,392
4 Dividends paid by a subsidiary

When a subsidiary pays a dividend during the year, the amount paid to the parent company
must be eliminated on consolidation.
Illustration 4: Dividends paid by a subsidiary
Subsidiary Co, a 60% subsidiary of Parent Co, pays a dividend of $1,000 on the last day of its
accounting period. Its retained earnings before paying the dividend stood at $5,000.
Required
Explain how the dividend paid by Subsidiary Co should be accounted for.
Solution
(1) $400 (40%) of the dividend is paid to non-controlling shareholders. The cash leaves the group
and will not appear anywhere in the consolidated statement of financial position.
(2) The parent company receives $600 of the dividend, debiting cash and crediting profit or loss.
This will be cancelled on consolidation.
(3) The remaining balance of retained earnings in Subsidiary Co’s statement of financial position
($5,000 less $1,000 dividend paid) will be consolidated in the normal way. The group’s share
(60% × $4,000 = $2,400) will be included in group retained earnings in the statement of
financial position; the non-controlling interest share (40% × $4,000 = $1,600) is credited to the
non-controlling interest account in the statement of financial position.
5 Intragroup trading
5.1 IFRS 10 requirement
IFRS 10 Consolidated Financial Statements states ‘Intragroup balances, transactions, income and
expenses shall be eliminated in full’ (IFRS 10: para. B86).
HB2022

The purpose of consolidation is to present the parent and its subsidiaries as if they are trading as
one entity.
Therefore, only amounts owing to or from outside the group should be included in the statement
of financial position, and any assets should be stated at cost to the group.
5.2 Intragroup balances

Trading transactions will normally be recorded via a current account between the trading
companies, which would also keep a track of amounts received and/or paid.
The current account receivable in one company’s books should equal the current account
payable in the other. These two balances should be cancelled on consolidation as intragroup
receivables and payables should not be shown.
5.2.1 Reconciliation of intragroup balances

Where current accounts do not agree at the year-end, this will be due to in transit items such as
inventories and cash.
Prior to consolidation, adjustments will need to be made for the cash or goods in transit. This is
usually done by following through the transaction to its ultimate destination (IFRS 10 is not
specific).
5.3 Method
Make the adjustments for in transit items on your proforma answer after consolidating the assets
and liabilities.
• Cash in transit
DEBIT Cash
CREDIT Receivables
• Goods in transit
DEBIT Inventories
CREDIT Payables
• Eliminate intragroup receivables and payables
DEBIT Intragroup payable
CREDIT Intragroup receivable
6 Inventories sold at a profit (within the group)

6.1 Cost and NRV
Inventories must be valued at the lower of cost and net realisable value (NRV) to the group.
Inventories transferred at a profit within group
Sold to a third party Remain in inventories
Profit realised Profit unrealised
6.2 Method
Calculate the unrealised profit included in inventories and mark the adjustment to inventories on
your proforma answer and to retained earnings in your workings.
HB2022

To eliminate the unrealised profit from retained earnings and inventories a provision is usually
made in the books of the company making the sale (IFRS 10 is not specific). This only happens on
consolidation. Following this approach, the entries required are:
Sale by P to S Adjust in P’s accounts

DEBIT Cost of sales/Retained earnings of P
CREDIT Consolidated inventories
Sale by S to P Adjust in S’s accounts

DEBIT Cost of sales/Retained earnings of S
CREDIT Consolidated inventories
The non-controlling interests will be affected

by this adjustment (when allocating their
share of post-acquisition profits).
Activity 6: Sale of inventory at a profit
follows:
Portus Co Sanus Co
$’000 $’000
Non-current assets
70,400 16,200
Current assets
Cash 1,700 100
7,900 2,400
78,300 18,600
Equity
Reserves 54,100 10,600
62,100 13,000
Current liabilities
78,300 18,600
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Notes.
Sanus’s total comprehensive income for the year ending 31 December 20X4 was $2 million,
accruing evenly over the year. Sanus Co did not pay any dividends in the year.
2 At the date of acquisition, the fair value of Sanus Co’s assets was equal to their carrying
amounts with the exception of the items listed below which exceeded their carrying amounts
as follows (see table below). Sanus Co has not adjusted the carrying amounts as a result of
the fair value exercise. The inventories were sold by Sanus Co before the year end.
date of acquisition. An impairment test conducted at the year end revealed that the
consolidated goodwill of Sanus Co was impaired by $150,000.
4 On 1 October 20X4, Sanus Co sold goods to Portus Co for $200,000 at a gross profit margin
of 40%. The goods were still in Portus Co’s inventories at the year end. No other sales were
made between Portus Co and Sanus Co in the year. At 31 December 20X4, Portus Co’s
current account with Sanus Co was $130,000 (credit). This did not agree with the equivalent
balance in Sanus’s books due to cash in transit of $70,000 which was not received by Sanus
Co until after the year end.
$’000
Inventories 300
1,500
Required
20X4 (incorporating the changes from the previous example identified in bold text).
Solution
PORTUS GROUP
$’000
Non-current assets
Goodwill (W2)
Current assets
Inventories (2,900 + 1,200
Trade receivables (3,300 + 1,100
Cash (1,700 + 100
HB2022

$’000
Reserves (W3)
Current liabilities
Trade and other payables (3,000 + 800
Workings
1 Group structure
Portus Co
Sanus Co
Pre-acq'n reserves
2 Goodwill
$’000 $’000
Share capital 2,400
Reserves (10,600 – (2,000 × 9/12)) 9,100
Fair value adjustments (W5) 1,500
HB2022

$’000 $’000
(13,000)
4,000
Less impairment losses (150)
3,850
Portus Co Sanus Co
$’000 $’000
Fair value movement (W5) (390)
Provision for unrealised profit (W6)
Sanus Co (
× 80%)
Less impairment losses: Sanus Co (150 × 80%) (120)
$’000
NCI share of post-acquisition reserves (
(W3) × 20%)
NCI share of impairment losses (150 (W2) × 20%) (30)
HB2022

At acquisition
$’000 $’000 $’000
Inventories 300 (300) -
Plant and equipment 1,200 (90)* 1,110
1,500 (390) 1,110
*Extra depreciation $1,200,000 × Take to Take to COS &

1/10 × 9/12 Goodwill reserves Take to SOFP
(1) Cash in transit
$’000 $’000
DEBIT Group cash
CREDIT Trade receivables
(2) Cancel intragroup balances
$’000 $’000
DEBIT Group payables
CREDIT Group receivables
(3) Eliminate unrealised profit

Sanus Co:
Profit element in inventories: $200,000 × 40% = $80,000
$’000 $’000
DEBIT Cost of sales (& reserves) (of Sanus Co the seller)
CREDIT Group inventories
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7 Intra-group sale of property, plant and equipment
Group companies may sell items of property plant and equipment (PPE) from one group
company to another.

In their individual accounts, the companies will treat the sale of PPE just like a sale between
unconnected parties:
• The selling company will record a profit or loss on sale.
• The purchasing company will record the asset at the amount paid to acquire it and will use
that amount as the basis for calculating depreciation.
However, the consolidated statement of financial position must show assets at their cost to the
group, and any depreciation charged must be based on that cost. Therefore, two consolidation
adjustments are required:
(a) An adjustment to alter retained earnings (profit or loss in the year the transfer is made) and
non-current assets cost to remove unrealised profit
(b) An adjustment to alter retained earnings (profit or loss for the current year) and accumulated
depreciation so that consolidated depreciation is based on the asset’s cost to the group
7.2 Method
(a) Calculate the unrealised profit on the transfer of the item of property, plant and equipment
(PPE).
(b) Calculate the amount of this unrealised profit that has been depreciated by the year-end.
This is the ‘excess depreciation’ that must be added back to group PPE.
(c) Adjust for these amounts in your consolidation workings.
The double entry is as follows:

(a) Sale by parent to subsidiary
DEBIT Retained earnings (group’s column in retained earnings working)

CREDIT PPE
With the unrealised profit on disposal
DEBIT PPE
CREDIT Retained earnings (subsidiary’s column in retained earnings working)
With the excess depreciation
(b) Sale by subsidiary
DEBIT Retained earnings (subsidiary’s column in retained earnings working)

CREDIT PPE
DEBIT PPE
CREDIT Retained earnings (group’s column in retained earnings working)
HB2022

Illustration 5: Intragroup sale of PPE
Percy Co owns 60% of the equity shares of Edmund Co, giving Percy Co control over Edmund Co.
On 1 January 20X1, Edmund Co sold a machine with a carrying amount of $10,000 to Percy Co
for $12,500.
The reporting date of the group is 31 December 20X1 and the balances on the retained earnings of
Percy Co and Edmund Co at that date are:
$
Percy Co, after charging depreciation of 10% on the machine 27,000
Edmund Co, including profit on the sale of the machine to Percy Co 18,000
Required
Show the working for consolidated retained earnings.
Solution
Consolidated retained earnings
Percy Co Edmund Co
$ $
Disposal of plant
Profit (2,500)
Excess depreciation: 10% × $2,500 250 ––––––
15,500
Share of Edmund Co: $15,500 × 60% 9,300
Notes.
1 The NCI in the retained earnings of Edmund Co is 40% × $15,500 = $6,200.
2 The profit on the transfer of $2,250 ($2,500 – $250) will be deducted from the carrying
amount of the machine to write it down to cost to the group.
Activity 7: Non-current asset transfer
Sanus Co sells plant with a remaining useful life of four years and a carrying amount of $120,000
to Portus Co for $200,000 on 1 October 20X4.
Required
Using the options below, select the correct entries for the journals to remove the unrealised profit
in the consolidated statement of financial position as at 31 December 20X4.
Debit Credit
Retained earnings ▼
Property, plant and equipment ▼
HB2022

Debit Credit
Retained earnings ▼
Property, plant and equipment ▼
Pull down list

• $20,000
• $5,000
• $60,000
• $75,000
• $80,000
Essential reading
Chapter 8 Section 4 of the Essential reading provides a further activity relating to the
consolidated statement of financial position.
PER alert
to classify information in accordance with the requirements for external financial statements
or for inclusion in disclosure notes in the statements. You can apply the knowledge you obtain
from this chapter to help to demonstrate this competence.
HB2022

Chapter summary
The consolidated statement of financial position
Approach to the Goodwill

consolidated statement
of financial position
Basic procedure Calculation of goodwill Impairment of positive goodwill

• Combined on line by line basis $ For a wholly-owned subsidiary:
• Present as if group is single Consideration transferred X DEBIT Expenses (and reduce
entity Non-controlling interests X retained earnings)
Less fair value of net assets CREDIT Goodwill
at acquisition (X)
Standard approach
Goodwill X
• Establish group structure Fair value of consideration
• Enter proforma transferred
• Transfer figures from question • Measure at fair value:
to proforma – Assets transferred by
• Complete workings for • Positive purchased goodwill:
the parent
standard adjustments for – Intangible non-current asset
– Liabilities incurred by
– Goodwill – Test annually for impairment
the parent
– Non-controlling interests • Negative purchased goodwill: – Equity instruments issued
– Retained earnings and other – Reassess by the parent
reserves – Credit to profit or loss
• Deferred consideration:
– Other transactions per – Gain from a bargain
– Discount to present value
question purchase
• Contingent consideration:
• Transfer workings to proforma • Internally generated goodwill:
– Measure at fair value at
and complete – Do not recognise
acquisition
– Adjust goodwill if additional
info re facts at acquisition
date
– Any other change, do not
adjust equity and take
changes in liability to P/L
Fair values
Definition of fair value Fair value of subsidiary’s net assets at acquisition

Market-based measure (IFRS 13) • Identifiable
– Separable; or
– Arise from contractual or other legal rights
Measuring NCI at acquisition • Meet the Conceptual Framework's definitions of assets and liabilities
• At proportionate share of net • Detailed rules:
assets; or • Recognise identifiable net assets even if not in subsidiary's accounts eg
• At fair value – Intangible assets
– Contingent liabilities
HB2022

Pre- and post-acquisition Dividends paid
profits and other reserves by subsidiary
Pre- and post-acquisition profits • Dividends paid to NCI not

• Pre-acquisition reserves cancelled as not generated under parent's presented in consolidated
control statement of financial position
• Include group share of subsidiary's post-acquisition reserves • Dividends paid to parent
cancelled on consolidation
Other reserves
• Include in goodwill working
• Include parent + group share of subsidiary post-acquisition
Intragroup Unrealised profit on Transfer of

balances transfer of inventory non-current assets
IFRS 10 requirement Cost v NRV Carrying amount and

• Single entity concept • One group company sells depreciation
• Eliminate intragroup balances goods to another • If sale at a profit, profit is
• If goods still in inventory at the unrealised
year end: • Depreciation will be based on
Intragroup payables and – Internal profit: must be transfer value
receivables eliminated
• Arise from credit transactions – Inventory overstated: state at
between group companies lower of cost and NRV to the Method
• Eliminate them on group • Adjust profit in the selling
consolidation company
• Adjust depreciation in the
Method for eliminating receiving company
Reconciliation of intragroup unrealised profit • NCI takes share of any
balances • In the consolidated retained adjustment that impacts profit
• If balances do not agree, earnings working:
adjust for in transit items – Deduct the unrealised profit
• Push them forward to their from the sellers column
ultimate destination • When adding across inventory
of parent and subsidiary:
– Deduct the unrealised profit
Method • If the subsidiary is the seller,
(1) Account for items in transit adjustment is required in NCI
• Cash: DEBIT working
CREDIT
• Goods: DEBIT
CREDIT
(2) Eliminate intragroup payable
and receivable
DEBIT Intragroup payable
CREDIT Intragroup receivable
HB2022

1. Approach to the consolidated statement of financial position

Consolidated financial statements should show the financial information of the group as if it was
a single entity. BPP recommends following a methodical step by step approach. You need to
practice preparing consolidated financial statements in the exam software. Remember to show all
workings.
2. Goodwill
Positive goodwill is capitalised and tested annually for impairment. ‘Negative’ goodwill (once
reassessed to ensure it is accurate) is recognised as a bargain purchase in profit or loss.
The consideration transferred comprises any assets or equity transferred at the date of
acquisition, less any liabilities incurred, deferred consideration and any contingent consideration.
3. Fair values
Non-controlling interests at acquisition can be measured either at their fair value or at their
proportionate share of the fair value of the acquiree’s identifiable net assets.
The fair value of the assets acquired and liabilities assumed must be recognised at fair value at
the date of acquisition. Internally generated intangible assets and contingent liabilities not
recognised in the individual financial statements of the subsidiary are recognised on acquisition,
provided criteria satisfied.
4. Pre- and post-acquisition profits and other reserves

Pre-acquisition profits of the subsidiary are included in the reserves (net assets) of the subsidiary
at the date of acquisition.
Post-acquisition profits of the subsidiary are included in the consolidated financial statements.
Other components of equity (eg revaluation surplus) should be treated in the same way as
retained earnings.
5. Dividends paid by the subsidiary

Dividends paid to the NCI are not shown in the consolidated statement of financial position.
Dividends paid to the parent company are cancelled on consolidation.
6. Intragroup trading
In the consolidated accounts (only), items in transit must be accounted for and intragroup
balances cancelled.
7. Inventories sold at a profit

Where inventories that are sold intragroup have not been sold onto a third party, the unrealised
profit must be eliminated in the group financial statements.
8. Transfer of property, plant and equipment

A similar adjustment must be made to eliminate unrealised profit remaining on intragroup
transfers of property, plant and equipment.
HB2022

Question practice
the Workbook):
Section A Q8
Section C Q31 Barcelona Co and Madrid Co
Section C Q32 Reprise Group
Section C Q36 Highveldt Co
Section C Q56 Armstrong Co
Further reading
There are useful articles written by the examining team on the calculation of goodwill, which can
be found on the ACCA website.
Accounting for goodwill
Watch your step
The use of fair values in the goodwill calculation
Impairment of goodwill
www.accaglobal.com
HB2022

Activity answers
Activity 1: Basic goodwill calculation

SING GROUP
CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 MARCH 20X5
Assets
Non-current assets
Goodwill arising on consolidation (W) 32,500
Current assets (40,000 + 60,000) 100,000
Ordinary shares 75,000
Non-controlling interests 12,500
Working
Goodwill
$ $
Non-controlling interest 12,500
Net assets acquired as represented by:
Ordinary share capital 50,000
Retained earnings on acquisition 10,000
(60,000)
Goodwill 32,500
Activity 2: Consideration
1 $ 360,750
$
Cash 250,000
Deferred consideration (88,200 × (1/1.052)) 80,000
Contingent consideration 30,750
360,750
HB2022

2 $ 735,000
Shares in ABC (300,000/3 × $7.35) $735,000
Activity 3: Fair values

1
1 PORTUS GROUP
$’000
Non-current assets
Property, plant and equipment (56,600 + 16,200 + 1,110 (W5)) 73,910
Goodwill (W2) 3,850
77,760
Current assets
Inventories (2,900 + 1,200) 4,100
Cash (1,700 + 100) 1,800
10,300
88,060
62,868
66,260
Current liabilities
88,060
HB2022

Workings
1 Group structure
Portus Co
1.4.X4
80%
Cost $13.8m
Sanus
($10.6m – ($2.0m × 9/12))
or ($10.6m – $2.0m + ($2.0 × 3/12))
2 Goodwill
$’000 $’000

acquisition:
Share capital 2,400
Reserves (10,600 – (2,000 × 9/12)) 9,100
(13,000)
4,000
3,850
Portus Co Sanus Co
$’000 $’000
Pre-acquisition reserves (10,600 – (2,000 ×

9/12)) (9,100)
1,110
Sanus Co (1,110 × 80%) 888
HB2022

Portus Co Sanus Co
$’000 $’000
54,868
$’000
NCI share of impairment losses ((W2) 150 × 20%) (30)
At acquisition
$’000 $’000 $’000
Inventories 300 (300) –
(390)
1,500 Take to 1,110
Take to Goodwill CoS/reserves Take to SOFP
*Extra depreciation $1,200,000 × 1/10 × 9/12

2
2 Changes:
Workings
1 Goodwill
$’000 $’000
Non-controlling interests (at %FVNA) (13,000 × 20%) 2,600

acquisition:
Share capital 2,400
Reserves (10,600 – (2,000 × 9/12)) 9,100
HB2022

$’000 $’000
(13,000)
3,400
Less impairment losses (150 × 80%) (120)
3,280
$’000
NCI share of impairment losses (0)
2,822
3 Where the goodwill calculation results in a negative figure (ie where the fair value of net assets
at acquisition exceeds the consideration paid and value attributed to non-controlling
interests), the full amount is treated as a ‘bargain purchase’. It is credited directly to profit or
loss (and retained earnings) attributable to the parent. There is no non-controlling interest
effect.
This situation could arise for several reasons:
(1) The seller needed to make a quick/forced sale (eg due to liquidity or regulatory reasons)
resulting in a bargain purchase of the net assets at less than their fair value.
(2) An expectation that losses will be made lowering the value of the net assets acquired
before the business can be turned around.
(3) An expectation that the business will need to be broken up and sold off with significant
break-up costs.
(4) The existence of liabilities that did not meet the recognition criteria for recognition in the
fair value of the net assets acquired (for this reason, IFRS 3 actually requires a review of
the calculations of net assets acquired to ensure no contingent liabilities that can be
recognised have been missed before a credit is allowed to be made to profit or loss).
Activity 4: Assets and liabilities only recognised on consolidation

The customer list and contingent liability are examples of assets and liabilities that are only
recognised on consolidation. Their fair value must be adjusted for when determining the fair value
of the identifiable net assets of Apricot Co at the date of acquisition.
Goodwill is calculated as follows:
$’000 $’000
Consideration 3,800
NCI at FV 1,600
Fair value of identifiable net assets:
Share capital 1,000
HB2022

$’000 $’000
FV adjustment - intangible asset 150
FV adjustment - contingent liabilities (220)
(5,130)
Goodwill 270
Activity 5: Other components of equity
PORTUS GROUP
CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20X4 (EXTRACT)
$’000
Retained earnings (W1) 43,228
Revaluation surplus (W2) 11,640
66,260
Workings
Portus Co Sanus Co
$’000 $’000
Pre-acquisition retained earnings (7,800)
810
Group share of post-acq’n retained earnings:
Sanus Co (810 × 80%) 648
43,228
2 Consolidated revaluation surplus
Portus Co Sanus Co
$’000 $’000
HB2022

Portus Co Sanus Co
$’000 $’000
(1,300)
Pre-acquisition revaluation surplus 300
Group share of post-acq’n revaluation surplus:
Sanus Co (300 × 80%) 240
11,640
$’000
NCI at acquisition (Activity 3 (W2)) 3,200
NCI share of post-acquisition retained earnings ((W1) 162

(810 × 20%))
NCI share of post-acquisition revaluation surplus ((W2) 60

(300 × 20%))
NCI share of impairment losses (Activity 3 (W2) 150 × 20%) (30)
3,392
Activity 6: Sale of inventory at a profit
PORTUS GROUP
$’000
Non-current assets
Property, plant and equipment (56,600 + 16,200 + (W5) 1,110) 73,910
Goodwill (W2) 3,850
77,760
Current assets
Inventories (2,900 + 1,200 – 80 (W6)) 4,020
Trade receivables (3,300 + 1,100 – 70 (W6) – 130 (W6)) 4,200
Cash (1,700 + 100 + 70 (W6)) 1,870
10,090
87,850
HB2022

$’000
62,804
66,180
Current liabilities
Trade and other payables (3,000 + 800 – 130 (W6)) 3,670
87,850
Workings
1 Group structure
Portus Co
31.12.X4
100%
Cost $13.8m
Sanus Co
2 Goodwill
$’000 $’000
Share capital 2,400
Reserves (10,600 – (2,000 × 9/12)) 9,100
(13,000)
4,000
3,850
HB2022

Portus Co Sanus Co
$’000 $’000
Provision for unrealised profit (W6) (80)
1,030
Sanus Co (1,030 × 80%) 824
54,804
$’000
NCI share of post-acquisition reserves (1,030 (W3) × 20%) 206
NCI share of impairment losses (150 (W2) × 20%) (30)
3,376
At acquisition
$’000 $’000 $’000
1,500 (390) 1,110
*Extra depreciation $1,200,000 × Take to Take to COS &

1/10 × 9/12 Goodwill reserves Take to SOFP
(1) Cash in transit
$’000 $’000
DEBIT Group cash 70
CREDIT Trade receivables 70
HB2022

(2) Cancel intragroup balances
$’000 $’000
DEBIT Group payables 130
CREDIT Group receivables 130

Sanus Co:
$’000 $’000
DEBIT Cost of sales (& reserves) (of Sanus Co the seller) 80
CREDIT Group inventories 80
Activity 7: Non-current asset transfer
Debit Credit
Retained earnings $80,000
Property, plant and equipment $80,000
Debit Credit
Retained earnings $5,000
Property, plant and equipment $5,000
Working
Unrealised profit
$
Profit on transfer (200 – 120) 80,000
Excess depreciation (80 × 3/12 × ¼) 5,000
HB2022

The consolidated statement
9 of profit or loss and other
comprehensive income
9
Learning objectives
Prepare a consolidated statement of profit or loss and D2(b)

consolidated statement of profit or loss and other comprehensive
income for a simple group dealing with an acquisition or disposal
in the period and non-controlling interest.
Account for the effects in the financial statements of intra-group D2(d)

trading.
Explain the need for using coterminous year-ends and uniform A4(f)
accounting polices when preparing consolidated financial
statements.
9
Exam context
The group accounting question in Section C of the Financial Reporting exam may ask you to
prepare and/or interpret a consolidated statement of profit or loss and other comprehensive
income (SPLOCI). This chapter builds on the knowledge gained in Chapters 7 and 8, focusing on
the inclusion of a subsidiary in the group financial statements. As with Chapter 8, it is important
that you develop an approach to preparing the SPLOCI and that you can apply that approach
efficiently in an exam question.
HB2022

9
Chapter overview
The consolidated statement of profit or loss and other comprehensive income (SPLOCI)
Approach to the consolidated statement of profit or loss Intragroup

and other comprehensive income (SPLOCI) trading
Aim of the consolidated SPLOCI Issue
Allocation of profit and other comprehensive income Method
Basic procedure
Mid year acquisitions
Impairment
Dividends paid to subsidiary
Intragroup loans
and interest
Issue
Method
HB2022

1 Approach to the consolidated statement of profit or loss
and other comprehensive income (SPLOCI)
1.1 Aim of the consolidated SPLOCI
The aim of the consolidated SPLOCI is to show the results of the group for an accounting period
as if it were a single economic entity. The same logic is used as for the statement of financial
position, ie all income and expenses controlled by the parent are reported in the consolidated
statement of profit or loss and other comprehensive income.
1.2 Allocation of profit and other comprehensive income

Non-controlling interest needs to be allocated its share of profit for the year and total
comprehensive income for the year as follows:
Revenue
Add all of P + 100% S as represents what is controlled

Profit for the year (PFY)
Other comprehensive income
Total comprehensive income (TCI)
Profit for the year attributable to:

Owners of parent β – balancing figure
NCI S's PFY × NCI%
Ownership reconciliation
Total comprehensive income for the year attributable to:
Owners of parent β – balancing figure
NCI S's TCI × NCI%
A working is required to calculate non-controlling interests in profit and total comprehensive

income for the year:
Total
comprehensive
Profit for the income for the
year (PFY) year (TCI)
$ $
S’s PFY/S’s TCI per the question X X
Consolidation adjustments affecting the subsidiary’s
profit:
• Impairment loss on goodwill for the year (Non-
controlling interest (NCI) is measured at fair value at
acquisition) (X) (X)
• Provision for unrealised profit (if the subsidiary is the
seller) (X) (X)
• Interest on intragroup loans (X)/X (X)/X
• Fair value adjustments – movement in the year (X)/X (X)/X
A B
NCI share NCI % × A NCI % × B
HB2022
9: The consolidated statement of profit or loss and other comprehensive income 219

1.3 Basic procedure
Step 1 Read the question and create a short note in your blank spreadsheet workspace, or in
the scratch pad, which shows:
• The group structure
- The percentage owned
- Acquisition date
- Pre- and post-acquisition profits
Remember if the subsidiary was acquired during the year it may be useful to create a
quick timeline (Section 1.4).
Step 2 Enter a proforma SPLOCI in your spreadsheet workspace.
• Remember to add lines for the NCI in profit it in the year and NCI in total
comprehensive income reconciliations at the foot of the statement.
Step 3 Transfer figures from the parent and subsidiary financial statements to the proforma:
• 100% of all income/expenses (or if acquired in the year, time apportioned if
appropriate)
• Exclude dividends from subsidiary (Section 1.6)
Step 4 Go through question, calculating and making the necessary adjustments to profit for the
year to eliminate the effects of:
• Intragroup trading (Section 2)
• Intragroup loans and interest (Section 3)
• Fair value adjustments (Essential reading Chapter 9, available in the digital edition of
the Workbook)
• Remember to make the adjustments in the NCI working where the subsidiary’s profit is
affected
Step 5 Complete NCI in subsidiary’s PFY and TCI calculation (Section 1.2).
Exam focus point

The December 2019 and July 2020 Examiner’s reports both noted that a big disappointment in
the Section C group accounts preparation question was the number of students who
neglected to split the profit between the parent’s shareholders and the non-controlling interest
(NCI). This is a fundamental part of a consolidated statement of profit or loss, and too many
students lost substantial marks by not attempting this. The split of profit is an essential
element of this type of question and will continue to be tested. There is no reason for students
to not attempt this.
1.4 Mid‑year acquisitions

Simply include results in the normal way but only from date of acquisition ie time apportion them
as appropriate. Assume revenue and expenses accrue evenly unless told otherwise.
Exam focus point

The July 2020 Examiner’s report noted that accounting correctly for mid-year acquisitions is
an area of weakness among candidates. Many candidates fail to time-apportion the figures of
a subsidiary with a mid-year acquisition. This is a regularly tested area and one which we
would expect students to know. Failure to time-apportion is a fundamental error by not
recognising the principle of only consolidating the results from the date of acquisition.
HB2022

Essential reading
Chapter 9, Section 1 of the Essential reading provides further detail and an Activity on the pre-
and post-acquisition profits.
1.5 Impairment losses

Only impairment losses arising in the current year are reported in the consolidated statement of
profit or loss and other comprehensive income (while cumulative impairment losses to date are
reported in the statement of financial position).
1.6 Intragroup dividends

If the parent has some dividend income from the subsidiary in its SPLOCI, this must be cancelled
on consolidation for the following reasons:
• It is showing the legal form (the parent owns shares in the subsidiary and earns dividends from
the shares) rather than the substance (the parent controls the subsidiary’s income, expenses
and OCI) so dividend income is replaced by adding across the subsidiary’s results line by line.
This is similar to the cancellation of the investment in the subsidiary when preparing the
consolidated statement of financial position.
• The aim of the consolidated SPLOCI is to show the group as a single entity. Therefore,
intragroup transactions must be cancelled. Dividends paid are reported as a deduction to
retained earnings in the statement of changes in equity (SOCIE). Therefore, the dividend
income in the parent’s SPLOCI is cancelled with the deduction in retained earnings in the
subsidiary’s SOCIE.
Activity 1: Basic consolidated statement of profit or loss
The statements of profit or loss and other comprehensive income of Portus Co and its subsidiary
Sanus Co for the year ended 31 December 20X4 are as follows:
Portus Co Sanus Co
$’000 $’000
Revenue 28,500 11,800
Cost of sales (17,100) (7,000)
Gross profit 11,400 4,800
Expenses (4,400) (2,200)
Finance costs (400) (200)
Profit before tax 6,600 2,400
Income tax expense (2,100) (800)
PROFIT FOR THE YEAR 4,500 1,600
Other comprehensive income:
Gains on property revaluation 900 400
TOTAL COMPREHENSIVE INCOME FOR THE YEAR 5,400 2,000
Note. On 1 April 20X4, Portus Co purchased an 80% holding in Sanus Co for $13.8 million in cash.
Sanus’s total comprehensive income for the year ended 31 December 20X4 was $2.0 million,
accruing evenly over the year. Sanus Co did not pay any dividends in the year. Portus Co paid
dividends of $3 million in the year.
HB2022

Required
Using the proformas provided, prepare the consolidated statement of profit or loss and other
comprehensive income for the Portus Group for the year ended 31 December 20X4 (excluding
consolidation adjustments).
Solution
PORTUS GROUP
CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR
THE YEAR ENDED 31 DECEMBER 20X4
$’000
Revenue
Cost of sales
Gross profit
Expenses
Finance costs
Profit before tax
Income tax expense
PROFIT FOR THE YEAR
Gains on property revaluation
Other comprehensive income for the year
TOTAL COMPREHENSIVE INCOME FOR THE YEAR
Profit attributable to:
Owners of the parent
HB2022

$’000
Total comprehensive income attributable to:
Owners of the parent
Workings
1 Group structure
Portus Co
1.4.X4
80%
Cost $13.8m
Sanus
($10.6m – ($2.0m × 9/12))
or ($10.6m – $2.0m + ($2.0 × 3/12))
2 Non-controlling interests (SPLOCI)
Profit for Total comp

the year income
$’000 $’000
PFY/TCI per
× ×
% %
HB2022

2.1 Issue
There are two issues caused by intragroup trading to address in the consolidated SPLOCI.
Consider the following:
Example
3rd party
supplier
Supplier sells goods

to P for $1,600
P sells goods on to S
80% for $2,000, making a
profit of $400
S holds inventories of
S
$2,000 at the year end
After this transaction, the individual company and consolidated statements of profit or loss
(before cancellation of intragroup trading) look like this:
P S Consolidated
$ $ $ $ $ $
Revenue 2,000 – 2,000
Cost of sales:
Opening inventory – – –
Purchases 1,600 2,000 3,600
Closing inventory (–) (2,000) (2,000)
(1,600) (–) (1,600)
Gross profit 400 – 400
The two issues are:

(a) Intragroup revenue and cost of sales
When considering the group as if it were a single entity, intragroup trading represents
transactions which the group undertakes with itself. These have to be eliminated in the
consolidated SPLOCI. In this Illustration, the intragroup revenue of $2,000 and intragroup
purchase of $2,000 (in cost of sales) must be eliminated.
(b) Unrealised profit
The value of inventories in consolidated cost of sales also needs to be adjusted to ensure that
it represents the cost to the group. As closing inventory is a deduction from cost of sales,
unrealised profit is eliminated from inventory by increasing cost of sales. In this Illustration,
closing inventory must be reduced from $2,000 to the $1,600 cost to the group by increasing
cost of sales by $400. Increasing cost of sales reduces the gross profit, thereby successfully
removing the unrealised profit.
After these adjustments, the consolidated statement of profit or loss is now as follows:
HB2022

P S Adj Consolidated
$ $ $ $ $ $ $
Revenue 2,000 – (2,000) –
Cost of sales:
Opening inventory – – –
Purchases 1,600 2,000 (2,000) 1,600
Closing inventory (–) (2,000) 400 (1,600)
(1,600) (–) (–)
Gross profit 400 – –
Note. The intragroup revenue and purchase of $2,000 have been eliminated leaving the $1,600
purchase from the third-party supplier. Closing inventory has been reduced to the cost to the
group of $1,600 and the unrealised profit of $400 has been eliminated.
2.2 Method
There are two potential adjustments needed when group companies trade with each other:
2.2.1 Eliminate intragroup transactions

Intragroup transactions need to be eliminated from the revenue and cost of sales figures:
$ $
DEBIT Group revenue X
CREDIT Group cost of sales X
With the total amount of the intragroup sales between the companies. This adjustment is needed
regardless of whether any of the goods are still in inventories at the year end or not.
2.2.2 Eliminate unrealised profit

An adjustment is required to cancel any unrealised profit in respect of any goods still in inventories
at the year end:
DEBIT Cost of sales (SOPL)/Retained

earnings X (PUP)
CREDIT Inventories (SOFP) X (PUP)
An adjustment will also need to be made in the NCI calculation if it is the subsidiary that makes
the sale.
Note. You should be aware that whilst this section focuses on the transfer of goods between group
companies, the transfer of non-current assets (as covered in Chapter 8) may also impact on the
consolidated statement of profit or loss. Recall that there were two adjustments when non-current
assets are transferred:
(a) An adjustment to alter retained earnings (profit or loss in the year the transfer is made) and
non-current assets cost to remove unrealised profit
(b) An adjustment to alter retained earnings (profit or loss for the current year) and accumulated
depreciation so that consolidated depreciation is based on the asset’s cost to the group
You should be prepared to answer a group accounting question which includes the transfer of
goods, the transfer of non-current assets, or both in a Financial Reporting exam question.
HB2022

Activity 2: Unrealised profit
Continuing from the previous example, the statements of profit or loss and other comprehensive
income of Portus Co and its subsidiary, Sanus Co, for the year ended 31 December 20X4 are as
follows:
Portus Co Sanus Co
$’000 $’000
Revenue 28,500 11,800
Cost of sales (17,100) (7,000)
Expenses (4,400) (2,200)
Gains on property revaluation 900 400
TOTAL COMPREHENSIVE INCOME FOR THE YEAR 5,400 2,000
Notes.
1 On 1 April 20X4 Portus Co purchased an 80% holding in Sanus Co for $13.8 million in cash.
Sanus’s total comprehensive income for the year ended 31 December 20X4 was $2.0 million,
accruing evenly over the year. Sanus Co did not pay any dividends in the year. Portus Co paid
dividends of $3 million in the year.
2 At the date of acquisition, the fair value of Sanus’s assets were equal to their carrying amounts
with the exception of the items listed below which exceeded their carrying amounts by the
following amounts (see table below). Sanus Co has not adjusted the carrying amounts as a
result of the fair value exercise. The inventories were sold by Sanus Co before the year end.
3 The NCI in Sanus Co is to be valued at its fair value of $3.2 million at the date of acquisition.
An impairment test conducted at the year-end revealed that the consolidated goodwill of
Sanus Co was impaired by $150,000.
4 On 1 October 20X4, Sanus Co sold goods to Portus Co for $200,000 at a gross profit margin
made between Portus Co and Sanus Co in the year. At 31 December 20X4, Portus Co’s current
account with Sanus Co was $130,000 (credit). This did not agree with the equivalent balance
in Sanus’s books due to cash in transit of $70,000 which was not received by Sanus Co until
after the year end.
$’000
Inventories 300
Plant and equipment (10-remaining useful life) 1,200
1,500
Required
1 Prepare the consolidated statement of profit or loss and other comprehensive income for the
Portus Group for the year ended 31 December 20X4.
HB2022

2 Explain how the statement of profit or loss and other comprehensive income would differ if
Portus Co had sold the goods in Note (4) to Sanus.
Solution
1
PORTUS GROUP
CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME
FOR THE YEAR ENDED 31 DECEMBER 20X4
$’000
Revenue
Cost of sales
Gross profit
Expenses
Finance costs
Profit before tax
Income tax expense
PROFIT FOR THE YEAR
Owners of the parent (β)
NCI (W2)
HB2022

$’000
NCI (W2)
Workings
1 Group structure
Portus Co
1.4.X4
80%
Cost $13.8m
Sanus
($10.6m – ($2.0m × 9/12))
or ($10.6m – $2.0m + ($2.0 × 3/12))
Total comp
Profit for the year income
$’000 $’000
PFY/TCI per question
Less impairment losses (per question)
Less fair value movement (W3)
Less unrealised profit (W4)
× 20% × 20%
At acquisition
$’000 $’000 $’000
Inventories –
HB2022

At acquisition
$’000 $’000 $’000
Plant and equipment
Take to COS &

Take to Goodwill reserves Take to SOFP
(1) Cancel intragroup trading
$’000 $’000
DEBIT Group revenue
CREDIT Group purchases (COS)

Sanus:
Profit element in inventories:

$’000 $’000
DEBIT Cost of sales (& reserves) (of Sanus Co – the

seller)
CREDIT Group inventories
3 Intragroup loans and interest

3.1 Issue
It is common for a parent to advance a loan at a preferential interest rate to a subsidiary.
Similarly, a loan may be made by a cash-rich subsidiary to its parent.
HB2022

These items are intragroup borrowings which do not represent additional finance or finance costs
from the group point of view, and must therefore be eliminated on consolidation.
3.2 Method
3.2.1 Cancel the loan in the consolidated statement of financial position
Adjustment is required to cancel the loans in the consolidated statement of financial position:
The loan balance will be a receivable in the statement of financial position of the provider of the
loan and a payable to the recipient of the loan. The balances need to be cancelled in the
consolidated statement of financial position:
$ $
DEBIT Loan payable X
CREDIT Loan receivable X
3.2.2 Cancel the finance cost and finance income in the consolidated statement of profit or
loss and other comprehensive income
The provider of the loan will present finance income in its statement of profit or loss and the
recipient of the loan will show a finance cost. This is an intragroup income and expense which
must be cancelled in the consolidated statement of profit or loss and other comprehensive
income:
$ $
DEBIT Group finance income X
CREDIT Group finance costs X
Example
P acquired 100% of S on its incorporation. On the same date, P made a fixed rate 4% loan to S.
The loan has not been repaid at the year end. The loan is eliminated on consolidation as follows:
STATEMENTS OF FINANCIAL POSITION
P S Adjustment Consolidated
$’000 $’000 $’000 $’000
Non-current assets
Property, plant and
equipment 6,200 3,050 9,250
Investment in S 1,000 – –
4% loan to S 400 – (400) –
7,600 3,050 9,250
Current assets 1,350 850 2,200
8,950 3,900 11,450
Equity
Share capital 800 1,000 800
Retained earnings 6,900 1,800 8,700
7,700 2,800 9,500
HB2022

$’000 $’000 $’000 $’000
Bank loan 200 – 200
4% loan from P – 400 (400) –
200 400 200
Current liabilities 1,050 700 1,750
8,950 3,900 11,450
STATEMENT OF PROFIT OR LOSS
$’000 $’000 $’000 $’000
Revenue 2,200 1,100 3,300
Cost of sales and expenses (1,540) (770) (2,310)
Profit before interest and
tax 660 330 990
Finance income (from S) 16 – (16) –
Finance costs (20) (16) (16) (20)
Profit before tax 656 314 970
Income tax expense (196) (94) (290)
PROFIT FOR THE YEAR 460 220 680

We saw in Chapter 8 that both the consideration transferred and the net assets at acquisition in
the goodwill working must be measured at fair value to arrive at goodwill.
The fair value of the consideration transferred is not relevant to the consolidated SPLOCI.
However, the fair value adjustments made to net assets at acquisition may impact on the
consolidated SPLOCI in subsequent periods.
4.1 Impact on the consolidated SPLOCI

4.1.1 Income and expense lines
Fair value adjustments at acquisition typically impact on the consolidated SPLOCI in subsequent
periods due to the deprecation of revalued assets, the sale of assets or the settlement of liabilities.
Adjustments should be posted to the relevant line(s) in the consolidated SPLOCI. For example:
• Movement in inventories (due to sale) post to ‘cost of sales’.
• Movement in property, plant and equipment (due to depreciation or sale) post to ‘cost of sales’,
‘distribution costs’ or ‘administrative expenses’ depending on the how the asset is used in the
business.
4.1.2 Impact on NCI

Posting the movement in the year on the fair value adjustments to the consolidated SPLOCI will
result in an increase or decrease in the subsidiary’s profit for the year, so it should also be
adjusted for in the NCI working:
HB2022

PFY TCI
$ $
S’s PFY/TCI per the question X X
Consolidation adjustments affecting the subsidiary’s profit, eg:
• Impairment loss on goodwill for the year (if NCI is measured
at fair value at acquisition) (X) (X)
• Provision for unrealised profit (if the subsidiary is the seller) (X) (X)
• Fair value adjustment – movement in the year (X)/X (X)/X
A B
NCI share NCI % × A NCI % × B
Illustration 1: Fair value adjustments
P acquired 60% of the ordinary share capital of S on 1 January 20X0. At 1 January 20X0, the fair
value of S’s net assets was the same as their carrying amount with the exception of a factory. The
fair value of the factory was $500,000 higher than its carrying amount. At acquisition, the
remaining useful life of the factory was 20 years. Depreciation on the factory is presented in cost
of sales.
In the year ended 31 December 20X4, P and S had cost of sales of $900,000 and $700,000
respectively and profits for the year of $3.9 million and $2.1 million respectively.
Required
Calculate the following figures for inclusion in the consolidated statement of profit or loss of the P
Group for the year ended 31 December 20X4:
(1) Cost of sales
(2) Profit for the year attributable to non-controlling interest
Solution
Step 1 Calculate the movement in the fair value adjustments in the year
= $500,000 fair value adjustment on factory × 1/20 depreciation = $25,000
Step 2 Calculate consolidated cost of sales
$’000
P 900
S 700
Fair value adjustment - movement in the year 25
1,625
Step 3 Calculate profit for the year attributable to NCI
HB2022

$’000
Per question 2,100
Fair value adjustment – movement in the year (25)
2,075
NCI share × 40%
= 830
HB2022

Chapter summary
The consolidated statement of profit or loss and other comprehensive income (SPLOCI)
Approach to the consolidated statement of profit or loss Intragroup

and other comprehensive income (SPLOCI) trading
Aim of the consolidated SPLOCI Issue

Show group as a single entity • Treat group as if it were a
single entity
• Eliminate intragroup trading
Allocation of profit and other comprehensive income and unrealised profit
Non-controlling interests (NCI)
Working:
Method
PFY TCI
$ $ • Eliminate intragroup revenue
Per question X X and cost of sales
DEBIT (↓) Group revenue
CREDIT (↓) Group cost for
profit:
sales
Impairment loss on goodwill for year (if NCI at fair
for all intragroup trading in
value at acq’n) (X) (X)
the year
Provision for unrealised profit (if sub is the seller) (X) (X)
• Eliminate unrealised profit on
Interest on intra group loans (X)/X (X)/X
goods still in inventory at the
Fair value adjustments – movement in the year (X)/X (X)/X year end
A B DEBIT (↑) Cost of sales
NCI share NCI % A NCI % B CREDIT (↓) Inventories
Basic procedure
• Draw up group structure, % ownership, date of acquisition
• Create proforma
• Transfer parent and 100% sub to proform (pro-rate mid year)
• Adjust for intragroup trading, loans, fair value adjustments
• Complete NCI calculations
Mid year acquisitions

Include results from date of acquisition
Impairment
Only current year impairment losses included
Dividends paid to subsidiary

• Dividends paid to the parent are eliminated on consolidation
• Remove dividend income and reinstate subsidiary retained earnings
HB2022

Intragroup loans
and interest
Issue
• Intragroup borrowings do not
represent:
– Amounts owed/owing
– Additional finance
income/expense
– From a group perspective
Method
• Cancel the loan
DEBIT (↓) Loan payable
CREDIT (↓) Loan receivable
• Eliminate the interest
DEBIT (↓) Finance income
CREDIT (↓) Finance expense
HB2022

1. Approach to the consolidated statement of profit or loss and other comprehensive income
The purpose of the consolidated statement of profit or loss and other comprehensive income is to
show the results of the group as a single business entity.
Where an acquisition occurs part way through an accounting period, income and expenses are
only consolidated for the number of months that the subsidiary is controlled by the parent.
2. Intragroup trading
In order not to overstate group revenue and costs, intragroup trading is cancelled. Similarly,
unrealised profits on intragroup trading are eliminated.
3. Intragroup loans and interest

Intragroup loans and interest must be cancelled as the group is treated as a single business entity
and cannot lend money to itself.
4. Fair value adjustments

Fair value adjustments on acquisition of a subsidiary may have an impact on the consolidated
statement of profit or loss and other comprehensive income. The impact on non-controlling
interest also needs to be reflected.
HB2022

Question practice
You should attempt the following questions from the Further question practice (available in the
digital edition of the Workbook):
Section A Q9 and Q10
Section C Q33 Fallowfield Co and Rusholme Co
Section C Q34 Panther Group
Further reading
You should make time to read the following articles, which is available in the study support
resources section of the ACCA website:
Watch your step
The use of fair values in the goodwill calculation
www.accaglobal.com
HB2022

Activity answers
Activity 1: Basic consolidated statement of profit or loss

PORTUS GROUP
$’000
Revenue (28,500 + (11,800 × 9/12)) 37,350
Cost of sales (17,100 + (7,000 × 9/12)) (22,350)
Gross profit 15,000
Expenses (4,400 + (2,200 × 9/12)) (6,050)
Finance costs (400 + (200 × 9/12)) (550)
Profit before tax 8,400
Income tax expense (2,100 + (800 × 9/12)) (2,700)
PROFIT FOR THE YEAR 5,700
Gains on property revaluation (900 + (400 × 9/12)) 1,200
Other comprehensive income for the year 1,200
TOTAL COMPREHENSIVE INCOME FOR THE YEAR 6,900
Owners of the parent 5,460
Non-controlling interests (W2) 240
5,700
6,900
HB2022

Workings
1 Group structure
Portus Co
1.4.X4
80%
Cost $13.8m
Sanus
($10.6m – ($2.0m × 9/12))
or ($10.6m – $2.0m + ($2.0 × 3/12))
Profit for Total comp

the year income
$’000 $’000
PFY/TCI per question (1,600 × 9/12)/(2,000 × 9/12) 1,200 1,500
× 20% × 20%
240 300
Activity 2: Unrealised profit

1
1 PORTUS GROUP
$’000
Revenue (28,500 + (11,800 × 9/12) – 200 (W4)) 37,150
Cost of sales (17,100 + (7,000 × 9/12) + 390 (W3) – 200 (W4) + 80 (W4)) (22,620)
Expenses (4,400 + (2,200 × 9/12) + (150 per question) (6,200)
Finance costs (400 + (200 × 9/12)) (550)
HB2022

$’000
Owners of the parent (β) 4,964
NCI (W2) 116
5,080
NCI (W2) 176
6,280
Workings
1 Group structure
Portus Co
1.4.X4
80%
Cost $13.8m
Sanus
($10.6m – ($2.0m × 9/12))
or ($10.6m – $2.0m + ($2.0 × 3/12))
Total comp
Profit for the year income
$’000 $’000
PFY/TCI per question (1,600 × 9/12)/(2,000 ×

9/12) 1,200 1,500
Less impairment losses (per question) (150) (150)
Less fair value movement (W3) (390) (390)
Less unrealised profit (W4) (80) (80)
580 880
× 20% × 20%
116 176
HB2022

At acquisition
$’000 $’000 $’000
(390)
1,500 Take to COS & 1,110
Take to Goodwill reserves Take to SOFP
*Extra depreciation $1,200,000 × 1/10 × 9/12
(1) Cancel intragroup trading
$’000 $’000
DEBIT Group revenue 200
CREDIT Group purchases (COS) 200

Sanus:
$’000 $’000
DEBIT Cost of sales (& reserves) (of Sanus Co – the

seller) 80
2 If Portus Co (the parent) sold the inventories rather than Sanus Co, there would be no change
on the top half of the statement of profit or loss and other comprehensive income. However, in
the reconciliation of profit and total comprehensive income attributable to owners of the
parent and to non-controlling interests, unrealised profit would no longer affect profit
attributable to non-controlling interests. Non-controlling interests would therefore be:
Profit for the Total comp

year income
$’000 $’000
Less impairment losses (per question) (150) (150)
Less fair value movement (W3) (390) (390)
660 960
× 20% × 20%
132 192
Profit and total comprehensive income attributable to owners of the parent would therefore
decrease by the amount of the increase in the respective non-controlling interest, as they are
calculated as residual figures.
HB2022

HB2022

Changes in group
10 structures: disposals
10
Learning objectives
Syllabus reference
no.

group (parent and up to two subsidiaries controlled by the parent and
one associate of the parent) dealing with pre- and post-acquisition
profits, non-controlling interest (at fair value or as a proportion of net
assets at the acquisition date) and consolidated goodwill.
Prepare a consolidated statement of profit or loss and consolidated D2(b)

statement of profit or loss and other comprehensive income for a simple
group dealing with an acquisition or disposal in the period and non-
controlling interest.
Explain and illustrate the effect of the disposal of a parent’s investment D2(h)
in a subsidiary in the parent’s individual financial statements and/or
those of the group, including as a discontinued operation (restricted to
disposals of the parent’s entire investment in the subsidiary)
10
Exam context
You may be asked to calculate the effects of the disposal of a subsidiary in an OT question in
Section A or B. You should be prepared for an OT question that asks you to calculate the gain or
loss on disposal, the amount that would be presented as the profit or loss from discontinued
operations in the statement of profit or loss, or to calculate balances in the consolidated
statement of financial position after taking account of a disposal.
In Section C, disposals could feature if you are asked to prepare consolidated financial
statements, or the disposal of a subsidiary could be an important reason for the difference
between ratios, if comparing consolidated financial statements across two different periods.
HB2022

10
Chapter overview
Disposals of subsidiaries
Disposals Full disposal
Group financial statements – Full disposal
Group profit or loss on disposal
Parent's separate financial statements
HB2022

1 Disposals
Disposals, in the context of changes in group structure, occur when the parent company sells
some or all of its shareholding in a group company:
• Full shareholding is sold = full disposal.
• Only some shareholding is sold = partial disposal.
For a full or partial disposal of a shareholding in a subsidiary, there are four outcomes:
Disposal
Control is retained Control is lost
Subsidiary to Full disposal Subsidiary to Subsidiary to

subsidiary (subsidiary to no associate investment
(partial disposal, shareholding) (partial disposal, (partial disposal,
eg 70% to 60% eg 70% to 30% eg 70% to 10%
shareholding) shareholding) shareholding)
Exam focus point

The Financial Reporting examining team has made it clear that you will only be required to
account for the full disposal of subsidiaries in the exam. You may be faced with the situation
where a group has only one subsidiary, and therefore ceases to be a group after the disposal,
or the situation where there is another subsidiary within the group and therefore a group
continues after disposal.
When a full disposal takes place during the year:

• A consolidated statement of profit or loss and other comprehensive income (CSPLOCI) will
always be required when a subsidiary has been held for at least part of the year. If a
subsidiary is disposed of during the accounting period, its results are pro-rated accordingly.
• If the subsidiary disposed of was the only subsidiary in the group, there ceases to be a group
after disposal and a consolidated statement of financial position (CSOFP) is not required at
the period end. If there is another subsidiary within the group, a CSOFP will be prepared,
excluding the subsidiary disposed of. There is no pro-rating when preparing the CSOFP.
1.1 Accounting treatment in the financial statements of the parent

In the parent’s separate financial statements, investments in subsidiaries are held at cost or at fair
value under IFRS 9 (IAS 27: para. 10).
The profit or loss on disposal is calculated by comparing the proceeds on disposal with the
carrying amount of the investment at the date of disposal:
$
Fair value of consideration received X
Less carrying amount of investment disposed of (X)
Profit/(loss) X(X)
HB2022
10: Changes in group structures: disposals 245

2 Accounting treatment in the consolidated financial
statements
2.1 Presentation
2.1.1 Consolidated statement of profit or loss
If a parent disposes of all of its shareholding in a subsidiary, the accounting treatment is:
• Consolidate the results of the subsidiary to the date of disposal (pro-rata) and allocate the
relevant amounts to non-controlling interests.
• Calculate and account for the group gain or loss on disposal.
• Consider whether the disposal meets the definition of a discontinued operation in accordance
with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations (covered in Chapter
18 of this Workbook). Separate presentation of the profit or loss of the subsidiary and the gain
or loss on its disposal is required if the disposal meets the criteria of a discontinued operation.
2.1.2 Consolidated statement of financial position

• If the subsidiary disposed of was the only subsidiary of the parent, no consolidation (and no
non-controlling interests) is required as there is no subsidiary at the year end.
• If a group remains after disposal, a consolidated statement of financial position is required
which will exclude any balances and non-controlling interests relating to the subsidiary
disposed of.
2.1.3 Calculation of group profit or loss on disposal

The group profit or loss on the full disposal of a shareholding is calculated as:
$ $
Fair value of consideration received X
Less: Share of consolidated carrying amount at date control lost:
Net assets at date control lost X
Goodwill at date control lost X
Less non-controlling interests at date control lost (X)
(X)
Group profit/(loss) (recognise in CSPL) X/(X)
(IFRS 10: para. 25, B97–B98)

Note. Where significant, the profit or loss should be disclosed separately. (IAS 1: para. 85)
Activity 1: Profit or loss on disposal of subsidiary
Pelmer Co acquired 80% of Symta Co’s 100,000 $1 shares on 1 January 20X2 for $600,000 when
the net assets of Symta Co were $410,000. In addition to its net assets, Symta Co had a brand
name valued at $50,000 which was recognised on acquisition. It is group policy to measure non-
controlling interests at fair value at acquisition. The fair value of the non-controlling interests in
Symta Co at acquisition was $150,000. No impairment has been necessary.
On 1 June 20X6, Pelmer Co disposed of its shareholding for $1,500,000. At that date, Symta Co’s
statement of financial position showed net assets with a carrying amount of $660,000. The value
of the brand name which is not recognised in the individual financial statements of Symta Co, has
not changed since acquisition. The individual financial statements of Pelmer Co do not include
any profit or loss on the dispoal of Symta Co.
HB2022

Required
1 What is the group profit or loss on disposal of Symta Co to be shown in the consolidated
accounts for the year ended 31 December 20X6?
 $500,000
 $650,000
 $700,000
 $900,000
2 What is the profit or loss on disposal in the separate financial statements of Pelmer Co?
Solution
Illustration 1: Full disposal of a subsidiary
The summarised statements of profit or loss and other comprehensive income of Mart, Oat and
Pipe are shown below.
SUMMARISED STATEMENTS OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
YEAR ENDED 30 APRIL 20X4
Mart Oat Pipe

$m $m $m
Revenue 800 140 230
Cost of sales and expenses (680) (90) (170)
Profit before tax 120 50 60
Income tax expense (30) (15) (20)
Profit for the year 90 35 40
Other comprehensive income for the year (net of tax)
Gains on property revaluation 20 5 10
Total comprehensive income for the year 95 40 50
HB2022

Zusätzliche Informationen
(1) Mart has owned 60% of the equity interest in Oat for several years.
(2) On 1 May 20X2, Mart acquired 80% of the equity interests of Pipe. The purchase
consideration comprised cash of $250 million and the fair value of the identifiable net assets
acquired was $300 million at that date, which was equal to their carrying amount.
(3) There has been no impairment of goodwill in either Oat or Pipe since acquisition.
(4) Mart disposed of its equity interest in Pipe on 31 October 20X3 for $330 million. At that date
Pipe’s net assets were $370 million.
(5) Mart wishes to measure the non-controlling interest at its proportionate share of net assets at
the date of acquisition.
(6) The individual financial statements of Mart do not include any profit or loss on the disposal of
Pipe.
(7) Mart does not meet the criteria to be recognised as a discontinued operation.
Required
1 Calculate the group profit on disposal of the shares in Pipe.
2 Prepare the consolidated statement of profit or loss and other comprehensive income for the
year ended 30 April 20X4 for the Mart Group.
Solution
1 Group profit on disposal of the shares in Pipe
Group structure
Mart
1.5.X2 80% Subsidiary

60% 31.10.X3 (80%) Disposal
Oat Pipe
Calculate goodwill in Pipe (for inclusion in the group profit on disposal calculation)
Goodwill
$m
Consideration transferred 250
Non-controlling interests (20% × 300) 60
Fair value of identifiable net assets (300)
10
Calculate non-controlling interests at the disposal date (for inclusion in the group profit on
disposal calculation)
Non-controlling interests (SOFP)
$m
NCI at acquisition (20% × 300) 60
NCI share of post-acquisition reserves to disposal (20% × [370 – 300]) (note) 14
74
Note. In this question reserves were not provided. However, net assets at acquisition and
disposal were given. As net assets = equity, the movement in net assets will be the movement in
reserves (as there has been no share issue by Pipe).
HB2022

Calculate the group profit on disposal
$m $m
Fair value of consideration received 330
Less share of consolidated carrying amount at date control
lost
Net assets 370
Goodwill 10
Less non-controlling interests (74)
(306)
Group profit on disposal 24
2 Consolidated statement of profit or loss and other comprehensive income for the year ended
30 April 20X4
Draw up a timeline to work out the treatment in the consolidated statement of profit or loss
and other comprehensive income (SPLOCI)
Oat was a subsidiary for the full year so should be consolidated for a full year. However, there
was a change in the shareholding in Pipe in the year as shown below.
1.5.X3 31.10.X3 30.4.X4
SPLOCI
Consolidate for 6/12
NCI 20% for 6/12
Had 80% of Pipe Sold Pipe
Calculate non-controlling interests (NCI)

In profit for the year:
Oat Pipe Total

$m $m $m
Per question (40 × 6/12) (Note) 35 20
NCI share × 40% × 20%
= 14 =4
Total NCI in profit for the year (14 + 4) = 18
Note. Pro-rate Pipe as it was only a subsidiary for 6 months in the year (1.5.X3 – 31.10.X3).
In total comprehensive income:
Oat Pipe Total

$m $m $m
Per question (50 × 6/12) (Note) 40 25
NCI share × 40% × 20%
= 16 =5
Total NCI in other comprehensive income for the
year (16 + 5) = 21
Note. Pro-rate Pipe as it was only a subsidiary for 6 months in the year (1.5.X3 – 31.10.X3).
HB2022

Step 7
Prepare the consolidated statement of profit or loss and other comprehensive income
$m
Revenue (800 + 140 + [6/12 × 230]) 1,055
Cost of sales and expenses (680 + 90 + [6/12 × 170]) (855)
Profit on disposal of share in subsidiary 24
Profit before tax 224
Income tax expense (30 + 15 + [6/12 × 20]) (55)
Profit for the year 169
Other comprehensive income for the year (net of tax)
Gains on property revaluation (20 + 5 + [6/12 × 10]) 30

Total comprehensive income for the year 199

Owners of the parent (169 – 18) 151
Non-controlling interests 18
169
Owners of the parent (199 – 21) 178
Non-controlling interests 21
199
2.2 The relationship between the profit or loss in the parent’s separate
financial statements and the group profit or loss on disposal
We have seen how to calculate the profit or loss on disposal of a subsidiary in the separate
financial statements of the parent and in the consolidated financial statements.
In the parent’s individual financial statements, the carrying amount of the subsidiary is not
changed to reflect the change in the net assets of the subsidiary after the date of acquisition. The
group financial statements do reflect the group share of the change in the subsidiary’s net assets
after the date of acquisition, hence the difference in the profit or loss on disposal.
The following example will help to demonstrate the relationship.
Illustration 2: Relationship between profit on disposal of a subsidiary in the

separate financial statements of the parent and the consolidated financial
statements
Using the information in Activity 1 Profit or loss on disposal of a subsidiary, we saw that the profit
on disposal in the separate financial statements of Pelmer Co was $900,000 and the profit on
disposal in the consolidated financial statements was $700,000.
HB2022

Required
Explain the difference between the profit on disposal in the separate and consolidated financial
statements.
Solution
The investment in the Symta Co is held at its cost of $600,000 in the separate financial
statements of Pelmer Co. The carrying amount of the investment does not reflect the increase in
Symta Co’s net assets post acquisition. Symta Co’s net assets have increased from $410,000 at
acquisition to $660,000 at the date of disposal. The group share of this is $200,000 (80% ×
(660,000 – 410,000)), which is the same amount as the difference between the profit of $900,000
in the separate financial statements of Pelmer Co and the profit of $700,000 in the consolidated
Note. If the parent’s profit or loss on disposal has been recognised in the parent’s individual
financial statements, it will be included in the parent’s retained earnings on consolidation. In such
a case, an adjustment is needed to account for the parent’s share of the movement in the net
assets of the subsidiary between the date of acquisition and the date of disposal.
Exam focus point

You should only discuss the accounting in the parent’s separate financial statements if
specifically requested to do so in the exam.
Exam focus point

The FR Examining team has stated that the following scenarios relating to the disposal of
subsidiaries are examinable:
• A parent plus two subsidiaries to be consolidated, where there is no disposal (ie, you might
be asked to consolidate two subsidiaries)
• A parent plus two subsidiaries in which one is disposed of
• A parent with one subsidiary which is disposed of
• A mid-year disposal with the need for time-apportionment and subsequent impact on NCI
in the consolidated statement of profit or loss and other comprehensive income
The FR Examining team has confirmed that you will not be asked to prepare a consolidated
statement of financial position if there has been a mid-year disposal.
HB2022

Chapter summary
Disposals of subsidiaries
Disposals
Disposal
Control is retained Control is lost
Subsidiary to subsidiary Full disposal (subsidary Subsidiary to associate Subsidiary to investment

(partial disposal) to no shareholding) (partial disposal) (partial disposal)
Full disposal
Group financial statements – Full disposal

• SPLOCI:
– Consolidate/time apportion results/NCI to date
of disposal
– Nothing after
• SOFP:
– No consolidation if only sub is disposed of
– CSOFP required if group remains after disposal
Group profit or loss on disposal

FV consideration received X
Less share of consol carrying amount
at date control lost:
Net assets X
Goodwill X
Less NCI (X)
(X)
X/(X)
Parent's separate financial statements

Calculation of gain/(loss) on disposal:
FV consideration received X
Less carrying amount of investment (X)
X/(X)
HB2022

1. Disposals where significant influence or control is lost

The accounting treatment in the group financial statements is driven by the concept of substance
over form.
When a full disposal occurs, the subsidiary is derecognised in the group financial statements and
a gain/loss on disposal is calculated, being the difference between the fair value of the
consideration received less the carrying amount of the subsidiary in the consolidated statement of
financial position.
In the consolidated statement of profit or loss and other comprehensive income, the subsidiary is
consolidated for the period up to the disposal.
A consolidated statement of financial position is only required if a group remains after the
disposal.
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Question practice
the Workbook):
Section A Q5
Section A Q19
Further reading
The Study support resources section of the ACCA website does not include any specific articles
relating to disposal, but the following provides a useful reminder about important concepts such
as pro-rating in the consolidated statement of profit or loss which are relevant to this Chapter.
• Watch your step
www.accaglobal.com
HB2022

Activity answers
Activity 1: Profit or loss on disposal of subsidiary

$’000 $’000
Less share of consolidated
carrying amount at date
control lost:
Net assets (660 + 50) 710
Goodwill (W1) 290
(W2) (200)
(800)
Gain 700
Workings
1 Goodwill
$’000
Consideration 600
NCI at fair value 150
Less: Net assets acquisition 410
Fair value adjustment 50
290
$’000
NCI at acquisition 150
Add NCI share of post-acquisition reserves
(20% × (660 – 410) 50
200
$’000
Consideration received 1,500
Cost of investment (600)
Profit on disposal 900
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HB2022

Accounting for
11 associates
11
Learning objectives
Define an associate and explain the principles and reasoning A4(j)

for the use of equity accounting.
Prepare a consolidated statement of financial position for a D2(a)

simple group (parent and up to two subsidiaries controlled by
the parent and one associate of the parent) dealing with pre-
and post-acquisition profits, non-controlling interests (at fair
value or as a proportion of net assets at the acquisition date)
and consolidated goodwill.
Prepare a consolidated statement of profit or loss and D2(b)

consolidated statement of profit or loss and other
comprehensive income for a simple group dealing with an
acquisition in the period and non-controlling interest.
11
Exam context
When investing in another company, a parent may not wish to buy a controlling stake. It may
instead buy a smaller stake but still obtain significant influence over another entity, resulting in
the group having an associate. Accounting for associates may feature in an objective test
question in Section A or B of the Financial Reporting exam. Section C of the exam may require you
to prepare and/or interpret group financial statements that contain an associate. The approach
to accounting for an associate is very different to that for a subsidiary and you must be clear on
the correct approach.
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11
Chapter overview
Associates and joint arrangements
Associates – Associates – parent's Associates – consolidated

definitions separate financial statements financial statements
Associate Equity method
Significant influence
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1 Definitions
Associate: An associate is an entity over which the investor has significant influence. (IAS 28:
KEY
TERM para. 3)
Significant influence: ‘The power to participate in the financial and operating policy decisions
of the investee but is not control or joint control over those policies.’ (IAS 28: para. 3)
Significant influence could be shown by:

(a) Representation on the board of directors
(b) Participation in policy-making processes
(c) Material transactions between the entity and investee
(d) Interchange of managerial personnel
(e) Provision of essential technical information
(IAS 28: para. 6)
1.1 Presumptions
If an investor holds, directly or indirectly:
≥ 20% of voting power < 20% of voting power

Presumption of significant influence Presumption of no significant influence
unless demonstrated otherwise unless demonstrated otherwise
(IAS 28: para. 5)
Exam focus point

In the absence of other information, you should use the percentage ownership to determine
significant influence in the exam.
Activity 1: Identifying an associate
Athens has a number of investments.

Required
Which TWO of the following are associates of Athens? Tick the correct answers.
 Crete: Athens owns 30% of the ordinary shares of Crete and appoints 8 out of 10 directors to
Crete’s board.
 Rhodes: Athens owns 25% of the ordinary shares of Rhodes but does not have the power to
participate in policy-making processes.
 Lesbos: Athens owns 50% of the ordinary shares of Lesbos and provides essential technical
information to Lesbos
 Samos: Athens owns 40% of the preference shares of Samos.
 Thassos: Athens owns 45% of the ordinary shares of Thassos and regularly sends its directors
to Thassos to assist senior management with strategic decisions.
HB2022
11: Accounting for associates 259

2 Parent’s separate financial statements
As we covered in Chapter 7, under IAS 27 Separate Financial Statements, the investment can be
recorded in the parent’s separate financial statements either:
At cost At fair value Using equity accounting method
Assumed in this As a financial asset under Only likely to be adopted for

course/ACCA FR exam IFRS 9 Financial Instruments investments in associates when
the parent does not prepare
consolidated financial statements
(IAS 27: para. 10)
3 Accounting treatment
3.1 Consolidated financial statements
An investment in an associate is accounted for in consolidated financial statements using the
equity method.
3.1.1 Equity method

The equity method is defined by IAS 28 Investments in Associates and Joint Ventures.
Equity method: ‘A method of accounting whereby the investment is initially measured at cost
KEY
TERM and adjusted thereafter for the post-acquisition change in the investor’s share of the investee’s
net assets. The investor’s profit or loss includes its share of the investee’s profit or loss and the
investor’s other comprehensive income includes its share of the investee’s other comprehensive
income.’ (IAS 28: para. 3)
Essential reading
Chapter 11, Section 1 of the Essential reading provides more detail on the requirement to apply
equity accounting.
3.1.2 Consolidated statement of financial position

The consolidated statement of financial position presents a single ‘Investment in associate’ line to
reflect any associates of the group.
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CONSOLIDATED STATEMENT OF FINANCIAL POSITION
Non-current assets
Investment in associate (Working) X
Working
Cost of associate X
Share of post-acquisition retained reserves X/(X)
Less impairment losses on associate to date (X)
Less group share of unrealised profit (X)
X
3.1.3 Impairment losses

After application of the equity method, any impairment losses are considered re: the investor’s net
investment in the associate as a whole in the statement of financial position. (IAS 28: para. 40)
3.1.4 Consolidated statement of profit or loss and other comprehensive income

The consolidated statement of profit or loss and other comprehensive income presents a single
‘Share of profit of the associate’ line in the profit or loss and another ‘Share of other
comprehensive income of the associate’ line in other comprehensive income. The group presents
its share of the associate’s profit for the year (ie its profit after tax) but presents this in the profit
before tax of the group.
Profit or loss $
Share of profit of associate:
A’s profit for the year × Group % X
Less Impairment losses (X)
Less Group share of unrealised profit (X)
Share of other comprehensive income of the associate
A’s other comprehensive income for the year × Group % X
Activity 2: Share of profit of associate
Holly Co owns 35% of Hock Co, its only associate. During the year to 31 December 20X4, Hock Co
made a profit for the year of $721,000. Holly Co considers its investment in Hock to have suffered
a $20,000 impairment during the year.
Required
At what amount should ‘share of profit of associate’ be stated in the consolidated statement of
profit or loss of Holly Co for the year ended 31 December 20X4?
$
3.1.5 Unrealised profit

An associate is not a group company (as the parent does not control its associates) so no
elimination of ‘intragroup’ transactions and balances is required.
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However, IAS 28 states that the investor’s share of unrealised profits and losses on transactions
between investor and associate should be eliminated in the same way as for transactions between
a parent and its subsidiaries (para. 28). It is important to remember that only the group’s share is
eliminated.
The accounting treatment depends on whether there is an upstream or downstream transaction:
• An upstream transaction occurs when an associate sells goods to a parent. In an upstream
transaction, the associate is the seller and therefore earns the unrealised profit. The parent is
the buyer and therefore holds the inventory at the year end. The adjustment required to
eliminate the unrealised profit is:
DEBIT Group share of profit of associate Group % × unrealised

(SOPL) profit
Group % ×
CREDIT Inventories (SOFP) unrealised profit
• A downstream transaction occurs when a parent sells goods to an associate. The parent is the
seller and therefore earns the unrealised profit. The associate is the buyer and therefore holds
the inventory at the year end. As the inventory of the associate is not separately presented in
the group financial statements, the adjustment is made to investment in associate and not to
inventory. The adjustment required to eliminate the unrealised profit is:
Group % × unrealised
DEBIT Cost of sales (SOPL) profit
Group % ×
CREDIT Investment in associate(SOFP) unrealised profit
Exam focus point

The Financial Reporting syllabus was amended for exams from September 2022 to make it
clear that a distinction must be made between upstream and downstream transactions. You
must pay attention to the direction of the transaction and ensure that you prepare the journal
entries as stated above.
Activity 3: Equity method
Beta purchased a 60% holding in Delta’s ordinary shares on 1 January 20X0 for $6.1 million when
the retained earnings of Delta were $3.6 million. The retained earnings of Delta at 31 December
20X4 were $10.6 million. Since acquisition, there has been no impairment of the goodwill in Delta.
Beta also has a 30% holding in Kappa’s ordinary shares, which it acquired on 1 July 20X1 for $4.1
million when the retained earnings of Kappa were $6.2 million. The retained earnings of Kappa at
31 December 20X4 were $9.2 million.
An impairment test conducted at the year end revealed that the investment in the associate
(Kappa) was impaired by $500,000.
During the year, Kappa sold goods to Beta for $3 million at a profit margin of 20%. One-third of
these goods remained in Beta’s inventories at the year end. The retained earnings of Beta at 31
December 20X4 were $41.6 million.
Required
1 State the accounting adjustment required in respect of the unrealised profit on the sale of
goods from Kappa to Beta.
2 Calculate the following amounts for inclusion in the consolidated statement of financial
position of the Beta group as at 31 December 20X4:
(a) Investment in associate
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(b) Consolidated retained earnings
Solution
Activity 4: Consolidated statement of financial position
At 31 December 20X4, the statements of financial position of Portus Co, Sanus Co and Allus Co
were as follows:
Portus Co Sanus Co Allus Co

$’000 $’000 $’000
Non-current assets
Property, plant and equipment 56,600 16,200 16,100
Investment in Sanus Co (at cost) 13,800 – –
70,400 16,200 16,100
Current assets
Inventories 2,900 1,200 500
Trade receivables 3,300 1,100 1,100
Cash 1,700 100 300
7,900 2,400 1,900
78,300 18,600 18,000
Equity
Share capital ($1 shares) 8,000 2,400 2,800
Reserves 54,100 10,600 9,200
62,100 13,000 12,000
Long-term borrowings 13,200 4,800 5,100
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$’000 $’000 $’000
Current liabilities
Trade and other payables 3,000 800 900
78,300 18,600 18,000
(1) On 1 April 20X4, Portus Co purchased an 80% holding in Sanus Co for $13.8 million in cash.
(2) Portus Co also acquired a 30% holding in Allus Co on 1 July 20X4 for 500,000 of its own
shares. The stock market value of Portus Co’s shares at the date of this share exchange was
$9.40 each. Portus Co has not yet recorded the investment in Allus Co. Allus Co’s reserves
were $8.6 million on 1 July 20X4.
(3) At the date of acquisition, the fair value of Sanus Co’s assets were equal to their carrying
amounts, with the exception of the items listed below which exceeded their carrying amounts
as follows:
$’000
Inventories 300
1,500
Sanus Co has not adjusted the carrying amounts as a result of the fair value exercise. The
inventories were sold by Sanus Co before the year end.
(4) The non-controlling interest in Sanus Co is to be valued at its fair value of $3.2 million at the
date of acquisition.
An impairment test conducted at the year end revealed that the consolidated goodwill of
Sanus Co was impaired by $150,000.
Additionally, an impairment loss of $40,000 is to be recognised in respect of Portus Co’s
investment in Allus Co in the group financial statements.
(5) On 1 October 20X4, Sanus Co sold goods to Portus Co for $200,000 at a gross profit margin
made between Portus Co and Sanus Co in the year.
After the acquisition, Portus Co sold goods to Allus Co for $400,000 at a mark-up on cost of
25%. A quarter of these goods remained in Allus Co’s inventories at the year end.
(6) At 31 December 20X4, Portus Co’s current account with Sanus Co was $130,000 (credit). This
did not agree with the equivalent balance in Sanus Co’s books due to cash in transit of
$70,000 which was not received by Sanus Co until after the year end.
Required
20X4.
Solution
PORTUS GROUP
HB2022

$’000
Non-current assets
Goodwill (W2)
Investment in associate (W3)
Current assets
Inventories
Trade receivables
Cash
Share premium (W8)
Reserves (W4)
Current liabilities
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Workings
1 Group structure
Portus Co
1.4.X4
80%
Cost $13.8m
Sanus Co Allus Co
($10.6m – ($2.0m × 9/12))
or ($10.6m – $2.0m + ($2.0 × 3/12))
2 Goodwill
$’000 $’000
Share capital 2,400
Reserves (10,600 – (2,000 × 9/12)) 9,100
(13,000)
4,000
3,850
3 Investment in associate
$’000
Cost of associate
Add post-acquisition reserves (W4)
Less impairment losses on associate to date
HB2022


$’000 $’000 $’000
Per question
Sanus Co
Allus Co
Less impairment losses:

Sanus Co
Allus Co
5 Non-controlling interests (SOFP)
$’000
NCI share of post-acquisition reserves (W4) 206
NCI share of impairment losses (W2) 30
3,376
At acquisition At year
date Movement end
$’000 $’000 $’000
*Extra depreciation (1,200 × 10% × 9/12) 1,500 (390) 1,110
Take to Take to
Goodwill COS & SOFP
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date Movement end
$’000 $’000 $’000
reserves
(1) Cash in transit
$’000 $’000
DEBIT Group cash 70
(2) Cancel intragroup trading and balances (only with subsidiary)
$’000 $’000
CREDIT Group purchases (cost of sales) 200
$’000 $’000

Sanus Co:
$’000 $’000
DEBIT Cost of sales (& retained earnings) (of Sanus Co
the seller) 80
Allus Co:
Downstream transaction. Profit element in inventories:

Associate share:

$’000 $’000
DEBIT Cost of sales (and retained earnings) (of Portus
Co the seller)
CREDIT Investment in associate
Activity 5: Consolidated statement of profit or loss
The statements of profit or loss and other comprehensive income of Portus Co, its subsidiary
Sanus Co and its associate Allus Co for the year ended 31 December 20X4 are as follows:
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME
HB2022

$’000 $’000 $’000
Revenue 28,500 11,800 9,500
Cost of sales (17,100) (7,000) (5,800)
Gross profit 11,400 4,800 3,700
Expenses (4,400) (2,200) (1,600)
Finance costs (400) (200) (200)
Dividend income from Allus Co 60 – –
Profit before tax 6,660 2,400 1,900
Income tax expense (2,100) (800) (600)
PROFIT FOR THE YEAR 4,560 1,600 1,300
Gains on property revaluation 900 400 300
TOTAL COMPREHENSIVE INCOME FOR THE YEAR 5,460 2,000 1,600
(1) On 1 April 20X4, Portus Co purchased an 80% holding in Sanus Co for $13.8 million in cash.
(2) Portus Co also acquired a 30% holding in Allus Co on 1 July 20X4 for 500,000 of its own
shares. The stock market value of Portus Co’s shares at the date of this share exchange was
$9.40 each. Portus Co has not yet recorded the investment in Allus Co. Allus Co ‘s reserves
were $8.6 million on 1 July 20X4.
(3) At the date of acquisition, the fair value of Sanus Co’s assets were equal to their carrying
amounts, with the exception of the items listed below which exceeded their carrying amounts
as follows:
$’000
Inventories 300
1,500
Sanus Co has not adjusted the carrying amounts as a result of the fair value exercise. The
inventories were sold by Sanus Co before the year end.
(4) The non-controlling interest in Sanus Co is to be valued at its fair value of $3.2m at the date
of acquisition. An impairment test conducted at the year end revealed that the consolidated
goodwill of Sanus Co was impaired by $150,000. Additionally, an impairment loss of $40,000
is to be recognised in respect of Portus Co’s investment in Allus Co in the group financial
statements.
(5) On 1 October 20X4, Sanus Co sold goods to Portus Co for $200,000 at a gross profit margin
made between Portus Co and Sanus Co in the year. After the acquisition, Portus Co sold
goods to Allus Co for $400,000 at a mark-up on cost of 25%. A quarter of these goods
remained in Allus Co’s inventories at the year end.
(6) At 31 December 20X4, Portus Co’s current account with Sanus Co was $130,000 (credit). This
did not agree with the equivalent balance in Sanus Co’s books due to cash in transit of
$70,000 which was not received by Sanus Co until after the year end.
HB2022

Required
Prepare the consolidated statement of profit or loss and other comprehensive income for the
Portus Group for the year ended 31 December 20X4.
Solution
PORTUS GROUP
$’000
Revenue
Cost of sales
Gross profit
Expenses
Finance costs
Share of profit of associate
Profit before tax
Income tax expense
PROFIT FOR THE YEAR
Share of gain on property revaluation of associate
HB2022

$’000
Workings
1 Timeline
1.1.X4 1.4.X4 1.7.X4 31.12.X4
Portus Co – all year
Sanus Co – Income & expenses & 20% NCI × 9/12
Allus Co – PFY & OCI × 30% × 6/12
PUP
adjustment

year income
$’000 $’000
PFY/TCI per question
Less impairment losses (Activity 1 (W2))
Less fair value movement (Activity 1 (W6))
Less unrealised profit (Activity 1 (W7))
× 20% × 20%
HB2022

Essential reading
Chapter 11, Section 2 of the Essential reading contains a further Activity to allow you to practise
preparing consolidated financial statements containing an Associate.
Exam focus point

The FR Examining team has stated that a group accounting question may contain a parent
and up to two subsidiaries and an associate. You must be prepared to answer group
accounting questions featuring multiple entities.
HB2022

Chapter summary
Associates and joint arrangements
Associates – Associates – parent's Associates – consolidated

definitions separate financial statements financial statements
Associate Carry investment: Equity method

An entity over which the investor • At cost; or • Consolidated statement of
has significant influence • At fair value (financial financial position
instrument under IFRS 9); or – Investment in associate:
• Using equity method $
Significant influence Cost of associate X
• Usually 20% - 50% of voting Share of post-acquisition
power reserves X
• Other indicators: Impairment (X)
– Representation on board of Group share of
directors unrealised profit (X)
– Participation in
X
policy-making process
– Material transactions • Impairment of investment in
between entity and investee associate
– Interchange of management – Deduct from investment in
personnel associate
– Provision of essential • Consolidated statement of
technical information profit or loss and other
– Group share of associate's
profit for the year
– Group share of associate's
other comprehensive income
for the year
• Unrealised profit
– Upstream transaction:
DEBIT Share of profit of
associate
CREDIT Inventories
– Downstream transaction:
DEBIT Cost of sales
CREDIT Investment in
associate
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1. Definition
An associate relationship exists where there is significant influence. Significant influence is ‘the
power to participate in the financial and operating policy decisions of the investee but is not
control or joint control over those policies’ (IAS 28: para. 3). This is presumed where a parent holds
20% or more of voting shares, but also can be demonstrated in other ways.
2. Parent’s separate financial statements

The investment may be accounted for:
• At cost
• At fair value
• Using the equity accounting method (if only have an associate)
3. Accounting treatment
In the group financial statements, an associate is equity accounted as a one-line entry
‘investment in associate’ in the statement of financial position and the share of the associate’s
profit and other comprehensive income are shown on two separate lines in the statement of profit
or loss and other comprehensive income.
To adjust for unrealised profits in inventory in an upstream transaction:
$ $
DEBIT Group share of profit in associate Group % × unrealised
(SOPL) profit
CREDIT Inventory (SOFP) profit
To adjust for unrealised profits in inventory in a downstream transaction:
$ $
DEBIT Cost of sales (SOPL) profit
CREDIT Investment in associate (SOFP) profit
HB2022

Question practice
the Workbook):
Section A Q11
Section C Q35 Hever Co
HB2022

Activity answers
Activity 1: Identifying an associate

• Lesbos: Athens owns 50% of the ordinary shares of Lesbos and provides essential technical
information to Lesbos
• Thassos: Athens owns 45% of the ordinary shares of Thassos and regularly sends its
directors to Thassos to assist senior management with strategic decisions.
(1) As Athens appoints the majority of the directors to Crete’s board, Crete is likely to be a
subsidiary, rather than an associate
(2) As Athens does not have the power to participate in policy-making processes, Athens does
not have significant influence over Rhodes, making Rhodes a simple financial asset, rather
than an associate.
(3) 50% does not give Athens control (> 50% indicates control) so Lesbos is not a subsidiary.
However, 50% is sufficient to give Athens significant influence over Lesbos and this influence
is further evidenced by the essential technical information Athens provides to Lesbos.
(4) Preference shares do not have voting rights, so do not give Athens significant influence. This
investment would make Samos a simple financial asset, rather than an associate.
(5) 45% indicates significant influence and this is supported by the interchange of management
personnel.
Activity 2: Share of profit of associate

$ 232,350
The share of profit of associate is calculated as ($721,000) × 35% = $252,350 – $20,000

impairment loss for the year.
Activity 3: Equity method

1 Kappa is the associate and therefore this is an upstream transaction. The accounting
adjustment is:
DEBIT Group share of profit of associate

(SOPL) 60,000
CREDIT Inventories (SOFP) 60,000
Unrealised profit adjustment

PUP = $3,000,000 (× 20%/100% margin × 1/3 in inventory × 30% group share = $60,000.
2 Calculations
(a) Investment in associate
$’000
Cost of associate 4,100
Share of post-acquisition retained earnings (9,200 – 6,200) × 30% 900
5,000
Less impairment losses on associate to date (500)
4,5000
(b) Consolidated retained earnings
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Beta Delta Kappa
$’000 $’000 $’000
At the year end 41,600 10,600 9,200
Unrealised profit (part (a)) (60) – –
At acquisition (3,600) (6,200)
7,000 3,000
Delta – share of post-acquisition retained

earnings (7,000 × 60%) 4,200
Kappa – share of post-acquisition retained

earnings (3,000 × 30%) 900
46,140 – –
Note. Even though the associate was the seller for the intragroup trading, the group share
has already been reflected in arriving at the PUP of $60,000 and is therefore adjusted in
the parent’s column so as not to multiply it by the group share twice.
Working
Group structure
Beta
1.1.X0 60% 1.7.X1 30%
Delta Kappa
Pre-acquisition retained earnings = $3.6m Pre-acquisition retained earnings = $6.2m
Activity 4: Consolidated statement of financial position

PORTUS GROUP
$’000
Non-current assets
Property, plant and equipment (56,600 + 16,200 + (W6) 1,110) 73,910
Goodwill (W2) 3,850
Investment in associate (W3) 4,834
82,654
Current assets
Inventories (2,900 + 1,200 – (W7) 80) 4,020
Trade receivables (3,300 + 1,100 – (W7) 70 – (W7) 130) 4,200
Cash (1,700 + 100 + (W7) 70) 1,870
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$’000
10,090
92,684
Share capital ($1 shares) (8,000 + (W8) 500) 8,500
Share premium (W8) 4,200
67,638
71,014
Current liabilities
Trade and other payables (3,000 + 800 – (W7) 130) 3,670
92,684
Workings
1 Group structure
Portus Co
1.4.X4 1.7.X4
80% 30%
Cost $13.8m (W8) $4.7m
Sanus Co Allus
Pre-acq'n reserves $9.1m $8.6m
($10.6m – ($2.0m × 9/12))
or ($10.6m – $2.0m + ($2.0 × 3/12))
2 Goodwill
$’000 $’000
Share capital 2,400
Reserves (10,600 – (2,000 × 9/12)) 9,100
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$’000 $’000
(13,000)
4,000
3,850
$’000
Cost of associate 4,700
Add post-acquisition reserves (W4) 180
Provision for unrealised profit (W7) (6)
4,834

$’000 $’000 $’000
Per question 54,100 10,600 9,200
Provision for unrealised profit (W7) (6) (80)
Pre-acquisition reserves (9,100) (8,600)
1,030 600
Sanus Co (1,030 × 80%) 824
Allus Co (600 × 30%) 180
Less impairment losses:

Sanus Co (150 × 80%) (120)
Allus Co (40)
54,938
5 Non-controlling interests (SOFP)
$’000
HB2022

$’000
NCI share of post-acquisition reserves (W4) 206
NCI share of impairment losses (W2) 30
3,376
date Movement end
$’000 $’000 $’000
*Extra depreciation (1,200 × 10% × 9/12) 1,500 (390) 1,110
Take to
COS & Take to
Goodwill reserves SOFP
(1) Cash in transit
$’000 $’000
DEBIT Group cash 70
(2) Cancel intragroup trading and balances (only with subsidiary)
$’000 $’000
CREDIT Group purchases (cost of sales) 200
$’000 $’000

Sanus Co:
$’000 $’000
DEBIT Cost of sales (& retained earnings) (of Sanus Co
the seller) 80
Allus Co:
Downstream transaction. Profit element in inventories: $400,000 × 25/125 × 1/4 = $20,000
Associate share: $20,000 × 30% = $6,000
HB2022

$’000 $’000
DEBIT Cost of sales (and retained earnings) (of Portus
Co the seller) 6
CREDIT Investment in associate 6
Activity 5: Consolidated statement of profit or loss

PORTUS GROUP
$’000
Revenue (28,500 + (11,800 × 9/12) – Activity 1 (W7) 200) 37,150
Cost of sales (17,100 + (7,000 × 9/12) + (W6) 390 – (W7) 200 + (W7) 80 + (W7) 6)) (22,626)
Expenses (4,400 + (2,200 × 9/12) + Activity 1 (W2) 150) (6,200)
Finance costs (400 + (200 × 9/12)) (550)
Share of profit of associate [(1,300 × 30% × 6/12) – 40 imp losses)] 155
Share of gain on property revaluation of associate (300 × 30% × 6/12) 45
5,229
6,474
HB2022

Workings
1 Timeline
1.1.X4 1.4.X4 1.7.X4 31.12.X4
Portus Co – all year
Sanus Co – Income & expenses & 20% NCI × 9/12
Allus Co – PFY & OCI × 30% × 6/12
PUP
adjustment

year income
$’000 $’000
Less impairment losses (Activity 1 (W2)) (150) (150)
Less fair value movement (Activity 1 (W6)) (390) (390)
Less unrealised profit (Activity 1 (W7)) (80) (80)
580 880
× 20% × 20%
116 176
HB2022

Skills checkpoint 3
Using spreadsheets
effectively
Chapter overview
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Exam suc
Answer planning
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Introduction
Section C of the FR exam will have two longer questions worth a total of 40 marks. One question
will require you to prepare extracts from the financial statements (this may be for a single entity
or for a group, and it may be any of the primary financial statements). You will be required to use
a spreadsheet to prepare your answer to the accounts preparation question and must be
prepared to use spreadsheets effectively in your exam.
HB2022

Skills Checkpoint 3: Using spreadsheets effectively
FR Skill: Using spreadsheets effectively
The key steps in applying this skill are outlined below and will be explained in more detail in the
following sections as the exam standard question Viagem Co is used as an example question.
STEP 1: Understanding the data in the question

Where a question includes a significant amount of data, read the requirements
carefully to make sure that you understand clearly what the question is asking
you to do. You can use the highlighting function to pull out important data from
the question. Use the data provided to think about what formula you will need to
use. For example, if the company calculates the allowance for receivables as a
percentage of the balance, use the percentage function.
STEP 2: Use a standard proforma working.

You will be asked to prepare an extract or a set of financial statements. Set out
your statement of profit or loss or the statement of financial position before you
start to work through the question. This will give you the basic structure from
where you can enter the data in the question.
Format your cells to ensure the workings look consistent, for example, using the
comma function to mark the thousands in numerical answers.
STEP 3: Use spreadsheet formulae to perform basic calculations.

Ensure you are showing your workings by using the spreadsheet formula for simple
calculations, for example, the cost of sale figure will be made up of different
balances, so add them together using the formula. Cross refer any more detailed
workings, and link workings into your main answer.
Step 4: Include the results of workings in the proforma

You must ensure that you include your workings form in the proforma and
complete your final answer. Remember to show how you have included your
workings by cross referencing to the relevant working and by using the formula
within the cell to add/subtract the balance.
The ACCA FR Examining Team has stated that some candidates are poorly prepared to use the
spreadsheet software used in the FR exam. It is essential that you attempt questions using the
exam software as part of your preparation for the FR exam. You should ensure that you use the
ACCA Practice Platform (www.accaglobal.com) to practice exam standard questions prior to the
exam.
Exam success skills

The following question, Viagem Co, is a past exam question worth 20 marks.
For this question, we will focus on the following exam success skills:
• Managing information. It is easy for the volume of information contained in a Section C
question to feel over-whelming. Active reading is a useful technique to help avoid this. This
involves focusing on the requirement first, on the basis that until you have done so the detail in
the question will have little meaning.
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This is especially important in a question that may have lots of information, such as one which
requires you to prepare a set of financial statements based on a draft trial balance, and a
series of further elements of information.
• Correct interpretation of requirements. The requirement clearly has two separate parts. The
calculation of goodwill and, separately, the preparation of a consolidated statement of profit
or loss.
• Efficient numerical analysis. The key to success here is applying a sensible proforma for the
calculation of goodwill and for key figures within the consolidated statement of profit or loss,
such as non-controlling interest. (You must show all workings and use the formula facility in the
spreadsheet tool to link your workings to the consolidated statement of profit or loss where
appropriate).
• Good time management. Complete all tasks in the time available, being careful not to overrun
the calculation of goodwill at the expense of the second part of the question.
Skill activity
STEP 1 Understanding the data in the question.
Where a question includes a significant amount of data, read the requirements carefully to make sure that
you understand clearly what the question is asking you to do. You can use the highlighting function to pull
out important data from the question. Use the data provided to think about what formula you will need to
use. For example, if the company calculates the allowance for receivables as a percentage of the balance,
use the percentage function.
When you initially open your online exam for Section C,

the screen will look something like this, with the question
scenario given on the left of the screen, and your
answer workspace on the right.
Symbol Calculator Scratch Pad
The question scenario will appear here. The question requirement will appear here.
Edit Format
100%
11
A1
A B C D E F G H I
1
2
3
4
5
6
7
8
9
10
11
The ACCA website (www.accaglobal.com) has a useful

tool which enables you to familiarise yourself with the
functionality of the workspace (both the spreadsheet
and the word processing space).
For FR, you will be required to use the spreadsheet to

answer the Section C question which requires the
preparation of the financial statements of a group or
single entity.
HB2022
Skills Checkpoint 3: Using spreadsheets effectively 285

In the ribbon across the top, there are tools you can use
to highlight and mark up the question.
On 1 January 20X2, Viagem Co acquired 90% of the

equity share capital of Greca Co in a share exchange in
which Viagem Co issued two new shares for every three 4
Use the highlight function to highlight
4 key areas. Here there are details of a
shares it acquired in Greca Co. Additionally, on 31
share issue in order to obtain a
December 20X2, Viagem Co will pay the shareholders of subsidiary.
Greca Co $1.76 per share acquired. Viagem Co’s cost of

capital is 10% per annum.
At the date of acquisition, shares in Viagem Co and

5
Highlighting the MV of Viagem shares at
Greca Co had a market value of $6.505 and $2.506
$6.50
each respectively. 6
Highlighting the MV of Greca shares at
$2.50
STATEMENTS OF PROFIT OR LOSS FOR THE YEAR
ENDED 30 SEPTEMBER 20X2
Viagem Co Greca Co
$’000 $’000
Revenue 64,600 38,000
Cost of sales (51,200) (26,000)
Distribution costs (1,600) (1,800)
Administrative expenses (3,800) (2,400)
Investment income 500 –
Finance costs (420) –
Income tax expense (2,800) (1,600)
Profit for the year 5,280 6,200
Equity as at 1 October 20X1
Equity shares of $1 each 30,000 10,000
The following information is relevant:
(a) At the date of acquisition the fair values of Greca

Co’s assets were equal to their carrying amounts 7
Two issues here: Fair value adjustment
7 on PPE and the contingent liability which
with the exception of two items :
will require adjusting the goodwill
calculation.
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(i) An item of plant had a fair value of $1.8 million
above its carrying amount. The remaining life
of the plant at the date of acquisition was
three years. Depreciation is charged to cost of
sales.
(ii) Greca Co had a contingent liability which

Viagem Co estimated to have a fair value of
$450,000. This has not changed as at 30
September 20X2.
(iii) Greca Co has not incorporated these fair value

changes into its financial statements.
(b) Viagem Co’s policy is to value the non-controlling 8

Method of valuing non-controlling
8 interest is fair value in this question (don’t
interest at fair value at the date of acquisition. For
use the alternative method of
this purpose, the market value of Greca Co’s shares proportionate share!)
at that date can be deemed to be representative of

the fair value of the shares held by the non-
controlling interest.
(c) Sales from Viagem Co to Greca Co throughout the

year ended 30 September 20X2 had consistently
been $800,000 per month. Viagem Co made a
mark-up on cost of 25% on these sales. Greca Co
had $1.5 million of these goods in inventory as at 30 9
Another area to highlight: Intragroup
9 sales and Purp for calculation and
September 20X2.
adjustment in the consolidated financial
statements
(d) Viagem Co’s investment income is a dividend 10
Adjustment: a dividend received from
received10 from its investment in a 40% owned the associate. Requires calculation: 40%
x $2m and inclusion as share of profit of
associate which it has held for several years. The associate in CSOPL.
associate’s profit for the year ended 30 September

20X2 was $2 million.
(e) Although Greca Co has been profitable since its

acquisition by Viagem Co, the market for Greca
Co’s products has been badly hit in recent months
and Viagem Co has calculated that the goodwill
11
Goodwill adjustment: an impairment of
has been impaired by $2 million11 as at 30
$2m.
September 20X2.
Required
(a) Calculate the goodwill arising on the acquisition of

Greca Co. (6 marks)
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(b) Prepare the consolidated statement of profit or loss
for Viagem Co for the year ended 30 September
20X2. (14 marks)
(Total = 20 marks)
STEP 2 Use a standard proforma working.
You are likely to be asked for prepare an extract or a set of financial statements. Set out your statement of
profit or loss or the statement of financial position before you start to work through the question. This will
give you the basic structure from where you can enter the data in the question.
Format your cells to ensure the workings look consistent, for example, using the comma function to mark
the thousands in numerical answers.
In this example, the question is calling for two parts to be answered. Firstly, the calculation of
goodwill and secondly, preparation of the consolidated statement of profit or loss.
Start with part (a) first, setting out the key elements of the goodwill calculation. Give your working
a title ((a) Goodwill calculation) and reference it to the question so that the Examining Team can
see clearly what part of the question you are answering:
Edit Format
100%
11
C1
A B C D E F
1
2 (a) Goodwill calculaon $΄000 $΄000
3
4 Consideraon transferred:
5 Shares
6 Deferred consideraon
7
8
9
10
11
Columns C and D have been highlighted. At this point, it is a sensible idea to format the cells so
that they show thousand dividers. This makes the numbers easier to read and means you are less
likely to start answering in, for example thousands and later change to millions or full numbers,
which can be confusing.
Edit Format
100%
11
C4 45200 General
A B C
Custom D E F
1 0.00
2 (a) Goodwill calculaon $΄000
#,##0
$΄000
3
#,##0.00
4 Consideraon transferred:
5 Shares
6 Deferred consideraon
By highlighting the whole two columns, this speeds up the formatting process. This is where you
will insert the figures.
If you feel you will need more columns highlighting and formatting, then select more columns.
Once you have completed part (a) of the question, the second part calls for a proforma of a
consolidated statement of profit or loss. You may also want to consider setting up proforma some
of the sub-calculations you may require such as non-controlling interests.
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It is important to make your work clear to the Examining team using headings, referencing and
formatting the cells. Set out your proforma under a suitable heading, you may wish to use bold
text or underline to make your headings clearer.
STEP 3 Use spreadsheet formulae to perform basic calculations.
Ensure you are showing your workings by using the spreadsheet formula for simple calculations, for
example, the cost of sales figure will be made up of different balances, so add them together using the
formula.
One issue that repeatedly comes up in the Examiner’s Report, is that students do not show where
their figures have come from. This makes it difficult for marks to be awarded, as the workings are
often key to ensuring that students understand the process. Also, if a mistake is made in the
calculations, then marks cannot be awarded for the method or the parts which were correct.
There are some useful tools that will assist in both your calculation and presentation of your
answer:
Use the formula in the spreadsheet tool. This may be simple addition or subtraction formula, such
as adding numbers together to get the administrative costs figure or to calculate the subtotals:
11
C13 =C11-C12
A B C D
9 (b) Consolidated statement of profit or loss
10 $΄000 $΄000
11 Revenue 85,900
12 Cost of sales 64,250
13 Gross profit =C11-C12
14 Distribuon costs
15 Administraon costs
16
Here, the gross profit is calculated by subtracting the cost of sales figure from the revenue figure.
This does three things:
• It ensures that the arithmetic is correct
• It shows the Examining team where the numbers

have come from
• Future proofs the answer. If you later change the

revenue figure, the subtotals will automatically
update.
If the working is more complex, then set up a new working below the proforma and cross reference
it. It is also recommended (in order to ensure updates if you make changes later) that you link the
cells together:
B25 =(14400*.1)*(9/12)
A B C
20 Profit for the year
21
22 Workings
23 (W1) Finance costs $΄000
24 Viagem Co per statement of profit or loss 420
25 Unwinding of discount on deferred consideraon 1080
26 1500
27
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Then link the answer back to the consolidated statement of profit or loss:
5 Administraon costs -7,600
6 Finance costs (W1) =-B26
7 Share of profit of associate
8 Profit before tax
9 Income tax expense
10 Profit for the year
11
12 Workings $΄000
13 (W1) Finance costs 420
14 Viagem Co per statement of profit or loss 1080
15 Unwinding of discount on deferred consideraon 1500
16
17
STEP 4 Include the results of workings in the proforma

You must ensure that you include your workings form in the proforma and complete your final answer.
Remember to show how you have included your workings by cross referencing to the relevant working and
by using the formula within the cell to add or subtract the balance.
It is important to complete your answer by transferring your calculations and workings back to
the proforma. Ensure you understand what you were asked for; if the exam asks for a goodwill
calculation or statement of profit or loss and other comprehensive income, you must ensure that
your final answer addresses the requirement.
When transferring your workings, you can either use cell references (for example enter =G33) to
include your total, or you can refer the marker to a working (for example, enter See working 1). The
marker can interrogate the content of spreadsheet cells so will be able to see what you enter in
those cells.

demonstrated the exam success skills in answering the question. The table has been completed
below for the Viagem activity to give you an idea of how to complete the diagnostic.

Managing information There is a lot of information in this question, and there are two
separate workings to be set out using proformas.
Highlighting the relevant data within the question will help you
to ensure you have picked up all the information.
This question had separate elements which affected the
calculation of goodwill. These included two forms of
consideration (shares and deferred consideration), plus there
were adjustments to be made in respect of the impairment of
the fair value of the asset, the contingent liability and, in a
separate bullet point, the impairment of goodwill.
Due to the presentation of the points separately, it is easy to
miss information. Provided you show your workings, you will
gain some marks, but clearly it is better to ensure that all the
information is incorporated in the answer.
Correct interpretation of The question is asking for a calculation of goodwill and then
requirements preparation of the consolidated statement of profit or loss. It is
important to make sure that all parts of the question are
answered, and the relevant information taken from the
information given in the question.
Efficient numerical analysis The answer needs to be presented neatly, and all information
easily readable by the Examining team.
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Ensure that formula is used to show where the numbers have
come from, and to ensure accuracy in the calculation
(provided the formula has been correctly inserted).
Good time management The question is worth 20 marks but split into two sections. The
calculation of goodwill is worth six marks, so you should allow
no more than 10–11 minutes for this section, and then move
onto the consolidated statement of profit or loss. It is
important not to linger too long on one section as you may
miss easy marks in the next question at the expense of
spending longer than allowed to gain an additional mark or
two.
Most important action points to apply to your next question: show all workings.
Summary
Section C of the FR exam will contain questions that require proformas and calculations to be
carried out using the spreadsheet facility in the exam.
Make sure you are familiar with the tool (the ACCA website allows access both in completing an
online example paper, and also just to practice using the spreadsheet functionality).
It is also important to be aware that in the exam you are dealing with detailed calculations under
timed exam conditions and time management is absolutely crucial. You therefore need to ensure
that you:
• Interpret the date given in the question correctly.
• Use clear proformas (where appropriate) for your workings and your financial statement
extracts.
• Use spreadsheet formula to perform basic calculations.
• Show clear workings using a combination of formula and linking separate workings (such as
goodwill calculation that can be linked into your statement of financial position).
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HB2022

Financial instruments
12
12
Learning objectives
Explain the need for an accounting standard on financial B5(a)

instruments.
Define financial instruments in terms of financial assets and B5(b)

financial liabilities.
Explain and account for the factoring of receivables. B5(c)
Indicate for the following categories of financial instruments B5(d)

how they should be measured and how any gains and losses
from subsequent measurement should be treated in the
financial statements:
(a) amortised cost
(b) fair value through other comprehensive income (including
when an irrevocable election has been made for equity
instruments that are not held for trading)
(c) fair value through profit or loss
Distinguish between debt and equity capital. B5(e)
Apply the requirements of relevant IFRS Standards to the issue B5(f)

and finance costs of:
(a) equity
(b) redeemable preference shares and debt instruments with
no conversion rights (principle of amortised cost)
(c) convertible debt
12
Exam context
Financial instruments is frequently examined in all sections of the Financial Reporting exam. It is a
technical area which students sometimes find challenging. The December 2018 Examiner’s report
stated that students need to avoid a superficial understanding of this subject area and the June
2019 Examiner’s report identified that financial instruments is one of the more technical areas of
the course that students struggle with.
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12
Chapter overview
The need for Classification

a standard
Categories Compound financial instruments
Liabilities v equity Interest, dividends,

gains and losses
Recognition Derecognition Factoring of trade receivables
Measurement
Measurement of financial assets Measurement of financial liabilities
Initial and subsequent measurement Initial and subsequent measurement
Fair value Fair value
Amortised cost Amortised cost
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1 The need for a standard
The dynamic nature of international financial markets and the increasing number and variety of
financial instruments that have been introduced in recent years have meant the standard setters
struggled to keep pace with the rate of change in the market. As a result, there was a lack of
guidance as to how financial instruments should be accounted for. This caused problems such as:
• Inconsistencies in the way in which financial instruments were recognised and measured,
leading to comparability problems for international companies who reported under different
accounting regimes
• Criticism about the accounting and disclosure requirements following high-profile scandals
relating to financial instruments
• A lack of understanding from the users of financial statements, for example, one of the key
user ratios is the gearing ratio, ie the measure of the proportion of debt to equity. In order for
this measure to be meaningful, there must be consistency in the allocation of financial
instruments between these two categories.
In response to the issues with the accounting for financial instruments, the IASB has developed
and implemented the following standards relating to financial instruments:
IAS 32 Financial Instruments: IFRS 9 Financial IFRS 7 Financial Instruments:

Presentation Instruments Disclosures
2 Classification
2.1 Definitions
In order to understand how to account for financial instruments, we must first understand what we
mean by financial instruments.
Financial assets Financial liabilities Equity

Eg cash, trade receivables Eg bonds issued, trade Eg ordinary shares,
investments in shares, payables, redeemable irredeemable
investments in debt preference shares preference shares
Financial instrument: Any contract that gives rise to both a financial asset of one entity and a
KEY
TERM financial liability or equity instrument of another entity.
Financial asset: Any asset that is:
(a) Cash
(b) An equity instrument of another entity
(c) A contractual right to receive cash or another financial asset from another entity; or to
exchange financial instruments with another entity under conditions that are potentially
favourable to the entity.
Financial liability: Any liability that is:
(a) A contractual obligation:
(i) To deliver cash or another financial asset to another entity, or
(ii) To exchange financial instruments with another entity under conditions that are
potentially unfavourable.
Equity instrument: Any contract that evidences a residual interest in the assets of an entity
after deducting all of its liabilities. (IAS 32: para. 11)
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12: Financial instruments 295

2.2 Liability v equity
The classification of a financial instrument as a liability or as equity depends on:
• The substance of the contractual arrangement on initial recognition
• The definitions of a financial liability and an equity instrument
(IAS 32: para. 15)
The critical feature of a liability is an obligation to transfer economic benefit.
Illustration 1: Liability v equity
Jess Co issues $100,000 6% preference shares, redeemable on 1 January 20X6.

Required
Explain whether the preference shares are classified as debt or equity.
Solution
Although we may first think of shares as equity, in substance, redeemable preference shares meet
the definition of a financial liability as they contain an obligation to pay a fixed amount of interest
and are redeemable at a fixed future date. Accordingly, the redeemable shares will be reported
under non-current liabilities in the statement of financial position (unless they are repayable
within one year, in which case they are considered to be current liabilities).
2.3 Compound financial instruments

Compound instrument
Eg convertible debt
Liability element and Equity element
IAS 32 requires the component parts of the compound instrument, ie the liability element and the
equity element, to be classified separately. (IAS 32: para. 28)
The following method should be used to initially measure the liability and equity elements:
Step 1 Determine the value of the whole instrument

(the proceeds received on the issue of the instrument)
Step 2 Calculate the value of the liability element

(the present value of the principal and the present value of the interest)
Step 3 Calculate the residual value of the equity component

(the difference between the value of the whole instrument and the value of the
liability element)
(IAS 32: para. 32)
Activity 1: Compound instruments
Rathbone Co issues 2,000 convertible bonds at the start of 20X2. The bonds have a three-year
term, and are issued at par with a face value of $1,000 per bond, giving total proceeds of
$2,000,000. Interest is payable annually in arrears at a nominal annual interest rate of 6%. Each
bond is convertible into 250 ordinary shares.
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The carrying amount of the liability element of the compound instrument can be measured based
on an interest rate of 9%, which is the prevailing market interest rate for similar debt without
conversion options.
Relevant discount rates:
• Present value of 9% interest rate after 3 years is 0.772
• Cumulative present value of 9% interest rate after 3 years is 2.531
Required
Calculate the carrying amount of the liability and equity components of the bond.
Solution
Step 1: Calculate the value of the whole instrument
Step 2: Calculate the carrying amount of the liability element (which is the
present value of the future cash flows discounted using the 9% interest
rate for equivalent bonds without conversion rights)
PV of the principal
PV of the interest
Step 3:
Calculate the residual value of the equity component
(balancing figure)

HB2022

Essential reading
Chapter 12, Section 1 of the Essential reading provides more detail and a further activity relating
to compound financial instruments.
2.4 Interest, dividends, gains and losses

IAS 32 also considers how the treatment of the interest, dividends, losses or gains associated with
financial instruments varies, depending on whether they relate to a financial liability or an equity
instrument.
(a) Interest, dividends, losses and gains relating to a financial liability should be recognised as
income or expense in profit or loss. (IAS 32: para. 35)
(b) Distributions to holders of equity instruments (dividends to ordinary shareholders) should be
debited directly to equity by the issuer. (IAS 32: para. 35)
(c) Transaction costs of an equity transaction should be accounted for as a deduction from
equity, usually debited to share premium. (IAS 32: para. 39)
3 Recognition and derecognition

3.1 Recognition
A financial asset or financial liability should be initially recognised in the statement of financial
position when the reporting entity becomes a party to the contractual provisions of the
instrument. (IFRS 9: para. 3.1.1)
In practical terms, this usually means:
Type of financial instrument Recognition

Trade receivable/payable On delivery of goods or performance of
service
Loans, bonds, debentures On issue
Shares On issue
3.2 Derecognition
A financial instrument should be derecognised as follows:
Type of financial instrument Derecognition

Financial assets When the contractual rights to the cash flows
expire (eg because a customer has paid their
debt or an option has expired worthless); or
When the financial asset is transferred (eg
sold), based on whether the entity has
transferred substantially all the risks and
rewards of ownership of the financial asset.
(IFRS 9: paras. 3.2.3 & 3.2.6)
Financial liabilities When the obligation is discharged (eg paid

off), cancelled or expires. (IFRS 9: para. 3.3.1)
You need to apply the principles of derecognition only in respect of the factoring of trade
receivables.
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3.3 Factoring of receivables
An entity might sell, or factor, its trade receivables to a debt factoring company in return for a
cash amount that is less than the carrying amount of the trade receivables. The debt factor then
owns and collects the debts. However, we must consider the substance of the debt factoring
agreement to determine the appropriate accounting treatment. Debt factoring can lead to two
possible outcomes:
The transaction is in substance a

genuine sale of the debts for less than Trade receivable
market price, with the entity retaining no is derecognised
continuing interest in the debts
The transaction is in substance a secured Trade receivable is not

loan if the risk of non-payment remains derecognised and a corresponding
with the entity that sold the debts. liability is also recognised
Factors that tend to indicate a secured loan:

• The debt factoring company can claim
back unpaid amounts.
• Interest is charged on monies advanced
by the debt factoring company.
Activity 2: Debt factoring
Freddo Co sold its trade receivables balance of $300,000 to a debt factor for $270,000 on 1 July
20X1.
The factor charges interest of 5% per annum on amounts advanced.
The factor collected $150,000 of the amounts due on 31 December 20X1. No other amounts were
collected in 20X1, but the amounts due are still considered recoverable.
Under the terms of the agreement, any unpaid debts will be returned to Freddo Co for a cash
repayment on 1 July 20X2.
Required
Explain how Freddo Co should account for the debt factoring arrangement as at 30 June 20X2.
Solution
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4 Measurement
The following definitions are important for measurement:
Amortised cost: The amount at which the financial asset (financial liability) is measured at
KEY
TERM initial recognition, minus the principal repayments, plus (minus) the cumulative amortisation
using the effective interest.
Effective interest rate: The rate that exactly discounts estimated future cash receipts
(payments) through the expected life of the financial asset (financial liability) to the gross
carrying amount of a financial asset (amortised cost of a financial liability).
Exam focus point

The effective interest rate will always be provided in the FR exam.
4.1 Measurement of financial assets

The classification (type) of financial asset determines how it is initially and subsequently
measured. An entity should apply the business model test to determine how to account for
financial assets. The business model refers to how an entity manages its assets in order to
generate cash flows. It is important that you learn the rules in the below table.
Type of financial asset Initial measurement Subsequent

measurement
1 Investments in debt
instruments
Business model test Fair value + transaction Amortised cost
(a) Held to collect costs
contractual cash flows; and
cash flows are solely
principal and interest
(b) Held to collect Fair value + transaction Fair value through other
contractual cash flows and costs comprehensive income (with
to sell; and cash flows are reclassification to P/L on
solely principal and interest derecognition)
NB: interest revenue
calculated on amortised
cost basis recognised in P/L
2 Investments in equity Fair value + transaction Fair value through other

instruments not ‘held for costs comprehensive income (no
trading’ reclassification to P/L on
(optional irrevocable election derecognition)
on initial recognition) NB: dividend income
recognised in P/L
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Type of financial asset Initial measurement Subsequent
measurement
3 All other financial assets Fair value (transaction costs Fair value through profit or
(eg derivate financial assets expensed in P/L) loss
not covered further in ACCA
Financial Reporting)
(IFRS 9: paras. 4.1.1 – 4.1.4)
Exam focus point

Applying the business model test, the entity’s intention to hold the financial instrument to
collect the contractual cash flows is most common in exam scenarios, as it allows the examiner
to test the principles of amortised cost accounting.
Essential reading
In the Essential reading, Chapter 12, Section 2 provides more detail on the business model test
and Chapter 12, Section 3 provides more detail on the contractual cash flow test.
4.1.1 Financial assets at fair value

Investments in equity instruments can either be held at fair value through profit or loss (FVTPL) or
fair value through other comprehensive income (FVTOCI).
If equity instruments are held at FVTPL, no transaction costs are included in the carrying amount.
Equity instruments can be held at FVTOCI if:
(a) They are not held for trading (ie the intention is to hold them for the long term to collect
dividend income)
(b) An irrevocable election is made at initial recognition to measure the investment at FVTOCI
If the investment is held at FVTOCI, all changes in fair value go through other comprehensive
income. There is no recycling of amounts presented in other comprehensive income in respect of
equity instruments. Only dividend income will appear in profit or loss. (IFRS 9: para. 4.1.4)
Illustration 2: Financial assets at fair value
An entity holds an investment in shares in another company, which cost $45,000. At the date of
purchase the election was made to record changes in value in other comprehensive income for
this asset. At the year end, their value has risen to $49,000.
Required
How should the increase in value be accounted for?
Solution
The following adjustment would need to be made in an accounts preparation question:
$ $
DEBIT Investment in shares ($49,000 – $45,000) 4,000
CREDIT Other comprehensive income (and other
components of equity in SOFP) 4,000
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The amount presented in other comprehensive income is not subsequently recycled to profit or
loss. If the shares were held at fair value through profit or loss, the gain would be reported in profit
or loss.
In either case, dividends received on the share are reported as income.
Activity 3: Financial assets at fair value
Grafton Co’s draft statement of financial position as at 31 March 20X8 shows financial assets at
fair value through profit or loss with a carrying amount of $9.5 million as at 1 April 20X7.
These financial assets are held in a fund whose value changes directly in proportion to a specified
market index. At 1 April 20X7, the relevant index was 1,100 and at 31 March 20X8, it was 1,187.
Required
What amount of gain or loss should be recognised at 31 March 20X8 in respect of these assets?
 $827,000 gain
 $751,000 gain
 $1,000,000 loss
 $827,000 loss
4.1.2 Financial assets at amortised cost

This is the amount at which the item was initially recorded, less any principal repayments, plus
the cumulative amortisation of the difference between the initial and maturity values.
This difference is amortised using the effective interest rate of the instrument, ie its internal rate of
return (as seen in Chapter 2). It includes:
• Transaction costs
• Interest payments
• Any discount on the debt on inception
• Any premium payable on redemption
The proforma and double entries for the amortised cost table is as follows:
Financial asset:
$ Accounting entries:
DEBIT (↑) Financial asset
CREDIT (↓) Cash
Balance b/d X (if initial recognition at start of year)
DEBIT (↑) Financial asset
Finance income (effective interest × b/d) X SPL CREDIT (↑) Finance income
DEBIT (↑) Cash
Interest received (coupon × par value) (X) CREDIT (↓) Financial asset
Balance c/d X SOFP
Activity 4: Financial asset held at amortised cost
Zebidee Co purchases a deep discount bond with a par value of $500,000 on 1 January 20X1 for
proceeds of $440,000 with the intention of holding it until the redemption value is received.
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Annual coupon payments of 5% are payable on 31 December. Zebidee Co incurred transaction
costs of $5,867. The bond will be redeemed on 31 December 20X3 at par.
The effective interest rate on the bond has been calculated at 9.3%.
Required
What is the interest income in the profit or loss for the year ended 31 December 20X2?
Solution
20X1 20X2 20X3
$ $ $
b/d at 1 January
(
Interest income @ 9.3%
Cash received
c/d at 31 December
Essential reading
Chapter 11, Section 4 of the Essential reading provides further activities relating to the
measurement of amortised cost financial assets.
4.2 Measurement of financial liabilities

Similar to financial assets, the category (type) of financial liability determines how it is initially
and subsequently measured.
Type of financial Subsequent

Initial measurement
liability measurement
1 Most financial liabilities (eg Fair value less transaction Amortised cost
trade payables, loans, costs
preference shares classified
as a liability)
2 Financial liabilities at fair Fair value (transaction costs Fair value through profit or
value through profit or loss expensed in P/L) loss
• ‘Held for trading’ (short-
term profit making)
• Derivatives that are
liabilities
(IFRS 9: para. 4.2.1)
4.2.1 Financial liabilities at amortised cost

The amortised cost approach for a financial liability is consistent with that for a financial asset:
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Financial liability $ Accounting entries:
DEBIT (↑) Cash
CREDIT (↑) Financial liability
Balance b/d X (if initial recognition at start of year)
DEBIT (↑) Finance cost
Finance cost (effective interest × b/d) X SPL CREDIT (↑) Financial liability
DEBIT (↓) Financial liability
Interest paid (coupon × par value) (X) CREDIT (↓) Cash
Balance c/d X SOFP
Activity 5: Financial liability at amortised cost
Dire Co issued 3,000 convertible bonds at par on 1 January 20X1. The bonds are redeemable on
31 December 20X4 at their par value of $100 per bond.
The bonds pay interest annually in arrears at an interest rate (based on nominal value) of 5%.
Each bond can be converted at the maturity date into five $1 shares.
The prevailing market interest rate for four-year bonds that have no right of conversion is 8%.
The present value at 8% of $1 receivable at end of each year is as follows:
Year 1 0.926
Year 2 0.857
Year 3 0.794
Year 4 0.735
Required
Show the accounting treatment of the:
1 Bond at inception
2 Finance cost for the year ended 31 December 20X1 and financial liability component at 31
December 20X1 using amortised cost
Note. The examining team has stated that they will not test the treatment of the equity
component after inception.
Solution
1
Bond at inception:
At 1 January 20X1 $
Financial liability component of convertible bond (W1)
Equity component of convertible bond
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Working
Financial liability component
Present value of principal
Present value of interest
2
Finance cost:
At 31 December 20X1 $
Finance costs (profit or loss)
Effective interest on financial liability component of

convertible bond (W)
Financial liability component of convertible bond (W2)
Working
Amortised cost financial liability
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Essential reading
Chapter 12, Section 5 of the Essential reading includes detail on the disclosure requirements of
IFRS 7.
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Chapter summary
The need for Classification

a standard
• Increase in number and variety Categories Liabilities v equity

of financial instruments • Financial asset: • Substance over form important
• Standard setters did not keep – Cash • Liabilities contain a
pace – Equity instrument of another contractual obligation
• Inconsistencies in recognition entity
and measurement – Contractual right to:
• Criticism about recognition ◦ Receive cash (or another Compound financial instruments
and disclosure financial asset) • Split into financial liability and
• Lack of understanding from ◦ Exchange financial equity components
users instruments under • Financial liability:
favourable conditions Present value of principal X
• Financial liability: Present value of interest X
– Contractual obligation to X
◦ Deliver cash (or another • Equity:
financial asset) – Proceeds – financial liability
◦ Exchange financial
instruments under
unfavourable conditions Interest, dividends, gains and
• Equity: losses
– Evidences a residual interest • Presented in p/l if associated
in the assets after deducting with liabilities
all of its liabilities • Presented in equity if
associated with equity
Recognition Derecognition Factoring of trade receivables
• When entity becomes party to • Financial assets – rights to • In substance a genuine sale
contractual provisions of the cashflows expire or – Derecognise trade receivable
instrument • Substantially all risks and • In substance a secured loan
• Usually: rewards transferred – Continue to recognise a
– Trade receivable/payable • Financial liabilities – trade receivable and
◦ On transfer of promised discharged, cancelled, expires recognise a financial liability
goods/services
– Loans
◦ On issue
– Shares
◦ On issue
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Measurement
Measurement of financial assets Measurement of financial liabilities

Business model test Two categories
Initial and subsequent measurement Initial and subsequent measurement

• Investments in debt instruments held to collect • Most financial liabilities:
contractual cash flows (solely principal and – Initial: Fair value - transaction costs
interest) – Subsequent: Amortised cost
– Initial: FV + transaction costs • Financial liabilities at fair value through P/L
– Subsequent: Amortised cost ('held for trading' and derivative liabilities)
• Investments in debt instruments held to collect – Initial: Fair value
contractual cash flows (solely principal and – Subsequent: Fair value through P/L
interest) and to sell
– Initial: FV + transaction costs
– Subsequent: FV through OCI Fair value
• Investments in equity instruments not 'held for Price to sell an asset or transfer a liability in
trading' (optional irrevocable election on orderly transaction between market
initial recognition) participants at the measurement date
– Initial: FV + transaction costs
– Subsequent: FV through OCI
• All other financial assets Amortised cost
– Initial: FV (TC to P/L) • Amount at which item was initially recorded
– Subsequent: FV through P/L less any principal repayments, plus the
cumulative amortisation of the difference
between the initial and maturity values
Fair value • Calculation:
Price to sell an asset or transfer a liability in Balance b/d X
orderly transaction between market X
participants at the measurement date Interest received (coupon × par value) (X)
Balance c/d X
Amortised cost
• Amount at which item was initially recorded
less any principal repayments, plus the
cumulative amortisation of the difference
between the initial and maturity values
• Calculation:
Balance b/d X
X
Interest received (coupon × par value) (X)
Balance c/d X
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1. The need for an accounting standard

The market for financial instruments developed faster than the standard setters could keep pace
with. There was a lack of guidance around accounting for financial instruments, leading to
inconsistencies and a lack of understanding.
2. Classifications
Financial assets are cash, the right to receive cash under a contract or derivative assets. Similarly,
financial liabilities are an obligation to deliver cash under a contract or derivative liabilities.
Financial instruments are classified in accordance with their substance. Redeemable preference
shares are, in substance, debt and are shown as a non-current liability in the statement of
Compound instruments must be split into its financial liability and equity components. This is
done by measuring the financial liability (debt) component, first by discounting the debt’s cash
flows, and then assigning the residual cash received to the equity component.
3. Recognition and derecognition

Recognition – A financial asset or financial liability should be initially recognised in the statement
of financial position when the reporting entity becomes a party to the contractual provisions of
the instrument.
Derecognition of financial assets – When the contractual rights to the cash flows expire; or when
the financial asset is transferred, based on whether the entity has transferred substantially all
the risks and rewards of ownership of the financial asset.
Derecognition of financial liabilities – When the obligation is discharged (eg paid off), cancelled
or expires.
Factoring of trade receivables – If factoring is, in substance, a genuine sale, derecognise the
trade receivables. If factoring is, in substance, a secured loan, continue to recognise the trade
receivable and recognise a financial liability.
4. Measurement
Financial assets are measured depending upon their classification.
Financial assets that are investments in debt instruments held for the purpose of collecting cash
flows that are solely interest and principal cash flows are held at amortised cost.
Investments in debt instruments held to collect cash flows that are solely payments of principals
and interest and the intention is to sell the instrument are accounted for at fair value through
other comprehensive income (FVTOCI) with no reclassification to profit or loss.
All other financial instruments (including all derivatives) are held at fair value through profit or loss
(FVTPL). An exception is permitted for investments in equity instruments of another entity (eg an
investment in shares) that are not held for trading which can be accounted for as FVTOCI with
reclassification to profit or loss if an election is made to use that treatment at the original date of
purchase.
Most financial liabilities are accounted for as amortised cost.
Financial liabilities held for trading are accounted for as FVTPL.
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Question practice
the Workbook):
Section A Q15
Section C Q40 Financial assets and liabilities
Further reading
There is a useful article regarding this subject on the ACCA website:
Financial Instruments
www.accaglobal.com
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Activity answers
£
Step 1: Calculate the value of the whole instrument 2,000,000
Step 2: Calculate the carrying amount of the liability element (which is the
present value of the future cash flows discounted using the 9% interest
rate for equivalent bonds without conversion rights)
1,544,000
PV of the principal ($2m × 0.772) 303,720
PV of the interest ($120,000* × 2.531) 1,847,720
Step 3:
Calculate the residual value of the equity component
(balancing figure) 152,280
*The annual interest is 6% × $2m = $120,000
Activity 2: Debt factoring

This arrangement is a secured loan as the risk of non-payment is borne by Freddo Co, and the
lender (the factor) charges interest on amounts advanced.
The receivables should remain in Freddo Co’s books and a liability equal to the $270,000 received
from the factor should be recognised. Interest of $6,750 ($270,000 × 5% × 6/12m) is accrued on
the $270,000 for the six months to 31 December 20X1 and should be added to the loan balance.
The $150,000 collected by the factor will reduce receivables and reduce the loan payable. Interest
of $3,000 ($120,000 × 5% × 6/12m) is accrued on the outstanding balance of $120,000 for the six
months to 30 June 20X2 and should be added to the loan balance.
The outstanding loan balance must be repaid by Freddo Co on 1 July 20X2.
Activity 3: Financial assets at fair value

The correct answer is: $751,000 gain
$’000
$9,500 × 1,187/1,100 10,251
Carrying amount (9,500)
Gain 751
Activity 4: Financial asset held at amortised cost
20X1 20X2 20X3
$ $ $
b/d at 1 January
(440,000 + 5,867) 445,867 462,333 480,330
Interest income @ 9.3% 41,466 42,997 44,670
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20X1 20X2 20X3
$ $ $
Cash received (25,000) (25,000) (25,000)
c/d at 31 December 462,333 480,330 500,000
At inception the bond is classed as a financial asset:
DEBIT Financial asset 445,867

CREDIT Cash 445,867
Activity 5: Financial liability at amortised cost

1
1 Bond at inception:
At 1 January 20X1 $
Financial liability component of convertible bond (W1) 270,180
Equity component of convertible bond (300,000 – (W1) 270,180) 29,820
Working
Financial liability component
Present value of principal payable at end of

four years
(3,000 × $100 = $300,000 × 0.735) 220,500
Present value of interest payable annually in arrears for four

years
Year 1 (5% × 300,000) = 15,000 × 0.926 13,890
Year 2 15,000 × 0.857 12,855
Year 3 15,000 × 0.794 11,910
Year 4 15,000 × 0.735 11,025
49,680
270,180
2
2 Finance cost:
Finance costs (profit or loss)
Effective interest on financial liability component of

convertible bond (W) 21,614
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Financial liability component of convertible bond (W2) 276,794
Working
Amortised cost financial liability
1.1.X1 Liability b/d 270,180
1.1.X1–31.12.X1 Interest at 8% 21,614
31.12.X1 Coupon interest paid (15,000)
31.12.X1 Liability c/d 276,794
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HB2022

Leasing
13
13
Learning objectives
Account for right-of-use assets and lease liabilities in the B6(a)

records of the lessee.
Explain the exemption from the recognition criteria for leases in B6(b)
the records of the lessee.
Account for sale and leaseback agreements. B6(c)

13
Exam context
Leasing is an important area both in the Financial Reporting exam and in the wider business
context. You will be considering leasing from the perspective of the lessee only for your Financial
Reporting exam. It is vital that you understand how to account for right of use assets and lease
liabilities before going on to account for sale and leaseback transactions. Question practice is key
in order to consolidate your knowledge and application in this important topic.
Leasing questions could be asked in any section of the FR exam. In Section C questions, you
should be prepared to see leasing as an adjustment in a single entity accounts preparation
question or you may be asked to comment on the impact of leasing as opposed to the outright
purchase of assets as part of an interpretation of financial statements question, including the
statement of cash flows.
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13
Chapter overview
Leases (IFRS 16)
Issue Identifying a lease Lease liability
Definitions
Right-of-use asset Presentation Recognition exemptions
Right-of-use asset
Sale and leaseback

transactions
Transfer is in substance a sale
Transfer is NOT in
substance a sale
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1 Issue
1.1 Objective
Under IFRS 16 Leases, lessees must recognise a right of use asset and a lease liability for all
leases with a term of more than 12 months, unless the underlying asset is of low value. IFRS 16
was developed in response to criticism of the previous standard which required lease agreements
meeting certain criteria to be accounted for as expenses in profit or loss. The leased asset and
lease liability were not presented in the statement of financial position, which did not represent
the underlying reality of the agreement.
Exam focus point

You are only concerned with the accounting treatment of a lease from the perspective of the
lessee for your Financial Reporting exam. However, it is important that you have a good
understanding as the concept will be developed further, including understanding the lessor
accounting, at Strategic Business Reporting.
2 Identifying a lease
2.1 Definitions
Lease: A contract is, or contains, a lease if there is an identifiable asset and the contract
KEY
TERM conveys the right to control the use of the identified asset for a period of time in exchange for
consideration (IFRS 16: para. 9).
Underlying asset: An asset that is the subject of a lease, for which the right to use that asset
has been provided by a lessor to a lessee (IFRS 16: Appendix A).
The contract has to meet the definition of a lease contract to be within the scope of IFRS 16. A
lessee does not control the use of an identified asset if the lessor can substitute the underlying
asset for another asset during the lease term and would benefit economically from doing so.
Some contracts may contain elements that are not leases, such as service contracts. These must
be separated out from the lease and accounted for separately (IFRS 16: para. 13).
2.2 Elements of a lease

Right to control Identified asset Period of use
Entity must have the • Stated in the contract • Period of use in time or
right to: • May be part of a larger in units produced
• Obtain substantially all asset • Lease may only be for
economic benefits from • The lessor has no a portion of the term
the use of the asset; and substitution rights (a of the contract (if the
• Direct the use of the similar asset cannot be right to control the
asset used instead of the asset exists for part of
original leased asset) the term)
Illustration 1: Identifiable asset
Coketown Council has entered into a five-year contract with Carefleet Co, under which Carefleet
Co supplies the council with ten vehicles for the purposes of community transport. Carefleet Co
owns the relevant vehicle, all ten of which are specified in the contract. Coketown Council
determines the routes taken for community transport and the charges and eligibility for discounts.
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The council can choose to use the vehicles for purposes other than community transport. When
the vehicles are not being used, they are kept at the council’s offices and cannot be retrieved by
Carefleet Co, unless Coketown Council defaults on payment. If a vehicle needs to be serviced or
repaired, Carefleet Co is obliged to provide a temporary replacement vehicle of the same type.
Required
Explain whether this contract contains a lease under the definition of IFRS 16.
Solution
This is a lease. There is an identifiable asset, the ten vehicles specified in the contract. The council
has a right to use the vehicles for the period of the contract. Carefleet Co does not have the right
to substitute any of the vehicles unless they are being serviced or repaired. Therefore, Coketown
Council would need to recognise a right-of-use asset and a lease liability in its statement of
Activity 1: Is it a lease?
Outandabout Co provides tours around places of interest in the tourist city of Sightsee. While
these tours are mainly within the city, it does the occasional day trip to visit tourist sites further
away. Outandabout Co has entered into a three-year contract with Fastcoach Co for the use of
one of its coaches for this purpose. The coach must seat 50 people, but Fastcoach Co can use
any of its 50-seater coaches when required.
Required
Explain whether this agreement constitutes a lease.
Solution
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3 Lease liability
3.1 Initial measurement of the lease liability
On commencement of the lease, the lease liability is measured at the present value of future
lease payments, including any expected payments at the end of the lease, discounted at the
interest rate implicit in the lease (IFRS 16: para. 26).
If that rate cannot be readily determined, use the lessee’s incremental borrowing rate.
The rate will be given to you in your exam.
Note. The present value of future lease payments excludes any payments made on or before
commencement of the lease. Any deposits paid to secure the lease, or instalments paid in
advance on the first day of the lease, are not, by definition, future payments and should not be
included.
Exam focus point

In the examination, the question will specify a value for the cumulative present value of $1
payable in X years’ time, so that candidates can calculate the present value quickly. So, for
example, you will be given the cumulative value of $1 in four years’ time at 5% as $3.546, and
a lease with an annual charge of $50,000 would have a present value of $50,000 × $3.546 =
$177,300.
3.2 Subsequent measurement of the lease liability

The lease liability will subsequently:
• Be increased due to interest accrued on the outstanding liability
• Be decreased due to lease payments made
3.3 Lease payments

As the company benefits from paying the lease over a period of time, the total amount paid will
therefore include capital and interest payments. The interest is referred to as an interest charge or
finance charge.
3.4 Allocating the finance charge

IFRS 16 requires the finance charge to be allocated to periods during the lease term, ie applying
the interest rate implicit in the lease (the lease’s internal rate of return) to the amount of capital
outstanding to calculate the finance charge for the period.
Consequently, at the start of the lease, the finance charges will be a higher proportion of the
lease payments. Towards the end of the lease’s life, the finance charge will be smaller as the
outstanding lease liability is smaller.
3.5 Calculation of lease liability

The approach to calculating the lease liability differs slightly depending on whether payments are
made in arrears or in advance. If payments are made in arrears, a payment is made in each
period and interest is calculated on the liability balance brought forward at the start of each
period as follows:
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13: Leasing 319

Payments in arrears
$
1.1.X1 Lease liability (PVFLP) X
1.1.X1-31.12.X1 Interest at X% X
31.12.X1 Instalment in arrears (X)
31.12.X1 Liability c/d X
1.1.X2–31.12.X2 Interest at x% X
31.12.X2 Instalment in arrears (X)
31.12.X2 Liability > 1 year X
The current liability at 31.12.X1 is calculated as the difference between the liability at 31.12.X1 and
the liability at 31.12.X2.
Alternatively, if payments are made in advance, there will be no lease payment in the first period
and interest is simply applied to the PVFLP on initial recognition of the liability. In subsequent
periods, interest is calculated after deducting the instalment payment as follows:
Payments in advance
$
1.1.X1 Lease liability (PVFLP) X
1.1.X1–31.12.X1 Interest at x% X
31.12.X1 Liability c/d X
Instalment in advance
1.1.X2 (current liability) (X)
Liability > 1 year (non-current

liability) X
Activity 2: Lease liabilities
Bento Co enters into a contract to gain the right to use an asset from 1 January 20X1. The
contract meets the definition of a lease under IFRS 16. The terms of the lease require Bento Co to
pay a non-refundable deposit of $575 followed by seven annual instalments of $2,000 payable in
arrears. The present value of the future lease payments on 1 January 20X1 is $10,000.
The interest rate implicit in the lease is 9.2%.
Required
1 What is the interest charge in the statement of profit or loss of Bento Co for the year ended 31
December 20X1?
$
2 What are the current and non-current liability balances included in the statement of financial
position of Bento Co as at 31 December 20X1?
 Current liability $1,179; Non-current liability $7,741
 Current liability $Nil; Non-current liability $8,920
 Current liability $2,000; Non-current liability $6,920
 Current liability $Nil; Non-current liability $7,741
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4 Right-of-use asset
Right-of-use asset: An asset that represents a lessee’s right-to-use an underlying asset for the
KEY
TERM lease term.
The key is the right to control the use of the asset. The right to control the use of an identified
asset depends on the lessee having:
(a) The right to obtain substantially all of the economic benefits from use of the identified asset;
and
(b) The right to direct the use of the identified asset. This arises if either:
(i) The customer has the right to direct how and for what purpose the asset is used during
the whole of its period of use; or
(ii) The relevant decisions about use are predetermined and the customer can operate the
asset without the supplier having the right to change those operating instructions, or the
customer designed the asset in a way that predetermines how and for what purpose the
asset will be used throughout the period of use.
4.1 Initial measurement of the right-of-use asset

The right-of-use asset is initially measured at cost, consisting of:
$m $m
Initial measurement of lease liability X
Payments made before or at commencement of lease X
Less incentives received (X)
X
Initial direct costs X
PV of costs of dismantling, removing and restoring the site X
Right-of-use asset X
At the commencement date, recognise a right-of-use asset, representing the right to use the
underlying asset and a lease liability representing the company’s obligation to make lease
payments
DEBIT Right-of-use asset X

CREDIT Lease liability X
DEBIT / CREDIT Cash/provision/other X X
4.2 Subsequent measurement of the right-of-use asset

After the commencement date, the right-of-use asset should be measured using the cost model in
IAS 16, unless it is an investment property or belongs to a class of assets to which the revaluation
model applies (IAS 16: para. 29).
IAS 16 cost model
Depreciation must be provided on the right-of-use asset:
DEBIT Depreciation (SPL) X

CREDIT Right-of-use asset (accumulated depreciation) (SOFP) X
The right-of-use asset must be depreciated over:
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13: Leasing 321

(a) The useful life of the asset, if ownership transfers at the end of the lease term, or if the lessee
has a purchase option and is likely to exercise it; or
(b) If there is no transfer of ownership or purchase option, the shorter of the lease term and the
useful life of the asset.
The depreciation rate should be consistent with other non-current assets in the same class, to
ensure a consistent accounting policy.
Revaluation model
If a lessee applies the IAS 16 Property, Plant and Equipment revaluation model to a certain class of
property, plant and equipment, then the lessee can choose to also apply the revaluation model to
right-of-use assets that relate to that same class of property, plant and equipment (IFRS 16: para.
35).
If the revaluation model has been adopted for the same type of class of non-current asset, and
the entity must therefore apply the same accounting policy to the right-of-use asset. Impairment
reviews will be required in accordance with IAS 36 Impairment of Assets.
Investment property
If the type of asset meets the criteria of an investment property, then the fair value model under
IAS 40 Investment Property must be adopted.
Exam focus point

The June 2018 Examiner’s report identifies that candidates struggled with leases where the
payments were made in advance. Ensure that careful question practice on the topic of leases
is completed.
5 Presentation
5.1 Statement of financial position
Right-of-use assets
Right-of-use assets should be disclosed separately from other assets, either as a separate line on
the statement of financial position or separately within the notes.
Right-of-use assets which qualify as investment property are an exception; they should be
presented within investment property in the statement of financial position.
Lease liabilities
Lease liabilities should be disclosed separately from other liabilities, either in the statement of
financial position or in the notes.
The balance remaining at the year-end needs to be split between current liabilities and non-
current liabilities. (IFRS 16 does not require this, but this should be in accordance with IAS 1
Presentation of Financial Statements.)
Lease liabilities X
Current liabilities
Lease liabilities X
5.2 Statement of profit or loss and other comprehensive income

Interest expense on the lease liability and depreciation on the right-to-use asset should be
presented separately.
Interest expense should be presented as part of finance costs.
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5.3 Disclosures
IFRS 16 requires information about a company’s leases to be disclosed in a separate note and
include:
$
Interest expense on lease liabilities X
Depreciation on right-of-use assets (by class of underlying asset) X

Expenses relating to short-term and low-value leases X
Carrying amount of right-of-use assets (by class of underlying asset) X
Activity 3: Alpha Co
Alpha Co makes up its accounts to 31 December each year. It enters an agreement, which meets
the definition of a lease under IFRS 16, for the right to use an item of equipment with the following
terms:
Inception of lease: 1 January 20X1
Term: Five years: $2,000 paid at commencement of

lease, followed by 4 payments of $2,000
payable in advance. Title to the asset does
not pass to Alpha Co at the end of the lease
term.
Fair value of equipment: $8,000
Present value of future lease payments: $6,075
Useful life: 8 years
Interest implicit in the lease: 12%
Required
1 What is the carrying amount of the right-of-use asset in the statement of financial position of
Alpha Co as at 31 December 20X1?
 $8,000
 $6,460
 $6,000
 $8,075
2 What is the non-current liability balance in the statement of financial position as at 31
December 20X1?
 $4,075
 $4,804
 $6,804
 $6,075
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13: Leasing 323

6 Recognition exemptions
6.1 Which leases are exempt?
IFRS 16 provides optional exemptions from applying the full requirements of IFRS 16 on the
following types of lease:
(a) Short-term leases. These are leases with a lease term of 12 months or less. This election is
made by class of underlying asset. A lease that contains a purchase option cannot be a
short-term lease.
(b) Leases of assets with a low underlying value (low value assets). These are leases where the
underlying asset has a low value when new (such as tablet and personal computers or small
items of office furniture and telephones). This election can be made on a lease-by-lease
basis. An underlying asset qualifies as low value only if two conditions apply:
(i) The lessee can benefit from using the underlying asset.
(ii) The underlying asset is not highly dependent on, or highly interrelated with, other assets.
An entity must elect to utilise the exemption. The election for leases of low value assets can be
made on a lease-be-lease basis, but the election for short-term leases is made by class of
underlying assets.

Lease payments are recognised as an expense in profit or loss on a straight-line basis over the
lease term, unless some other systematic basis is representative of the time pattern of the user’s
benefit.
Activity 4: Oscar Co
Oscar Co is preparing its financial statements for the year ended 30 June 20X6. On 1 May 20X6,
Oscar made a payment of $32,000 for an eight-month lease of a milling machine. Oscar has
elected to utilise any lease exemptions available.
Required
What amount would be charged to Oscar Co’s statement of profit or loss for the year ended 30
June 20X6 in respect of this transaction?
Solution
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7 Sale and leaseback transactions
7.1 Issue
A sale and leaseback transaction involves the sale of an asset and the leasing back of the same
asset. The key question in determining the accounting treatment is: does the transaction
constitute a sale? This is determined by considering when the performance obligation is satisfied
in accordance with IFRS 15 Revenue from Contracts with Customers.
Exam focus point

Sale and leaseback transactions in the Financial Reporting exam will only cover situations in
which the sales proceeds are equal to fair value at the date of sale and in which lease
payments are in arrears. More complex situations will be covered in Strategic Business
Reporting.

If the transaction is a sale, per IFRS 15
Measure the right-of-use asset arising from the leaseback at the proportion of the previous
carrying amount of the asset that relates to the right of use retained by the seller/lessee. This is
calculated as:
Present value of future lease payments (PVFLP)
Carrying amount ×
Fair value
The present value of future lease payments are calculated as for any other lease.
Recognise only the amount of any gain or loss on the sale that relates to the rights transferred to
the buyer/lessor. The gain or loss that can be recognised is calculated in three stages:
Stage 1: Calculate total gain = fair value (= proceeds) less carrying amount
Stage 2: Calculate gain that relates to rights retained:

Total gain × present value of future lease payments/fair value = Gain relating to
rights retained
Stage 3: Gain relating to rights transferred is the balancing figure:

Gain on rights transferred = total gain (Stage 1) less gain on rights retained (Stage
2)
The right-of-use asset continues to be depreciated as normal, although a revision of its remaining
useful life may be necessary to restrict it to the lease term.
Activity 5: Wigton Co
On 1 April 20X2, Wigton Co bought an injection moulding machine for $600,000. The carrying
amount of the machine as at 31 March 20X3 was $500,000. On 1 April 20X3, Wigton Co sold it to
Whitehaven Co for $740,000, its fair value. Wigton Co immediately leased the machine back for
five years, the remainder of its useful life, at $160,000 per annum payable in arrears. The present
value of the future lease payments is $700,000 and the transaction satisfies the IFRS 15 criteria to
be recognised as a sale.
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13: Leasing 325

Required
What gain should Wigton Co recognise for the year ended 31 March 20X4 as a result of the sale
and leaseback?
 $227,027
 $240,000
 $12,973
 $40,000
Activity 6: Capital Co
Capital Co entered into a sale and leaseback on 1 April 20X7. It sold a lathe with a carrying
amount of $300,000 for $400,000 (equivalent to fair value) and leased it back over a five-year
period, equivalent to its remaining useful life. The transaction constitutes a sale in accordance
with IFRS 15.
The lease required Capital Co to make five annual payments in arrears of $90,000. The rate of
interest implicit in the lease is 5%. The cumulative value of $1 in five years’ time is $4.329.
Required
What are the amounts to be recognised in the financial statements at 31 March 20X8 in respect of
the sale and leaseback transaction?
Solution
7.3 Transaction is not a sale per IFRS 15

If the transfer does not satisfy the IFRS 15 requirements to be accounted for as a sale:
• The seller must continue to recognise the transferred asset
• The transfer proceeds are treated as a financial liability, accounted for in accordance with
IFRS 9
The transaction is more in the nature of a secured loan.
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Essential reading
In Chapter 13 of the Essential reading there are additional examples relating to sale and
leaseback transactions.
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13: Leasing 327

Chapter summary
Leases (IFRS 16)
Issue Identifying a lease Lease liability
To prevent off-balance Definitions PVFLP (not paid at

sheet financing • A contract, or part of a contract, that conveys the commence. date) X
right to use an asset (the underlying asset) for a Interest at implicit % X
period of time in exchange for consideration Payment in arrears (X)
• Contract contains a lease if the contract conveys Liability c/d
the right to control an asset for a period of time for (split NCL & CL) X
consideration, where, throughout the period of use,
the customer has:
(a) Right to obtain
substantially all of the economic benefits from
use, and
(b) Right to direct use of identified asset
Right-of-use asset Presentation Recognition exemptions
Right-of-use asset • Right-of-use assets disclosed • Optional exemptions (expense

PVFLP X separately from other assets, in P/L):
Payments on/before EITHER as a separate line on – Short-term leases (lease term
comm. date X the face of the SOFP or as a < 12 months)
Initial direct costs X separate category within the – Underlying asset is low value
Notes. (eg tablet PCs, small office
Dismantling/restoration costs X
• Right-of-use investment assets furniture, telephones)
X to be presented within
investment property
• Lease liabilities should be split
Depreciate to earlier of end of between current and
useful life (UL) and lease term non-current (IAS 1)
(UL if ownership expected to • Interest expense presented in
transfer) finance costs
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Sale and leaseback transactions
Transfer is in substance a sale

• Seller/lessee:
– Derecognises asset transferred
– Recognises a right-of-use asset at proportion of
previous CA for right of use retained
– Recognises gain/loss in relation to rights
transferred
• Buyer-lessor accounts for:
– The purchase as normal purchase
– The lease per IFRS 16
Transfer is NOT in substance a sale

• Seller-lessee:
– Continues to recognise transferred asset
– Recognises financial liability equal to transfer
proceeds (and accounts for it per IFRS 9)
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13: Leasing 329

1. Issue
• Lessee accounting is an example of the application of the substance over form concept.
• The asset is recognised in the books of the entity that controls it, even though that asset may
never be owned by the entity.
2. Leases
• A contract, or part of a contract, that conveys the right to use an asset, the underlying asset,
for a period of time in exchange for consideration.
• Lessees must recognise assets and liabilities for all leases with a term of more than 12 months,
unless the underlying asset is of low value.
3. Recognition exemptions
• For short-term leases or leases of low value assets, the lease payments are simply charged to
profit or loss as an expense.
4. Sale and leaseback transactions

• Accounting for sale and leaseback transactions depends on whether the transaction meets the
IFRS 15 criteria for a sale.
• Sale: Recognise a right-of-use asset at the proportion of the previous carrying amount of the
asset that relates to the right-of-use retained. Recognises only the amount of any gain/loss
that relates to the rights transferred.
• Not a sale: Continue to recognise the transferred asset and treat the transfer as a financial
liability, as per IFRS 9.
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Question practice
the Workbook):
Section A Q16
Section B Q21
Section C Q45 Bulwell Aggregates Co
Section C Q46 Lis Co
Further reading
There are articles in the Exam Resources section of the ACCA website which are relevant to the
topics covered in this chapter and would be useful to read:
IFRS 16 Leases
www.accaglobal.com
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13: Leasing 331

Activity answers
Activity 1: Is it a lease?
This is not a lease. There is no identifiable asset. Fastcoach Co can substitute one coach for
another, and would derive economic benefits from doing so in terms of convenience. Therefore,
Outandabout Co should account for the rental payments as an expense in the statement of profit
or loss.
Activity 2: Lease liabilities
1 $ 920
$
1.1.X1–31.12.X1 Interest at 9.2% 920
31.12.X1 Instalment 1 (in arrears) (2,000)
2 The correct answer is: Current liability $1,179; Non-current liability $7,741
$
1.1.X1–31.12.X1 Interest at 9.2% 920
1.1.X2–31.12.X2 Interest at 9.2% 821
Liability c/d (payable > 1
31.12.X2 year) 7,741
Amount paid < 1 year (8,920

- 7,741) 1,179
Activity 3: Alpha Co
RIGHT-OF-USE ASSET
$
Initial measurement of lease liability 6,075
Payments made before or at commencement of lease 2,000
Right-of-use asset 8,075
Depreciation charge = $8,075/5 = $1,615 (depreciate over shorter of useful life or lease term)
Carrying amount = $8,075 – $1,615 = $6,460
STATEMENT OF FINANCIAL POSITION (EXTRACT)
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$
Non-current assets
Right-of-use asset (8,075 – 1,615) 6,460
Current liabilities
Lease liability 2,000
Lease liability (W) 4,804
Working
$
1.1.X1-31.12.X1 Interest at 12% 729
1.1.X2 Instalment 2 (in advance) – current liability (2,000)
1.1.X2 Non-current liability 4,804
Activity 4: Oscar Co
The lease is for eight months, which counts as a short-term lease, and so it does not need to be
recognised in the statement of financial position. The amount charged to profit or loss for the year
ended 30 June 20X6 is therefore $32,000 × 2/8 = $8,000.
Activity 5: Wigton Co
Step 1 Gain on sale: $740,000 – $500,000 = $240,000
Step 2 Gain relating to rights retained = $(240,000 × 700,000/740,000) = $227,027
Step 3 Gain relating to rights transferred = $240,000 – $227,027 = $12,973
Activity 6: Capital Co
$
Statement of profit or loss
Gain on transfer (W3) 2,598
Depreciation (W2) (58,442)
Interest (W1) (19,480)
Statement of financial position

Non-current asset
Right-of-use asset (W2) 233,766
Lease liability (W1) 245,044
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13: Leasing 333

$
Current liabilities
Workings
1 Lease liability
$
Lease liability (present value of future lease payments)
1.4.X7 ($90,000 × $4.329 = $389,610) 389,610
1.4.X7 – 31.3.X8 Interest at 5% 19,480
31.3.X8 Instalment paid in arrears (90,000)
31.3.X8 Liability carried down 319,090
1.4.X8 – 31.3.X9 Interest at 5% 15,954
31.3.X9 Instalment paid in arrears (90,000)
31.3.X9 Liability due in more than 1 year 245,044
Current liabilities of $74,046 ($319,090 – 245,044) reflect the amount of the lease liability that
will become due within 12 months.
2 Right of use asset
$
Right of use asset at commencement date
= carrying amount × PVFLP/fair value
= 300,000 × 389,610/400,000 292,208
Depreciation (over 5 years) (58,442)
Carrying amount at 31.3.X8 233,766
3 Gain on rights transferred
Stage 1: Total gain on the sale = Fair value – carrying amount
= $400,000 – $300,000
= $100,000
Stage 2: Gain relating to the rights retained PVFLP

Gain ×
Fair value
= $(100,000 × 389,610/400,000)
= $97,402
Stage 3: Gain relating to the rights = Total gain (Stage 1) – gain on rights
transferred retained (Stage 2)
= $100,000 – $97,402
= $2,598
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Skills checkpoint 4
Application of IFRS
Standards
Chapter overview
cess skills
Exam suc
Answer planning
c FR skills C
n Specifi o
tio
rr req
a
ec ui
of
m
t i rem
or
nt
inf
erp ents
ng
reta
agi

Man
tion
l y si s
skills
Go od
skills
ana
ti m
Approach
c al
em
to Case
e ri
OTQs
an
um
ag
tn
em
en
en
t ci
Effi
Effe cti
ve writing
a nd p r
esentation
Introduction
Financial Reporting introduces a number of IFRS Standards for the first time (such as IFRS 9
Financial Instruments) and tests further understanding of those already covered in your earlier
studies (for example, IAS 2 Inventories and IAS 16 Property, Plant and Equipment).
It is important that you understand how the IFRS Standards that are covered in the Financial
Reporting exam apply to financial statements, not just gaining the knowledge of what they are
and how they work, but also developing your application skills. These application skills will be
further developed in Strategic Business Reporting, so it is vitally important that you gain a
confident knowledge of the main IFRS Standards in your Financial Reporting studies.
Knowledge of the IFRS Standards will be required in all sections of the Financial Reporting exam.
You may be asked to identify the key requirements of an IFRS Standard in a knowledge based
narrative question and are likely to be asked questions about the application or impact of IFRS
Standards in an OT question. Knowledge of the requirements of IFRS Standards is essential when
preparing financial statements and may be relevant in the interpretation of an entity’s
performance and position in Section C.
The key to success in the Financial Reporting exam is:
• Understanding the key elements of the IFRS Standards; and
• Applying your knowledge of these IFRS Standards.
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Skills Checkpoint 4: Application of IFRS Standards
FR Skill: Application of IFRS Standards
We would suggest the following approach to ensure you can demonstrate your ability to correctly
apply the requirements of IFRS Standards in the Financial Reporting exam.
STEP 1: Overview of key standards

Ensure you have a high-level overview of the key standards covered in the FR
exam. Use the summary diagrams at the end of the chapters in the Workbook to
act as your summaries. These are a useful way of remembering the key points.
STEP 2: Numerical question practice

Practice the numerical questions in the Workbook and in the Practice & Revision
Kit. These will test your knowledge of the mechanics of the accounting standards.
Often there can be a difference between understanding what the standard does
and how it applies to a specific scenario. Practice OTQs as well as longer, Section C
questions to consolidate your knowledge.
STEP 3: Narrative question practice

Practice the narrative questions which test your understanding of how the standard
can affect the financial statements. This will help you to revise your understanding
of why the accounting standard is important in a scenario. For example, what are
the key tests for impairment of assets and why would this be important for the
Exam success skills

The following question is an example of the way in which you may be asked to demonstrate your
knowledge and application of a particular IFRS Standard. Here, the question is asking about IAS 8
Accounting Policies, Changes in Accounting Estimates and Errors.
For these questions, we will also focus on the following exam success skills:
• Managing information. It is easy for the volume of information contained in a question,
particularly the cases in Section B and the Section C questions, to feel overwhelming. Active
reading is a useful technique to help you avoid this. This involves focusing on the requirement
first, on the basis that until you have done this the detail in the question will have little
meaning.
• Correct interpretation of requirements. Make sure you understand why you are being asked
about a particular standard. Is it so can you apply the rules in a calculation question, or is it so
you understand for example a difference in accounting treatment that is relevant to
interpretation?
• Efficient numerical analysis. Ensure you understand what the IFRS Standard requires you to
do with the financial information you are provided with in the question. This is testing your
application of the standards.
• Effective writing and presentation. Section C questions require application of an IFRS
Standards both in the accounts preparation question as knowledge of the IFRS Standards is
essential in preparing calculations and adjustments and also in the interpretation question
where the standard applied may be relevant to your understanding of the entity. Set out your
points clearly and methodically, to enable the Examining team to read your answer easily.
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Skill activity
STEP 1 Ensure you have a high-level overview of the key IFRS Standards covered in the Financial Reporting exam.
Use the summary diagrams at the end of the chapters in the Workbook to act as your summaries. These are
a useful way of remembering the key points.
It is important that you have the knowledge of the mechanics of the standard. One way of doing
this is by using the chapter summaries in the Workbook which summarise the key points about the
standards discussed. IAS 8 is covered in Chapter 18 of the Workbook, and here is an extract of the
summary diagram.
Reporting financial performance
IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors
Accounting policies Accounting estimates Prior period errors

• Accounting policies are the • Changes in accounting • Prior period errors are
specific principles, bases, estimates result from new omissions from, and
conventions, rules and information or new misstatements in, the entity's
practices applied by an entity developments and, financial statements for one or
in preparing and presenting accordingly, are not correction more prior periods arising from
the financial statements of errors a failure to use reliable
• Area of judgment • Examples: information that:
• Information relevant and – Allowances for doubtful (a) Was available when the
reliable debts financial statements for
– Inventory provisions those periods were
– Useful lives of non-current authorised for issue; and
Changes in accounting policies assets (b) Could reasonably be
• A change in accounting policy expected to have been
is made only if: obtained and taken into
(a) It is required by an IFRS; or Changes in accounting account in the preparation
(b) It results in the financial estimates and presentation of those
statements providing • Changes in SOFP (assets, financial statements
reliable and more relevant liabilities, equity) – adjust in • Examples
information the period of the change – Arithmetical errors
• Change applied • Changes in SOPL (income, – Mistakes in applying
retrospectively expense) – adjust in current accounting policies
– Restate comparatives (as if and future period if the change – Deliberate errors
new policy had always affects both
applied)
– Adjust opening balance for Correction of the error
each component of equity Disclosure • An entity corrects material
for the earlier period • Nature of the change prior period errors
presented; and • Quantify the change retrospectively in the first set of
– Show adjustment in SOCIE financial statements
as separate (second) line authorised for issue after their
discovery
– Restate comparative
Disclosure amounts for each prior
• Nature of the change period in which the error
• Reason for the change occurred
• Quantify the effect of the – Show adjustment in SOCIE
change as separate (second) line
Disclosure
• Nature of the change
• Quantify the effect of the
change
Ensure that you are familiar with IAS 8, and understand the key points made in the summary. This
will act, initially, as your main reference for applying the accounting treatment. Once you have
gained additional question practice, you will be familiar with different question styles and
different scenarios.
STEP 2 Practice the numerical questions in the workbook and in the BPP Practice and Revision Kit. These will test
your knowledge of the mechanics of the accounting standards. Often there can be a difference between
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Skills Checkpoint 4: Application of IFRS Standards 337

understanding what the standard does and how it applies to a specific scenario. Practice OT questions as
well as longer Section C questions to consolidate your knowledge.
Question practice is key to success in your Financial Reporting exam. Practising the OT questions
are a relatively quick way of testing your knowledge, both of narrative and numerical questions.
However, having knowledge of the theory of the standard and applying that knowledge can often
cause problems for candidates, especially in the more complex standards such as IFRS 16 Leases.
STEP 3 Practice the narrative questions which test your understanding of how the standard can affect the financial
statements. This will help you to revise your understanding of why the IFRS Standard is important in a
scenario, for example, what are the key tests for impairment of assets and why would this be important for
the financial statements?
Success in answering narrative OT questions requires

knowledge of the requirements of an IFRS Standard.
These questions require you to read the answer options
very carefully. Depending on the style of questions
(MCQ, MR, hot area etc), you will be presented with
several answer options, all of which will at first seem like
viable alternatives so it can be difficult to discount any
options immediately or arrive at the correct answer
easily without giving the question due attention.
Here is an example of the type of narrative style

question you may get asked in a Section A OT question:
12
This is the key accounting standard in
12
Which of the following would be treated under IAS 8 the question, but the answer options
require knowledge of other standards.
Accounting Policies, Changes in Accounting Estimates
13
IAS 8 covers 3 areas - here we are
and Errors as a change of accounting policy13?
focused on change in accounting policy.
14
(a) A change in valuation of inventory14 from a Here you need to think of the
interaction between IAS 2 and IAS 8. Is
weighted average to a FIFO basis there an accounting policy choice
relating to the valuation of inventory?
(b) A change of depreciation15 method from straight 15
Here you need to think of the
interaction between IAS 16 and IAS 8.
line to reducing balance Depreciation is an accounting policy
choice, but the method of depreciation is
(c) The correction of the opening balance for accruals an accounting estimate.
as a result of a recording inaccuracy in the prior

16
year16 There is no mention of a policy here.
(d) Capitalisation of borrowing costs which have arisen 17

The fact that this policy is being
for the first time17 applied for the first time tells us that it
cannot be a change in policy.
(2 marks)
A change in valuation of inventory from a weighted

average to a FIFO basis.
Answering this question required you to understand IAS

8, but also the underlying accounting standards
relating to IAS 2, IAS 16 and to a lesser extent IAS 23.
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IAS 2 Inventories permits an entity to value its inventory
using either the weighted average or FIFO basis and
therefore permits an accounting policy choice. As such,
the change in valuation is an example of a change in
accounting policy.
The change of depreciation method is treated as a

change of accounting estimate. The difference between
these is subtle and is a good example of you needing to
understand not just IAS 8 – you need to know the
difference between a change in accounting policy and
a change in accounting estimate, but also IAS 16 as you
need to know that the policy is to depreciate, which has
not changed.
The correction of opening balances is clearly

accounting for an error and therefore not related to an
accounting policy.
Application of a new accounting policy (such as

capitalisation of borrowing costs) for transactions that
did not previously occur is not a change in accounting
policy according to IAS 8.
STEP 4 Practice the long-form questions that you will be faced with in Section C of the exam. Ensure you look at
both the financial statements preparation questions and the interpretation questions, and that you are
comfortable with how you would use the CBE software to answer each of these questions. Let’s consider an
example of a recent interpretation question.
The March/June 2021 exam included an interpretation question which required candidates to
‘Adjust the relevant extracts from Dough Co’s financial statements to apply the same accounting
policies as Cook Co and re-calculate Dough Co’s ratios provided in note (5).’
This is a good example of how knowledge of specific IFRS Standards can be asked in an
interpretation question. The scenario included differences in respect of:
• The revaluation of property, plant and equipment

(accounting policy); and
• Presentation differences in respect of expenses

The question required candidates to answer using a pre-formatted response area as follows:
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You will receive a clear instruction as to
which question part the pre-formatted
response option should be used to address
This is the information that was given These are the blank answer spaces in
in the question and can't be changed which you should type your answer.
You can see that the pre-formatted response area helps to give your answer structure and should
give you a good starting point for how you should approach this part of the question. Ensure that
you use pre-formatted response areas if they are provided.
STEP 5 Let’s also consider how you might answer an accounts preparation question, which also requires your
knowledge of IAS 8, this time using the spreadsheet software.
Remaining with IAS 8, Practice Exam 1 Q31, which is available on the ACCA Practice Platform,
contains the following information regarding an error: In September 20X5, the directors of Triage
Co discovered a fraud. In total, $700,000 which had been included as receivables in the above
trial balance had been stolen by an employee. $450,000 of this related to the year ended 31
March 20X5, the rest to the current year. The directors are hopeful that 50% of the losses can be
recovered from the company’s insurers.
Candidates were asked to prepare a schedule of adjustments to the draft profit or loss to take
account of adjustments, including the error. Consider how you would approach this using the
spreadsheet software:
You should cross-reference your
adjustments to any workings
Simple formula such as You should add short

the sum function can be explanations to your
used for calculations workings to explain
your thought process

below for the above question to give you an idea of how to complete the diagnostic.

Managing information Ensure that you read the question carefully, highlighting any
areas which you may need to refer back to. In a short OTQ
such as this one, the key was the standard which was IAS 8
and the fact that we were focusing on accounting policies.
Correct interpretation of Make sure you have answered the question by referring to the
requirements given information. As mentioned above, this question hinged
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on you understanding that you should focus on accounting
policies and not the whole of IAS 8.
Efficient numerical analysis There was not any numerical analysis in this narrative
question. Remember that FR is not all about getting the
numbers right. Expect a range of numerical and narrative
questions in the exam.
Effective writing and In an OTQ, you don’t need to worry about writing and
presentation presentation. However, consider how you might discuss the
impact of the change in accounting policy in an interpretation
question in Section C.
Most important action points to apply to your next question – work through each of the
alternative answers carefully as the differences between the options are often subtle.
HB2022

HB2022

Provisions and events
14 after the reporting
period
14
Learning objectives
Syllabus reference
no.
Explain why an accounting standard on provisions is necessary. B7(a)
Distinguish between legal and constructive obligations. B7(b)
State when provisions may and may not be made and demonstrate how B7(c)
they should be accounted for.
Explain how provisions should be measured. B7(d)
Define contingent assets and liabilities and describe their accounting B7(e)
treatment and required disclosures.
Identify and account for: B7(f)

(a) warranties/guarantees
(b) onerous contracts
(c) environmental and similar provisions
(d) provisions for future repairs or refurbishments
Events after the reporting period: B7(g)

(a) distinguish between and account for adjusting and non-adjusting
events after the reporting period.
(b) identify items requiring separate disclosure, including their
accounting treatment and required disclosures.
14
Exam context
You will already have covered the basic aspects of IAS 37 Provisions, Contingent Liabilities and
Contingent Assets in your earlier studies. The Financial Reporting exam builds on this knowledge
by looking at the need for discounting certain provisions and by considering in detail some
specific transactions. IAS 10 Events After the Reporting Period is also revisited. You need to be able
to review financial statements and correct for errors and omissions which occur after the
reporting date. The exam will test your application of IAS 37 and IAS 10 within both OT Questions
and as part of a single entity accounts preparation question in Section C. If you require revision
from your earlier studies, review the activities and information in the Essential reading section.
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14
Chapter overview
Provisions and events after the reporting period
Provisions Types of provision

(IAS 37)
Definition Warranties Future operating losses
Recognition Decommissioning costs Onerous contracts
Measurement Restructuring
Contingent Contingent Events after the

liabilities assets reporting period (IAS 10)
Definition Definition Definition
Accounting treatment Accounting treatment Accounting treatment
Nature of disclosure Nature of disclosure Nature of disclosure
Need for disclosure Need for disclosure Need for disclosure
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1 Provisions (IAS 37 Provisions, Contingent Liabilities and
Contingent Assets)
You were introduced to IAS 37 Provisions, Contingent Liabilities and Contingent Assets in your
earlier studies, so some of this section will be revision. In FR, provisions become more complex and
you need to be aware of the requirements of IAS 37 for specific types of provision. The complexity
of provisions is greater at FR as discounting is also introduced to reflect the time value of money
for amounts to be settled in the future.
Essential reading
For revision of IAS 37, refer to Chapter 13 of the Essential reading.

Provision: A provision is a liability of uncertain timing or amount. (IAS 37: para. 10)
KEY
TERM
Recognition
A provision shall be recognised when: an entity has a present obligation (legal or constructive) as
a result of a past event, it is probable that an outflow of resources embodying economic benefits
will be required to settle obligation, and a reliable estimate can be made of the amount of the
obligation.
(IAS 37: para. 14)
Unless all of these conditions are met, no provision can be recognised.
Provisions are reviewed each year and adjusted to reflect current best estimate. If it is no longer
probable that an outflow of resources embodying economic benefits will be required, the provision
is reversed.
Present obligations and obligating events
A past event which leads to a present obligation is called an obligating event. For an event to be
an obligating event, it is necessary that the entity has ‘no realistic alternative to settling that
obligation’ created by the event (IAS 37: para. 17).
In rare cases, it is not clear whether there is a present obligation. In these cases, a past event is
deemed to give rise to a present obligation if, taking into account all available evidence, it is more
likely than not that a present obligation exists at the end of the reporting period.
Legal and constructive obligations
An obligation can either be legal or constructive.
• A legal obligation is one that derives from a contract, legislation or any other operation of law.
• A constructive obligation is an obligation that derives from the actions of an entity where:
(i) From an established pattern of past practice, published policies or a specific statement,
the entity has indicated to other parties that it will accept certain responsibilities; and
(ii) As a result, the entity has created a valid expectation in other parties that it will
discharge those responsibilities. (IAS 37: para. 10)
Measurement
The amount recognised as a provision is the best estimate of the expenditure required to settle the
obligation at the end of the reporting period.
Provisions are discounted where the effect of discounting (time value of money) is material.
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14: Provisions and events after the reporting period 345

Activity 1: Discounting the provision
Cambridge Co is preparing its financial statements for the year ended 31 December 20X4.
Cambridge Co was informed on 31 December 20X4 that, due to a change in environmental
legislation, it will be required to pay environmental clean-up costs of $5 million on 31 December
20X9.
The relevant discount rate in this case is 10%.
The discounted values of $1 are as follows:
$1 in five years = $0.621
Required
1 Calculate the provision required for the year ended 31 December 20X4.
2 Calculate the provision required for the year ended 31 December 20X5.
Solution
Essential reading
The Essential reading has an example showing the double entry and full explanation of unwinding
of a discount, looking in depth at the impact on the financial statements.
Exam focus point

The Financial Reporting frequently asked questions (FAQs) section of the ACCA website
(www.accaglobal.com) explains the approach that will be taken in exam questions in which
discounting is required.
Candidates may be asked to determine the appropriate interest rate if the amount is payable
within one year.
For example, to calculate the present value of $2.7 million which is payable in one year with an
interest rate of 8%, then candidates would be expected to be able to perform the following
calculation: $2.7m/1.08 = $2.5m present value.
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The relevant discount factors will be given for amounts payable in more than one year.
Ensure you are comfortable calculating the present value and using discount tables.
Uncertainties
If the provision involves a large population of items:
• Use expected values, taking into account the probability of all expected outcomes.
If a single obligation is being measured:
• The individual most likely outcome may be the best evidence of the liability.
2 Types of provision
Financial Reporting develops your application of knowledge gained in your earlier studies as well
as introducing more complex ideas. You need to be aware of the specific requirements relating to
the following:
2.1 Warranties
Warranties are argued to be genuine provisions based on past experience that it is probable, ie
more likely than not, that some claims will emerge.
Due to the developments in IFRS 15, Revenue from Contracts with Customers, the nature of how
the liability has arisen should be taken into account regarding its accounting treatment. You
should consider whether:
• There is a legal obligation, such as all goods being purchased online may be returned within
14 days for a full refund under the Consumer Contracts Regulations; or
• There is a constructive obligation, such as the store has historically allowed a 12 month, ‘no
quibble’ return guarantee.
Then the entity should make the provision under IAS 37.
Warranties that the customer pays for separately (extended warranties, such as for white goods)
are covered by IFRS 15 Revenue from Contracts with Customers (see Chapter 6). This is due there
being a contract between the customer and the supplier in exchange for a separable component
(a performance obligation).
The nature of the warranty granted will determine whether the warranty should be accounted for
under IAS 37 or IFRS 15.
Activity 2: Warranties
Warren Co gives warranties, at no additional cost, to its customers. There is no legal requirement
to repair or replace these items after 28 days, but Warren Co promises, on its website, to make
good, by repair or replacement, manufacturing defects that become apparent within a period of
one year from the date of the sale. Warren Co has replaced between 4% and 6% of total sales of
the product in the past five years.
Required
Which of the following statements about the above scenario is correct?
 Warren Co is not required to make a provision because there is no legal obligation to
undertake the repair work.
 Warren Co has an obligation to repair or replace all items of product that show
manufacturing defects, therefore a provision for the cost of this should be made.
 Warren Co has an obligation to repair or replace all items that show manufacturing defects,
however, as the amount cannot be reliably estimated, no provision is required.
 Warren Co must make a provision under IAS 37 because this is a potential future operating
loss.
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2.2 Decommissioning or other environmental costs
These costs usually arise at the end of the useful life of an asset. A provision should only be
recognised if there is a present obligation as a result of a past event, eg if the future
decommissioning costs are legally required. If the provision relates to an asset, then it can be
capitalised as part of the cost of the asset. The decommissioning or other environmental costs
often occur many years in the future, and so the future cost should be discounted to present
value.
For example, when an oil company initially purchases an oilfield it is put under a legal obligation
to decommission the site at the end of its life.
IAS 37 considers that a legal obligation exists on the initial expenditure on the field and therefore
the provision should be recognised immediately. The view is taken that the cost of purchasing the
field in the first place is not only the cost of the field itself but also the costs of putting it right
again. Thus, the costs of decommissioning may be capitalised.
2.2.1 Capitalised provision costs

Costs which are capitalised will be depreciated over the useful life of the machine (or if it relates to
a specific overhaul or major refurbishment, the useful life prior to that date). So, if a machine
requires a major refurbishment every five years in order to remain functional, then the capitalised
provision will be depreciated over the five years.
This is demonstrating the accruals concept of accounting as the costs relating to the asset (both
its use and its required refurbishment) are spread across the period when the revenue is being
generated.
The double entry would be:
DEBIT Non-current assets

CREDIT Provision
The costs have not yet been expensed in the statement of profit or loss. Instead, the costs are
released to the profit or loss account by depreciating the asset (and the capitalised provision).
Subsequent double entries would be:
DEBIT Depreciation expense (SOPL)

CREDIT Accumulated depreciation (SOFP)
This will expense the cost of the provision over the period, such as a refurbishment required in five
years’ time, depreciation expensed over five years.
Once the provision is required in the final year, the accounting entries will be:
DEBIT Provision
CREDIT Cash
Exam focus point

Questions in Part B of your exam may ask multiple questions about a topic, and as we have
already seen in earlier examples, the questions may cover more than one area. The following
activity tests both your understanding of provisions (IAS 37) and also the effect on the non-
current assets (IAS 16).
Activity 3: Decommissioning costs
Petrolleo Co built an oil rig at a cost of $80 million. The oil rig came into operation on 1 January
20X2. The operating licence is for 20 years from 1 January 20X2, after which time Petrolleo Co is
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obliged to dismantle the oil rig and dispose of the parts in an environmentally friendly way. At 1
January 20X2, the cost of dismantling was estimated at $10 million.
An appropriate discount rate is 6%, when the present value of $1 is $0.312 in 20 years’ time.
Required
1 Which of the following statements are TRUE?
 A legal obligation to dismantle the rig exists from 1 January 20X2, therefore a provision
should be recognised at that date and expensed through the profit or loss immediately.
 A legal obligation to dismantle the rig exists from 1 January 20X2, therefore a provision
should be recognised at that date and added to the cost of the asset.
 A legal obligation accrues over the 20-year operating life of the asset, therefore the
provision should be accrued over the period.
 No obligation exists until the rig is dismantled and thus no provision is required.
2 What is the value of the provision in the statement of financial position at 31 December 20X2?
 Nil
 $500,000
 $3,118,000
 $3,307,000
3 What is the carrying amount of the oil rig asset at 31 December 20X2?
 $76 million
 $78.964 million
 $83.118 million
 $85.5 million
2.3 Future operating losses

Provisions are not recognised for future operating losses.
Future operating losses do not meet the definition of a liability or the Conceptual Framework
recognition criteria. However, it is important that you can distinguish this from an onerous
contract.
2.4 Onerous contracts
Onerous contracts: An onerous contract is a contract entered into with another party under
KEY
TERM which the unavoidable costs of fulfilling the terms of the contract exceed any revenues
expected to be received from the goods or services supplied or purchased directly or indirectly
under the contract and where the entity would have to compensate the other party if it did not
fulfil the terms of the contract (IAS 37: para. 68). An example might be a three-year contract to
make and supply a service to a third party. The seller can no longer provide the service, so it
becomes ‘onerous’, and the costs to the seller would be the costs of outsourcing the provision
of the service or any penalties for non-provision.
If an entity has a contract that is onerous, the present obligation under the contract should be
recognised as a provision (IAS 37: para. 66). The obligation is measured as:
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Unavoidable costs of meeting
an obligation are the lower of:
Cost of fulfilling Penalties from failure

the contract to fulfil the contract
An amendment to IAS 37 was issued in 2020 which sought to clarify what constitutes the cost of
fulfilling the contract:
The cost of fulfilling a contract comprises the costs that relate directly to the contract. Costs that
relate directly to a contract consist of both:
(a) the incremental costs of fulfilling that contract—for example, direct labour and materials; and
(b) an allocation of other costs that relate directly to fulfilling contracts—for example, an
allocation of the depreciation charge for an item of property, plant and equipment used in
fulfilling that contract
(IAS 37: para. 68A)
Activity 4: Onerous contract
You have a contract to buy 300 metres of silk from China Co each month for $9 per metre. From
each metre of silk, you make one silk shirt. You also incur labour and other direct variable costs of
$8 per shirt.
Usually you can sell each shirt for $22 but in late July 20X8 the market price falls to $14. You are
considering ceasing production since you think that the market may not improve. If you decide to
cancel the silk purchase contract without two months’ notice you must pay a cancellation penalty
of $1,200 for each of the next two months.
Required
What will appear in respect of the contract in your financial statements for the period ending 31
July 20X8?
 $1,800
 $2,400
 $8,400
 $10,200
2.5 Provisions for restructuring
Restructuring: A programme that is planned and is controlled by management and materially

KEY
TERM changes one of two things.
• The scope of a business undertaken by an entity
• The manner in which that business is conducted
(IAS 37: para. 10)
The IAS gives the following examples of events that may fall under the definition of restructuring.
• The sale or termination of a line of business
• The closure of business locations in a country or region or the relocation of business activities
from one country region to another
• Changes in management structure, for example, the elimination of a layer of management
• Fundamental reorganisations that have a material effect on the nature and focus of the
entity’s operations (IAS 37: para. 70)
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2.5.1 Constructive obligation
A provision for restructuring costs is recognised only when the entity has a constructive obligation
to restructure. Such an obligation only arises where an entity:
(a) Has a detailed formal plan for the restructuring; and
(b) Has raised a valid expectation in those affected that it will carry out the restructuring by
starting to implement the plan or announcing it main features to those affected by it (IAS 37:
para. 72).
Activity 5: Constructive obligation for business closure
On 12 December 20X1, the board of Shutdown Co decided to close down a division. The detailed
plan was agreed by the board on 20 December 20X1, and letters sent to notify customers. By the
year end of 31 December 20X1, the staff had received redundancy notices.
Required
Explain the appropriate accounting treatment for the closure for the year ended 31 December
20X1.
Solution
2.5.2 Provision recognition criteria

A mere management decision is not normally sufficient to recognise a provision. Management
decisions may sometimes trigger recognition, but only if earlier events such as negotiations with
employee representatives and other interested parties have been concluded subject only to
management approval. (IAS 37: para. 75)
Where the restructuring involves the sale of an operation then IAS 37 states that no obligation
arises until the entity has entered into a binding sale agreement. This is because until this has
occurred the entity will be able to change its mind and withdraw from the sale even if its intentions
have been announced publicly. (IAS 37: para. 78)
2.5.3 Restructuring expenses

A restructuring provision includes only direct expenditures arising from the restructuring and
which are:
(a) Necessarily entailed by the restructuring; and
(b) Not associated with the ongoing activities of the entity (IAS 37: para. 80)
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A restructuring provision does not include such costs as:
• Retraining or relocating continuing staff
• Marketing
• Investment in new systems and distribution networks (IAS 37: para. 81)
Activity 6: Provision or not?
In which TWO of the following circumstances would a provision be recognised in the year ended
31 December 20X8?
 On 13 December 20X8, the board of an entity decided to close down a division. The decision
was not communicated to any of those affected and no other steps were taken to implement
the decision until 18 January 20X9.
 The board agreed a detailed closure plan on 20 December 20X8 and details were given to
customers and employees.
 The entity is obliged to incur clean-up costs for environmental damage caused as a result of
the construction of its factory.
 The entity intends to carry out future expenditure to operate in a particular way in the future.
3 Contingent liabilities
3.1 Definition
Contingent liability:
KEY
TERM • A possible obligation that arises from past events and whose existence will be confirmed
only by the occurrence or non-occurrence of one or more uncertain future events not
wholly within the control of the entity; or
• A present obligation that arises from past events but is not recognised because:
- It is not probable that an outflow of resources embodying economic benefits will be
required to settle the obligation; or
- The amount of the obligation cannot be measured with sufficient reliability
(IAS 37: para. 10)
3.2 Recognition
Contingent liabilities should not be recognised in financial statements but they should be
disclosed (unless the possibly of the outflow of resources is remote) (IAS 37: para. 27).
Essential reading
See Chapter 14 Section 1.4 of the Essential reading for a decision tree summarising the recognition
criteria of IAS 37 for provisions and contingent liabilities.
3.3 Disclosure
For each class of contingent liability, an entity must disclose at the end of the reporting period all
of the following:
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(a) The nature of the contingent liability
(b) An estimate of its financial effect
(c) An indication of the uncertainties relating to the amount or timing of any outflow
(d) The possibility of any reimbursement (see illustration ‘Product recall’ later in the chapter for
an example of this).
(IAS 37: para. 86)
The users of the financial statements need to be made aware of any potential impact on cash
flows of the company and any impacts on future profits, hence the reason for explaining the
nature, possible timing and amount of the financial impact.
4 Contingent assets
4.1 Definition
Contingent asset: A possible asset that arises from past events and whose existence will be
KEY
TERM confirmed by the occurrence or non-occurrence of one or more uncertain future events not
wholly within control of the entity. (IAS 37: para. 10)
• A contingent asset must not be recognised (IAS 37: para. 31).
• A contingent asset should only be disclosed when an inflow of economic benefits is
probable (IAS 37: para. 34).
• Only when the realisation of the related economic benefits is virtually certain should
recognition take place. At that point, the asset is no longer a contingent asset.
Example – Legal dispute

A company is engaged in a legal dispute. The outcome is not yet known. A number of possibilities
arise:
• It expects to have to pay about $100,000. A provision is recognised.
• Possible damages are $100,000 but it is not expected to have to pay them. A contingent
liability is disclosed.
• The company expects to have to pay damages but is unable to estimate the amount. A
contingent liability is disclosed.
• The company expects to receive damages of $100,000 and this is virtually certain. An asset is
recognised.
• The company expects to probably receive damages of $100,000. A contingent asset is
disclosed.
• The company thinks it may receive damages, but it is not probable. No disclosure.
4.2 Timing of the obligating event

There may be instances when there is cause for a provision but with the added complication of
identifying the issue in one year and the actual problem occurring in another.
Illustration 1: Product recall
Jackaboo Co has an accounting year-end of 31 December 20X5. On 14 February 20X6, Jackaboo

Co released a product recall for its Bimblebat. It was discovered in February, that a batch of the
resin used to manufacture the Bimblebat was faulty, with the effect of all products manufactured
between 10 November 20X5 and 2 December 20X5 were fundamentally flawed.
The supplier of the resin has taken full responsibility and will reimburse Jackaboo Co for any costs
relating to the recall.
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Required
Advise whether a provision is required in respect of this transaction at the 31 December 20X5 year
end.
Solution
• There is a requirement for a provision at 31 December 20X5 as the obligating event was the
faulty Bimblebats which were manufactured prior to the year-end.
• The supplier has taken responsibility and agree to reimburse Jackaboo Co. However, there is
doubt as to the exact amount that will be recovered, however probable that recovery may be.
Therefore, it will be recognised as a contingent asset.
4.3 Let out clause

• IAS 37 permits reporting entities to avoid disclosure requirements relating to provisions,
contingent liabilities and contingent assets if they would be expected to seriously prejudice the
position of the entity in dispute with other parties.
• This should only be employed in extremely rare cases. Details of the general nature of the
provision/contingencies must still be provided, together with an explanation of why it has not
been disclosed (IAS 37: para. 92).
Activity 7: Provision or contingency?
During 20X0 Smack Co gives a guarantee of certain borrowings of Pony Co, whose financial
condition at that time is sound. During 20X1, the financial condition of Pony Co deteriorates and
at 30 June 20X1 Pony Co files for protection from its creditors.
Required
Explain the accounting treatment that is required:
1 At 31 December 20X0
Solution
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4.4 Disclosure
The following must be disclosed in a note to the accounts:
(a) A brief description of the nature of the contingent asset at the end of the reporting period
(b) Where possible, an estimate of the financial effect
Although the contingent asset will not be included within the figures of the financial statements,
the user should be made aware of any potential impact on cash flows of the company and any
impacts on future profits.
5 IAS 10 Events after the Reporting Period

This topic was covered in your earlier studies, so if you require a revision on the detail, please refer
to Chapter 14 of the Essential reading. In your Financial Reporting exam, you are likely to come
across IAS 10 questions either as an objective test question, or as part of an explanatory written
question in Section C. Making adjustments to existing draft financial statements or revising notes
to the financial statements should be expected in Section C longer questions, so ensure that you
are familiar with the difference between provisions and contingent liabilities or assets.
5.1 Definition
Events after the reporting period: Those events, both favourable and unfavourable, that occur
KEY
TERM between the end of the reporting period and the date when the financial statements are
authorised for issue.
5.2 Recognition
• Those that provide evidence of conditions that existed at the end of the reporting period –
adjusting
• Those that are indicative of conditions that arose after the reporting period – non-adjusting
(IAS 10: para. 3)
Essential reading
See Chapter 14, Section 4 of the Essential reading for revision on the main elements of IAS 10,
including a table which gives examples of adjusting and non-adjusting events.
Activity 8: IAS 10
Which ONE of the following events taking place after the year-end but before the financial
statements were authorised for issue would require adjustment in accordance with IAS 10 Events
After the Reporting Period?
 Three lines of inventory held at the year-end were destroyed by flooding in the warehouse.
 The directors announced a major restructuring.
 Two lines of inventory held at the year-end were discovered to have faults rendering them
unsaleable.
 The value of the company’s investments fell sharply.
5.3 Disclosure
• An entity discloses the date when the financial statements were authorised for issue and who
gave the authorisation (IAS 10: para. 17).
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• If non-adjusting events after the reporting period are material, non-disclosure could influence
the decisions of users taken on the basis of the financial statements. Accordingly, the following
is disclosed for each material category of non-adjusting event after the reporting period:
- The nature of the event; and
- An estimate of its financial effect, or statement that such an estimate cannot be made (IAS
10: para. 21).
PER alert
to review financial statements and correct for errors and make any required disclosures
regarding events after the reporting date. The information in this chapter will give you
knowledge to help you demonstrate this competence.
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Chapter summary
Provisions and events after the reporting period
Provisions Types of provision

(IAS 37)
Definition Warranties Future operating losses

Liability of uncertain timing or • Legal obligation or a Do not recognise provisions for
amount constructive obligation future operating losses
• Provision required under IAS 37
• Separate contract for
Recognition performance (such as Onerous contracts
Recognise provision if meet all extended warranty) requires • Definition: Unavoidable costs
three of: treatment under IFRS 15 exceed benefits
• Present obligation as result of • Provide for the least net cost of
past event exiting the contract ie lower of:
• Probable outflow Decommissioning costs – Net cost of fulfilling the
• Reliable estimate • Provision for contract
dismantling/removal of plant – Compensation or penalties
and restoring construction arising from failure to fulfil
Measurement damage: contract
• Best estimate – Recognise at time of
• Discount if time value of money construction and include as
is material part of asset cost Restructuring
• Expected values if large DEBIT Property, plant & • Constructive obligation exists if
population of items equipment entity has:
• Most likely outcome for single CREDIT Provision – A detailed formal plan
obligation • Provision for restoring damage – Raised a valid expectation in
– To create/increase a from plant's operation eg those affected
provision: extraction: • Provision should only include
DEBIT Expense/PPE – Recognise over the period of direct expenditure:
CREDIT Provision operation – Necessarily entailed by the
– To decrease a provision: DEBIT Expense restructuring
DEBIT Provision CREDIT Provision – Not associated with the
CREDIT Expense/PPE entity's ongoing activities
– To use a provision:
DEBIT Provision
CREDIT Cash
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Contingent Contingent Events after the
liabilities assets reporting period (IAS 10)
Definition Definition Definition

• Possible obligation • Possible asset from past events Events which occur between
• Present obligation: outflow not • Existence will be confirmed by the end of the reporting period
probable/ cannot measure future uncertain event(s) and the date when the
reliably financial statements are
authorised for issue
Accounting treatment Inflow:
Disclose in note to the financial • Virtually certain – recognise Accounting treatment
statements unless possibility of asset • Conditions which existed at
outflow is remote • Probable – disclose end of reporting period –
• Possible – do nothing adjusting
• Remote – do nothing • Conditions which arose after
Nature of disclosure the end of the reporting
• Nature of contingent liability period – non-adjusting
• Estimate of financial effect Nature of disclosure
• Uncertainties relating to • Brief description
amount or timing • Estimate of financial effect Nature of disclosure
• Possibility of reimbursement Material events to disclose the
nature and estimate of the
Need for disclosure financial impact (or why it
Need for disclosure Make users aware of potential cannot be reliably estimated)
Make users aware of potential positive impact on cash
adverse impact on cash flows/profit
flows/profit Need for disclosure
Users can understand the
reason behind unusual
movements or provisions in the
financial statements, and their
financial impact
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1. Provisions
Provisions are recognised when there is a present obligation as a result of a past event, with a
probable outflow of economics resources that can be measured reliably.
2. Specific types of provision

• Provisions are not made for future operating losses as there is no obligation to incur them
• Where a contract is onerous a provision is made for the unavoidable cost.
• Restructuring provisions are only recognised when certain criteria are met.
• A provision is recognised for decommissioning costs where there is a legal or constructive
obligation. Where it relates to an asset it is capitalised and depreciated.
3. Contingent liabilities
• Contingent liabilities are not recognised because they are possible rather than present
obligations, the outflow is not probable or the liability cannot be reliably measured.
• Contingent liabilities are disclosed.
4. Contingent assets
Contingent assets are disclosed, but only where an inflow of economic benefits is probable.
5. Events after the reporting period

• Events that occur after the end of the reporting period but before the financial statements are
authorised for issue can be adjusting or non-adjusting events
• Adjusting events are those which provide information about conditions that existed at the
year-end and are adjusted for in the financial statements
• Non-adjusting events do not provide information about conditions that existed at the year-end
and so are not adjusted, but are disclosed if material.
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Question practice
the Workbook):
Section A Q14
Section B Q20
Section C Q39 Provisions
Further reading
The FR examining team has provided a useful technical article on IAS 37 Provisions, Contingent
Liabilities and Contingent Assets. This should help you in understanding the key criteria of the
standard.
IAS 37, Provisions, contingent liabilities and contingent assets
www.accaglobal.com
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Activity answers
Activity 1: Discounting the provision

1 The provision for environmental damage should be initially measured at the present value of
the $5m payable in five-years’ time.
$
$5m × 0.621* 3,105,000
*The discount rate for five years at 10%.

2 At 31 December 20X5, the provision will be unwound as follows:
$
Carrying amount of provision at 1 January 20X5 3,105,000
Unwinding of the discount at 10% (β) 310,000
Carrying amount of the provision at 31 December 20X5 ($5m × 0.683**) 3,415,000
**The discount rate for four years at 10%.
Notes.
1 The increase in the year of $310,5000 is the unwinding of the discount. This is accounted
for as a finance cost expense in the statement of profit or loss. The original provision of
$3.105 million will be capitalised as part of the cost of the assets involved in the operation
and depreciated over five years.
2 The unwinding of the discount can be calculated as the difference between the opening
and closing carrying amounts, or by taking the opening carrying amount × 10%. Note that
there is a small rounding difference of $500 is the unwinding is calculated as $3,105,000 ×
10%. This is due to the discount rates being rounded to three decimal places.
Activity 2: Warranties
The correct answer is: Warren Co has an obligation to repair or replace all items of product that
show manufacturing defects, therefore a provision for the cost of this should be made.
Warren Co has an obligation to repair or replace all items of product that manifest
manufacturing defects in respect of which warranties are given before the end of the reporting
period, and a provision for the cost of this should therefore be made. The cost cannot be avoided.
Warren Co is obliged to repair or replace items that fail within the entire warranty period.
Therefore, in respect of this year’s sales, the obligation provided for at the end of the reporting
period should be the cost of making good items for which defects have been notified but not yet
processed, plus an estimate of costs in respect of the other items sold for which there is sufficient
evidence that manufacturing defects will manifest themselves during their remaining periods of
warranty cover.
Activity 3: Decommissioning costs

1 The correct answer is: A legal obligation to dismantle the rig exists from 1 January 20X2,
therefore a provision should be recognised at that date and added to the cost of the asset.
Petrolleo Co is obliged to dismantle the rig in 20 years’ time. A provision should be recognised
and added to the cost of the asset.
2 The correct answer is: $3,307,000
HB2022

Provision for dismantling costs
$’000
At 1 January 20X2 (10,000 × 0.312) 3,120
Finance cost (3,120 × 6%) 187
c/d at 31 December 20X2 3,307
3 The correct answer is: $78.964 million
Carrying amount of oil rig

$’000
Cost 80,000
Provision (10,000 × 0.312) 3,120
83,120
Depreciation (83,120/20 years) (4,156)
78,964
The provision has been capitalised, by crediting the provision and debiting the non-current
asset. This is applying the accruals method as it is matching the costs of the provision and the
asset with the revenue generated by the provision.
Activity 4: Onerous contract

Unavoidable costs of meeting

an obligation are the lower of:
Cost of fulfilling Penalties from failure

the contract to fulfil the contract
Fulfil contract Cancel contract

Revenue (300m × $14 × 2 months) $8,400 Penalties ($1,200 × 2 months = $2,400)
Costs (300m × ($9 + $8) × 2 months) ($10,200)
Loss ($1,800)
Therefore, the unavoidable cost is $1,800.

This will be shown as a provision in the statement of financial position and as an expense in profit
or loss.
Activity 5: Constructive obligation for business closure

The communication of the decision to the customers and employees gives rise to a constructive
obligation because it creates a valid expectation that the division will be closed.
The outflow of resources embodying economic benefits is probable so, at 31 December 20X1, a
provision should be recognised for the best estimate of the direct costs of closing the division.
HB2022

Activity 6: Provision or not?
• The board agreed a detailed closure plan on 20 December 20X8 and details were given to
customers and employees.
• The entity is obliged to incur clean-up costs for environmental damage caused as a result
of the construction of its factory.
(1) No provision would be recognised as the decision has not been communicated and therefore
the entity does not have a legal or constructive obligation.
(2) A provision should be recognised in the financial statements as an obligation was created
when the details were announced.
(3) A provision should be recognised for such present value of the environmental costs.
(4) No present obligation exists and under IAS 37 no provision would be required. This is because
the entity could avoid the future expenditure by its future actions.
Activity 7: Provision or contingency?

1 There is a present obligation as a result of a past obligating event. The obligating event is the
giving of the guarantee, which gives rise to a legal obligation. However, at 31 December 20X0
no transfer of resources is probable in settlement of the obligation.
No provision is recognised. The guarantee is disclosed as a contingent liability unless the
probability of any transfer is regarded as remote.
2 As above, there is a present obligation as a result of a past obligating event, namely the giving
of the guarantee.
At 31 December 20X1, it is probable that a transfer of resources will be required to settle the
obligation. A provision is therefore recognised for the best estimate of the obligation.
Activity 8: IAS 10
The correct answer is: Two lines of inventory held at the year-end were discovered to have faults
rendering them unsaleable.
We can assume that the faults that rendered the inventory unsaleable also existed at the year-
end, so this is the only option which would require adjustment. The others give information about
conditions that arose after the end of the reporting period and therefore do not require to be
adjusted.
HB2022

HB2022

Inventories and
15 biological assets
15
Learning objectives
Describe and apply the principles of inventory valuation. B4(a)
Apply the requirements of relevant IFRS Standards for biological B4(b)

assets and agricultural produce.
15
Exam context
You should be familiar with the key requirements of IAS 2 Inventories from your previous studies.
Inventory is an important balance as it is often a key figure in the statement of financial position
and impacts on cost of sales in the statement of profit or loss. IAS 41 Agriculture provides the
requirements relating to biological assets and produce before the point of harvest and is therefore
relevant only in the farming industry. Questions on inventory or biological assets could appear as
OT Questions in Section A or B or as a small part of a single entity accounts preparation or
interpretation question in Section C. Inventories may also feature in an accounts preparation
question and will be relevant when analysing the gross profit margin or the inventory holding
period in an interpretation question in Section C.
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15
Chapter overview
Inventories and biological assets
IAS 2 Inventories IAS 41 Agriculture
IAS 2 definition IAS 41 definition
Measurement Recognition
Disclosure Measurement
Presentation
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1 IAS 2 Inventories
1.1 Introduction
IAS 2 Inventories lays out the required accounting treatment for inventories. Inventories are
recorded as an asset of the entity until they are sold, at which point the asset (inventories) is
derecognised and an expense (cost of sales) is recognised.
1.2 IAS 2 definition
Inventories: Assets that are:

KEY
TERM • Held for sale in the ordinary course of business;
• In the process of production for such sale; or
• In the form of materials or supplies to be consumed in the production process or in the
rendering of services. (IAS 2: para. 6)
Examples of inventories include:

• Raw materials (awaiting use in the production process)
• Work in progress (WIP)
• Finished goods
• Goods purchased and held for resale
1.3 Measurement
Inventories shall be measured at the lower of cost and net realisable value (NRV) (IAS 2: para. 9).
1.4 Components of cost

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

• Purchase price, less any • Costs directly related to Costs related to bringing the
trade discounts or rebates units of production, for inventories to their present
• Import duties and any example: location and condition which
other taxes, for example - Direct materials are not already included in
non-refundable sales tax costs of purchase. For
- Direct labour
example, non-production
• Directly attributable costs - Sub‑contracted work overheads such as designing
of acquiring the inventory
• Systematic allocation of a product for a specific
including delivery and
fixed and variable customer.
handling costs
production overheads*
incurred in converting
materials into finished
goods
*Fixed production overheads relate to indirect costs such as the cost of factory management and
administration which remain relatively constant regardless of the volume of production. These
should be allocated to units of production based on a normal level of activity.
Variable production overheads include indirect materials and labour and vary with the volume of
production.
1.5 Determining cost

The cost of inventory should be the actual unit cost of the item, this can prove difficult to
determine and so estimation methods may be used for convenience if the results approximate to
actual costs.
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15: Inventories and biological assets 367

Examples include:
Standard cost Retail method

Cost is based on normal levels of materials Cost is determined by reducing sales value of
and supplies, labour efficiency and capacity the inventory by the appropriate percentage
utilisation. gross margin. The percentage used takes into
Standards must be regularly reviewed and consideration inventory which has been
revised where necessary. marked down to below its original selling price.
This is often used in the retail industry for
measuring inventories of rapidly changing
items that have similar margins.
1.6 Interchangeable items

If there are a large number of identical or very similar items of inventory that have been
purchased at different times during the year and at different prices, it may be impossible to
determine precisely which items are still held at the year-end and therefore the actual purchase
cost.
In such circumstances, IAS 2 Inventories allows the following estimation techniques to be used to
approximate cost:
First in, first out (FIFO) Weighted average cost

The calculation of the cost of inventories on The cost of inventories is calculated by using a
the basis that the quantities in hand represent weighted average price computed by dividing
the most recent purchases or production. the total cost of items by the total number of
such items.
The price is recalculated on a periodic basis
or as each additional shipment is received and
items taken out of inventory are removed at
the prevailing weighted average cost.
An entity must use the same cost formula for all inventories having a similar nature and use to
the entity.
You should be aware of these methods from your previous studies and also know that the last in,
first out (LIFO) formula is not permitted by IAS 2 on the basis that it does not bear a good
approximation to actual costs.
Essential reading
Chapter 15, Section 1 of the Essential reading provides more detail on the consistency of cost
formula used.
1.7 Net realisable value (NRV)
Net realisable value: The estimated selling price in the ordinary course of business, less:
KEY
TERM • The estimated cost of completion; and
• The estimated costs necessary to make the sale, eg marketing, selling and distribution costs
(IAS 2: para. 6).
As noted above, where the net realisable value of inventories is less than cost the inventories in the
financial statements should be measured at the lower of cost and net realisable value.
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1.8 NRV less than cost
The net realisable value of inventories may be less than cost due to:
Errors in An increase in A physical

production or costs or a fall in deterioration
purchasing selling price of inventories
A decision being Obsolescence

made as part of a of products
company's marketing
strategy to manufacture
and sell products at a loss
Essential reading
Chapter 15, Section 2 of the Essential reading provides more detail on the NRV of inventory.
Illustration 1: Carrying amount of inventory
The following figures relate to inventory held at the year-end:
A B C
$ $ $
Cost 20 9 12
Selling price 30 12 22
Modification cost to enable sale – 2 8
Marketing costs 7 2 2
Units held 200 150 300
Required
Calculate the carrying amount of inventory held at the year-end in accordance with IAS 2
Inventories.
Solution
The value of inventory is $8,800.
Product Cost NRV Valuation Quantity Total value

$ $ $ Units $
A 20 30 – 7 = 23 20 200 4,000
B 9 12 – 2 – 2 = 8 8 150 1,200
C 12 22 – 8 – 2 = 10 12 300 3,600
8,800
HB2022

Activity 1: Write down of inventory
Teddy Co has 500 items of product HGJ in inventory at 31 October 20X8. These items are no
longer saleable in their current condition. However, they can be adjusted for a cost of $2.50 per
item. Once adjusted, the items can be sold at their normal price of $5.30 each.
The original cost of the items was $2.25 each. The replacement cost of item HGJ at 31 October
20X8 is $2.45 each.
Required
At what amount should Teddy Co measure its inventory at 31 October 20X8?
 $nil
 $275
 $1,125
 $1,400
1.9 Disclosure
The financial statements should disclose the following:
• The accounting policies adopted in measuring inventories, including the cost formula used;
• The total carrying amount of inventories and the carrying amount in classifications
appropriate to the entity;
• The carrying amount of inventories carried at fair value less costs to sell;
• The amount of inventories recognised as an expense during the period;
• The amount of any write‑down of inventories recognised as an expense in the period;
• The amount of any reversal of any write‑down that is recognised as a reduction in the amount
of inventories recognised as expense in the period;
• The circumstances or events that led to the reversal of a write‑down of inventories; and
• The carrying amount of inventories pledged as security for liabilities.
2 IAS 41 Agriculture
2.1 Introduction
IAS 41 Agriculture covers the accounting treatment of biological assets (except bearer plants) and
agricultural produce at the point of harvest. After harvest, IAS 2 Inventories applies to the
agricultural produce, as illustrated in the timeline below.
IAS 41 IAS 2
Zeit
Biological transformation
Planting/ Harvest/ Sale
birth slaughter
Bearer plants, which are plants that are used to grow crops but are not themselves consumed (eg
grapevines), are excluded from the scope of IAS 41. Instead they are accounted for under IAS 16
using either the cost or revaluation model.
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2.2 Definitions
Biological assets: Living animals or plants.

KEY
TERM
Biological transformation: The processes of growth, degeneration, production and procreation
that cause qualitative and quantitative changes in a biological asset.
Agricultural produce: The harvested product of an entity’s biological assets.
(IAS 41: para. 5)
Essential reading
Chapter 15, Section 3 of the Essential reading provides further explanation as to what a biological
asset is.
2.3 Recognition
As with other non-financial assets under the Conceptual Framework, a biological asset or
agricultural produce is recognised when:
(a) The entity controls the asset as a result of past events;
(b) It is probable that future economic benefits associated with the asset will flow to the entity;
and
(c) The fair value or cost of the asset can be measured reliably.
(IAS 41: para. 10)
2.4 Measurement
Biological assets are measured both on initial recognition and at the end of each reporting period
at fair value less costs to sell.
Agricultural produce at the point of harvest is also measured at fair value less costs to sell.
The fair value less costs to sell of agricultural produce harvested becomes its cost under IAS 2.
After harvest, the agricultural produce is measured at the lower of cost and net realisable value in
accordance with IAS 2.
Fair value is the price that would be received to sell the asset (IFRS 13 Fair Value Measurement).
Costs to sell are incremental costs directly attributable to disposal of the asset, eg commissions to
brokers and transfer taxes.
Changes in fair value less costs to sell are recognised in profit or loss.
Where fair value of biological assets cannot be measured reliably, they are measured at cost
less accumulated depreciation and impairment losses.
2.5 Presentation
Biological assets are presented as non-current assets.
HB2022

Activity 2: Biological assets
Which of the following are examples of biological assets?

(i) Sheep
(ii) Cotton plants
(iii) Wool
(iv) Fruit juice
 (i) only
 (i) and (ii) only
 (i) and (iii) only
 (ii) and (iv) only
PER alert
Performance objective 7 of the PER requires you to demonstrate that you can contribute to the
drafting or reviewing of primary financial statements according to accounting standards and
legislation. The Standards covered in this chapter will help you to do this for a business’s
inventory and biological assets.
HB2022

Chapter summary
Inventories and biological assets
IAS 2 Inventories IAS 41 Agriculture
IAS 2 definition IAS 41 definition

Assets that are: • Biological assets – living animals or plants
• Held for sale in the ordinary course of • Biological transformation – processes that
business cause qualitative and quantitative changes in
• In the process of production for sale a biological asset
• In the form of materials/supplies to be • Agricultural produce – the harvested product
consumed in the production process/ of an entity's biological assets
rendering of services
Recognition
Measurement • Entity controls the asset as a result of past
• At the lower of cost and net realisable value events
• Cost: • Probable that future economic benefits will
– Costs of purchase flow to the entity
– Costs of conversion • Fair value or cost of the asset can be
– Other costs measured reliably
• Estimation techniques to determine cost:
– Standard cost
– Retail method Measurement
– FIFO • Biological assets
– Weighted average – Initial measurement at fair value less costs
• NRV: to sell
– Estimated selling price less estimated costs – Subsequent measurement also at fair value
of completion and estimated costs less costs to sell
necessary to make the sale (marketing, • Agricultural produce
selling, distribution) – Initial measurement (at harvest) at fair value
less costs to sell
– Subsequent measurement per IAS 2
Disclosure
• Accounting policies including cost formula
• Total carrying amount of inventories Presentation
(RM, WIP, FG) Biological assets are non-current assets
HB2022

1. IAS 2 Inventories
Inventories are held at the lower of cost and net realisable value. The cost of interchangeable
inventories is measured using the FIFO or weighted average methods only.
2. Agriculture (IAS 41)

Biological assets and agricultural produce at the point of harvest are measured at fair value less
costs to sell, with changes reported in profit or loss.
HB2022

Question practice
the Workbook):
Section A Q12
Section C Q37 Villandry Co
Section C Q38 Biological assets
HB2022

Activity answers
Activity 1: Write down of inventory

Cost per question = $2.25
Net realisable value:
$
Selling price 5.30
Adjustment costs (2.50)
Net realisable value 2.80
Use lower of cost and net realisable value. This is the cost amount: $2.25 × 500 units = $1,125.
The replacement value is irrelevant.
Activity 2: Biological assets

The correct answer is: (i) and (ii) only
Wool is agricultural produce.
Fruit juice is a product that is a result of processing the agricultural produce (fruit) after harvest.
HB2022

Taxation
16
16
Learning objectives
Account for current taxation in accordance with relevant IFRS B8(a)

Standards.
Explain the effect of taxable temporary differences on B8(b)

accounting and taxable profits.
Compute and record deferred tax amounts in the financial B8(c)

statements.
16
Exam context
Current tax refers to tax on a company’s taxable profits in the current period. It is a relatively
simple concept to understand and account for. Deferred tax is more complex and is an
application of accrual accounting. Current and deferred tax could both be tested in Section A or
Section B of the exam as an OT Question, or may feature as an adjustment in a single entity
financial statements preparation question.
HB2022

16
Chapter overview
Taxation
IAS 12 Income Taxes Current tax
What is deferred tax?
Temporary differences
Measurement
Calculating deferred tax Other aspects of deferred tax
Presentation
HB2022

1 IAS 12 Income Taxes
1.1 Introduction
IAS 12 Income Taxes covers both current and deferred tax. Current tax is relatively straightforward.
Complexities arise when we consider the future tax consequences of items which are currently
recorded in the accounts. This can result in deferred tax, which we will look at later in this chapter.
Having calculated the amount of tax due to be paid on the company’s taxable profits using the
current rates set by legislation, the accounting entry is as follows:
DEBIT Tax charge (statement of profit or loss) X

Tax liability (statement of financial
CREDIT position) X
1.2 Definitions
IAS 12 provides the following definitions:
Accounting profit: Net profit or loss for a period before deducting tax expense is referred to as
KEY
TERM the accounting profit.
Taxable profit (tax loss): The profit (loss) for a period, determined in accordance with the rules
established by the taxation authorities, upon which income taxes are payable (recoverable).
Tax expense (tax income): The aggregate amount included in the determination of net profit
or loss for the period in respect of current tax and deferred tax.
Current tax: The amount of income taxes payable (recoverable) in respect of the taxable profit
(tax loss) for a period.
Deferred tax liabilities: The amounts of income taxes payable in future periods in respect of
taxable temporary differences.
Deferred tax assets: The amounts of income taxes recoverable in future periods in respect of:
• Deductible temporary differences
• The carry forward of unused tax losses
• The carry forward of unused tax credits
Temporary differences: Differences between the carrying amount of an asset or liability in the
statement of financial position and its tax base. Temporary differences may be either:
• Taxable temporary differences, which are temporary differences that will result in taxable
amounts in determining taxable profit (tax loss) of future periods when the carrying amount
of the asset or liability is recovered or settled
• Deductible temporary differences, which are temporary differences that will result in
amounts that are deductible in determining taxable profit (tax loss) of future periods when
the carrying amount of the asset or liability is recovered or settled
Tax base: The tax base of an asset or liability is the amount attributed to that asset or liability
for tax purposes.
(IAS 12: para. 5)
The main differences between current and deferred tax are:

(a) Current tax is the amount actually payable to the tax authorities in relation to the trading
activities of the entity during the period.
(b) Deferred tax is an accounting measure, used to match the tax effects of transactions with
their accounting impact.
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16: Taxation 379

2 Current tax
2.1 Recognition of current tax liabilities and assets
IAS 12 requires any unpaid tax in respect of the current or prior periods to be recognised as a
liability.
Any excess tax paid in respect of current or prior periods over what is due should be recognised as
an asset. (IAS 12: para. 12)
Current tax is recognised as income or expense in current period

except when
Tax arising from business combination Tax arising from transaction which
Treat as part of goodwill (IAS 12: para. 19) affects equity only
• Include within equity (IAS 12: Obj)
• Eg IAS 8 adjustment made to the opening
balances due to change in accounting policy
or fundamental error
Illustration 1: Darton Co
In 20X8, Darton Co had taxable profits of $120,000. In the previous year, (20X7) income tax on
profits had been estimated as $30,000. The income tax rate is 30%.
Required
Calculate tax payable and the charge for 20X8 if the tax due on 20X7 profits was subsequently
agreed with the tax authorities as:
1 $35,000; or
2 $25,000
Note. Any under- or over-payments are not settled until the following year’s tax payment is due.
Solution
1
$
Tax due on 20X8 profits ($120,000 × 30%) 36,000
Underpayment for 20X7 5,000
Tax charge and liability 41,000
$
Tax due on 20X8 profits (as above) 36,000
Overpayment for 20X7 (5,000)
Tax charge and liability 31,000
Alternatively, the rebate due could be shown separately as income in the statement of
comprehensive income and as an asset in the statement of financial position. An offset
approach like this is, however, most likely.
HB2022

Activity 1: Current tax
Tax of $60,000 is payable in respect of the profits for the year ended 31 December 20X8. The
balance of current tax in the trial balance is an under/over provision for tax in the previous year
and is shown below.
Debit Credit
$ $
Current tax 850
Required
What is the tax expense to be shown in the statement of profit or loss and the tax liability to be
included in the statement of financial position for the year ended 31 December 20X8?
 Expense $60,000; Liability $60,850
3 Deferred tax
Deferred tax is an accounting measure used to match the tax effects of transactions with their
accounting impact.
If the future tax consequences of transactions are not recognised, profit can be overstated,
leading to overpayment of dividends and distortion of share price and earnings per share (EPS).
Where a difference arises, IAS 12 requires companies to recognise a deferred tax liability (or
deferred tax asset).
Deferred tax is the tax attributable to temporary differences.
3.1 Temporary differences

There are two types of temporary difference (IAS 12: paras. 15 & 24).
Temporary differences
Differences between
Carrying amount Tax base of an

of an asset / liability asset / liability
There are
two types
• Taxable temporary • Deductible temporary

differences (amounts differences (amounts
taxable in the future) tax deductible in the
(eg accelerated future)
tax allowances) (eg tax losses)
• Result in a deferred • Result in a deferred
tax liability tax asset
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16: Taxation 381

3.2 Specific examples of temporary differences
Deferred tax
• Not a tax payable to the authorities
• Accounting adjustment only
Arises due to difference between
Carrying amount of asset/liability and Tax base of the asset/liability
Accounting treatment Difference arises Tax treatment

Accounting depreciation A temporary difference arises when the Tax depreciation (eg capital
accounting depreciation and the tax depreciation allowances in the UK)
occur at different rates
Accrued income/accrued expense

Accrued income/accrued Accrued income – deferred tax liability as tax Income and expenses are
expenses are included in will be paid in the future when the income is taxed on a cash basis ie
the financial statements in actually received. they are chargeable to tax
accordance with the Accrued expenses, deferred tax asset, as the when they are actually paid
accruals concept entity will get tax relief in the future when the or received.
expense is actually paid.
Provisions and allowances for doubtful debts

Provisions meeting criteria Deferred tax asset occurs as the entity benefits Tax relief when the debt
of IAS 37 from tax relief in the future when debt written off becomes irrecoverable and
written off
Revaluation of non-current assets

Asset is carried at its Temporary difference arises when asset is Revaluation gain is not
valuation with any gain revalued (accounting difference). This will only recognised until asset
recognised in revaluation impact tax upon the sale or use of the asset. is sold
surplus A deferred tax liability as the gain has been
recognised.
As the gain on the revaluation is charged to SPLOCI (other comprehensive income),

so the deferred tax is also only recognised in the SPLOCI
3.3 Tax base

Tax payable by an entity is calculated by the tax authorities using a tax computation. A tax
computation is similar to a statement of profit or loss, except that it is constructed using tax rules
instead of IFRS Standards.
Different tax jurisdictions may have different tax rules. The tax rules determine the tax base.
HB2022

Exam focus point
It is important for you to understand how to calculate and account for deferred tax. The
March 2018 examination required students to compare the carrying amount of property, plant
and equipment to the tax base provided and calculate a temporary difference to include in
the deferred tax calculation. In the June 2018 examination, deferred tax was tested in Section
A. The accounts preparation question in the September/December 2020 exam required an
adjustment in respect of deferred tax. The Examiner’s report for that session noted that the
deferred tax element was not well done by the majority of candidates, but the reason
appeared to be not reading the information in the question carefully rather than a lack of
technical knowledge.
3.4 Measurement
Deferred tax assets and liabilities are measured at the tax rates expected to apply to the period
when the asset is realised or liability settled, based on tax rates (and tax laws) that have been
enacted (or substantively enacted) by the end of the reporting period (IAS 12: para. 47).
Changes in tax rates after the year-end are therefore non-adjusting events after the reporting
period.
4 Calculating deferred tax

A standard approach can be taken to calculating deferred tax whereby the difference between
the carrying amount of an asset or liability and the tax base of that asset or liability is multiplied
by the tax rate to give the deferred tax asset or liability. The standard calculation is as follows:
4.1 Calculation of deferred tax

$
Carrying amount of asset/(liability) [in accounting statement of financial position] X/(X)
Less tax base [value for tax purposes] (X)/X
Taxable / (deductible) temporary difference X/(X)
× tax rate
Deferred tax (liability)/asset [always opposite sign to temporary difference] (X)/X
4.2 Non-current assets

The main reason for deferred tax occurring that you need to be aware of is due to the difference
in the tax depreciation (the amount of depreciation allowed for tax purposes) and the accounting
depreciation.
Illustration 2: Taxable temporary differences
Custard Co purchased machinery costing $1,500. At the end of 20X8 the carrying amount is
$1,000. The cumulative depreciation for tax purposes is $900 and the current tax rate is 25%.
Required
Calculate the deferred tax liability for the asset.
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16: Taxation 383

Solution
Carrying Temporary Deferred tax

amount Tax base difference asset / (liability)
$ $ $ $
Machinery 1,000 600 400 (100)
(1,500 – 900) (25% × 400)
Custard Co must therefore recognise a deferred tax liability of $100, recognising the difference
between the carrying amount of $1,000 and the tax base of $600 as a taxable temporary
difference.
Activity 2: Tax base
Calculate the tax base and temporary difference for each of the following assets, stating whether
the temporary difference is taxable or deductible.
1 A machine costs $10,000 and has a carrying amount of $8,000. For tax purposes,
depreciation of $3,000 has already been deducted in the current and prior periods and the
remaining cost will be deductible in future periods, either as depreciation or through a
deduction on disposal. Revenue generated by using the machine is taxable, any gain on
disposal of the machine will be taxable and any loss on disposal will be deductible for tax
purposes.
Required
Calculate the tax base and the temporary difference, stating whether it is taxable or
deductible.
2 Interest receivable has a carrying amount of $1,000. The related interest revenue will be taxed
on a cash basis.
Required
deductible.
3 Trade receivables have a carrying amount of $10,000. The related revenue has already been
included in taxable profit (tax loss).
Required
deductible.
4 A loan receivable has a carrying amount of $1 million. The repayment of the loan will have no
tax consequences.
Required
deductible
HB2022

Solution
4.3 Development costs

Development costs which have been capitalised, are treated in a similar way. Under IAS 38
Intangible Assets, development costs are capitalised when the criteria are met and are then
amortised over their useful life. Under tax rules, these costs are tax deductible once they are paid
(in the period incurred).
Therefore, a temporary tax difference occurs.
Activity 3: Epsilon Co
During the year ended 31 March 20X4, Epsilon Co correctly capitalised development costs of $1.6
million in accordance with IAS 38 Intangible Assets. The development project began to generate
economic benefits for Epsilon from 1 January 20X4. The directors of Epsilon Co estimated that the
project would generate economic benefits for five years from that date. Amortisation is charged
on a monthly pro-rata basis. The development expenditure was fully deductible against taxable
profits for the year ended 31 March 20X4 and the rate of tax applicable is 25%.
Required
Discuss the deferred tax implications of the above in the financial statements of Epsilon for the
year ended 31 March 20X4.
Solution
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4.4 Revaluation of non-current assets
Under IAS 16, assets may be revalued and will be carried at their revalued amount. The revaluation
is not recognised for tax purposes as the revaluation does not affect current taxable profits. The
tax base of the asset is not adjusted and therefore the whole amount of the revaluation gain will
be the temporary difference on which deferred tax is calculated.
The revaluation gain (or loss) gives rise to a deferred tax liability (or deferred tax asset) which is
recognised as a component of equity (as the revaluation is recorded in equity and shown on the
SOCIE).
Activity 4: Lecehus Co
Lecehus Co purchased some land on 1 January 20X7 for $400,000. On 31 December 20X8, the
land was revalued to $500,000. In the tax regime in which the company operates, revaluations do
not affect either the tax base of the asset or taxable profits.
The income tax rate is 30%. Profit for the year was $850,000.
Required
1 How much should be included with other comprehensive income and as a liability at 31
December 20X8?
 Other comprehensive income $100,000; Liability $30,000
2 What is the balance on the revaluation surplus at 31 December 20X8?
$
Exam focus point

The ACCA Examining Team has stated that whilst candidates generally understand that
deferred tax on revalued assets is presented in other comprehensive income, they do not
always present the revaluation surplus net of deferred tax.
4.5 Impairment losses and inventory losses

If an item of property, plant or equipment suffers an impairment loss, the carrying amount of that
asset is reduced.
If tax relief on the loss is only granted when the asset is sold, the reduction in value of the asset is
ignored for tax purposes until the sale. The tax base of the asset does not change, resulting in a
deductible temporary difference and a deferred tax asset.
Similarly, losses on inventory that are not tax deductible until the inventory is sold generate a
deferred tax asset.
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4.6 Provisions and allowances for expected credit losses
As for non-current assets, there is a potential timing difference between the accounting and the
tax treatment of provisions and allowances for expected credit losses (doubtful debts). A provision
is recognised for accounting purposes in accordance with IAS 37 Provisions, Contingent Liabilities
and Contingent Assets. The creation of a provision is not recognised for tax purposes. Instead, tax
relief is provided when the expense is incurred. The same approach is taken when an allowance
for expected credit losses is created under IFRS 9 Financial Instruments (this is a complex matter
not covered in FR, but you should be aware of allowances for doubtful debts from your previous
studies, which you can consider as broadly equivalent for the purposes of deferred tax.
In this next question, the provision is in respect of warranty costs, but this could also apply to an
allowance for doubtful debts.
Activity 5: Pargatha Co
Pargatha Co recognises a warranty provision of $10,000 at 31 December 20X7. These product

warranty costs will not be deductible for tax purposes until the entity pays the warranty claims.
The tax rate is 25%.
Required
Explain the deferred tax implications of the warranty provision.
Solution
Exam focus point

Deferred tax can be tested on specific aspects of IAS 12. In the June 2018 examination,
candidates were asked to calculate deferred tax in relation to a revaluation surplus.
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16: Taxation 387

5 Other aspects of deferred tax
5.1 Changes in tax rates
Where the corporate rate of income tax fluctuates from one year to another, a problem arises in
respect of the amount of deferred tax to be credited (debited) to the statement of profit or loss in
later years.
IAS 12 requires deferred tax assets and liabilities to be measured at the tax rates expected to
apply in the period when the asset is realised or liability settled, based on tax rates and laws
enacted (or substantively enacted) at the end of the reporting period (IAS 12: para. 47).
Essential reading
In Chapter 16 of the Essential reading, there is an additional activity (Activity 11: Ginger Co) which
looks at the effect of changing tax rates on deferred tax. Do attempt further question practice on
this topic as it is a tricky area.
5.2 Losses that can be carried forward

Losses that can be carried forward to reduce current tax on future profits represent a future tax
saving.
Therefore, a deferred tax asset is recognised in respect of tax losses to the extent that it is
probable that the losses can be used before they expire. If an entity has a history of recent losses,
then this is evidence that future taxable profit may not be available.
Activity 6: Deorf Co
Deorf Co incurs $80,000 of tax losses in the year ended 31 December 20X1 which it can carry
forward for two accounting periods before they expire. Deorf Co expects to make a loss in 20X2
and to return to profitability in 20X3, expecting to make a profit of $50,000 in that year. The
company pays tax at 20%. What is the deferred tax balance in the statement of financial position
at 31 December 20X1?
Required
What is the deferred tax balance in the statement of financial position at 31 December 20X1?
 Deferred tax asset $10,000
 Deferred tax liability $10,000
 Deferred tax asset $50,000
 Deferred tax liability $50,000
5.3 Recognition and carrying amount of deferred tax assets

Deferred tax assets should only be recognised to the extent that it is probable that a taxable profit
will be available against which deductible temporary differences can be utilised (IAS 12: para. 24).
The carrying amount of deferred tax assets should be reviewed at the end of each reporting
period and reduced where appropriate (insufficient future taxable profits). Such a reduction may
be reversed in future years (IAS 12: para. 56).
5.4 Presentation of deferred tax

Current and deferred tax shall be recognised as income or an expense and included in profit or
loss for the period, except to the extent that the tax arises from a transaction or event which is
recognised either in other comprehensive income or directly in equity. (IAS 12: para. 58)
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Examples of IFRS Standards which allow certain items to be credited/charged directly to equity
include:
(a) Revaluations of property, plant and equipment (IAS 16)
(b) The effect of a change in accounting policy (applied retrospectively) or correction of a
material error (IAS 8)
Revaluations will appear under ‘other comprehensive income’ in the statement of profit or loss and
other comprehensive income and the tax element will be shown separately as ‘income tax relating
to components of other comprehensive income’ (IAS 12: para. 61).
5.5 Key disclosures

Taxation in the statement of financial position
In the statement of financial position, tax assets and liabilities should be shown separately from
other assets and liabilities.
Current tax assets and liabilities can be offset, but this should happen only when:
(a) There is a legally enforceable right to set off the recognised amounts.
(b) The amounts will be settled on a net basis, or the asset and liability settled at the same time.
The tax expense or income for the year should be presented in the statement of profit or loss.
In relation to tax, the statement of financial position will include several items:
(a) Amounts underprovided/overprovided in the prior year which appear as debits/credits to the
tax payable account.
(b) If no tax is payable (or very little), then there might be an income tax recoverable asset
disclosed in current assets (income tax is normally recovered by offset against the tax liability
for the year).
(c) There will usually be a liability for tax assessed as due for the current year.
(d) There may also be a liability on the deferred taxation account. Deferred taxation is shown
under ‘non-current liabilities’ in the statement of financial position.
Taxation in the statement of profit or loss
The tax on profit on ordinary activities is calculated by aggregating:
(a) Income tax on taxable profits
(b) Transfers to or from deferred taxation
(c) Any under provision or overprovision of income tax on profits of previous years
Activity 7: Awkward Co
Awkward Co buys an item of equipment on 1 January 20X1 for $1,000,000. It has a useful life of
10 years and an estimated residual value of $100,000. The equipment is depreciated on a
straight-line basis. For tax purposes, a tax expense can be claimed on a 20% reducing balance
basis.
The rate of income tax can be taken as 30%.
Required
In respect of the above item of equipment, calculate the deferred tax charge/credit in the profit or
loss of Awkward Co for the year to 31 December 20X2 and the deferred tax balance in the
statement of financial position at that date.
Solution
MOVEMENT IN THE DEFERRED TAX LIABILITY FOR THE YEAR ENDED 31 DECEMBER 20X2
$’000
Deferred tax liability b/d
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$’000
 Profit or loss charge
Deferred tax liability c/d
Workings
1 Deferred tax liability
Accounting Deferred tax

carrying Temporary liability @
amount Tax base differences 30%
$’000 $’000 $’000 $’000
20X1
Cost
Depreciation
(W2) and (W3)
c/d
20X2
b/d
Depreciation
(W2) and (W3)
c/d
2 Depreciation

3 Tax depreciation
20X1:
20X2:
Essential reading
In Chapter 16 of the Essential reading, there is an additional activity (Activity 12: Norman Kronkest
Co) which looks at the effect of deferred tax on a number of different adjustments to the financial
statements. Do attempt further question practice on this topic as it is generally an area that
students struggle with in the exam.
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Activity 8: Neil Down Co
In the accounting year to 31 December 20X3, Neil Down Co generated a profit before tax of
$110,000.
Income tax on the profit before tax has been estimated as $45,000. In the previous year (20X2),
income tax on profits had been estimated as $38,000 but it was subsequently agreed at $40,500.
A transfer to the credit of the deferred taxation account of $16,000 will be made in 20X3.
Required
1 Calculate the tax on profits for 20X3 for disclosure in the accounts.
2 Calculate the amount of tax payable.
Solution
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16: Taxation 391

Chapter summary
Taxation
IAS 12 Income Taxes Current tax
IAS 12 covers current and deferred tax • Tax actually payable to the tax authorities
• Tax charged by tax authority
• Unpaid tax due is recognised as a liability
• Excess tax paid over what is due is recognised as
an asset
• Having calculated the tax due:
– DEBIT Tax charge (SOPL)
– CREDIT Tax liability (SOFP)
What is deferred tax?
• Deferred tax is an accounting measure only Temporary differences continued

• Deferred tax is recognised for all temporary • Provisions and allowances for ECL (doubtful debts)
differences except – Provisions and allowances recognised for
– Tax arising on business combination accounting purposes per IAS 37/IFRS 9
(incl in goodwill) – Tax treatment allows tax relief when expense
– Taxes on adjustments which go to equity incurred
(IAS 8 accounting policy change) • Revaluation of non-current assets
– As the gain on the revaluation is charged to
Temporary differences SPLOCI (other comprehensive income), so the
• Property, plant & machinery deferred tax is also only recognised in the SPLOCI
– Temporary differences arises due to different • Tax base: tax rules set out by each jurisdiction
rates of depreciation between the accounting
and the tax rates Measurement
• Accrued income/accrued expense • Tax rates used that have been enacted by end of
– Accounting uses accruals principle to recognise the reporting period
income and expense • Changes in tax rates after the year end are
– Tax treatment takes the date of payment non-adjusting events after the reporting period
or receipt
Calculating deferred tax Other aspects of deferred tax
Deferred tax is calculated as follows: Losses can be carried forward to reduce the future
$ tax liability – future tax saving – deferred tax asset
Carrying amount of asset/(liability) [in recognised
accounting statement of financial position] X/(X)
Less tax base [value for tax purposes] (X)/X Presentation
X/(X) • Deferred tax assets/liabilities should be shown
Deferred tax (liability)/asset [always opposite separately from other assets/liabilities.
• Current tax – can be offset ONLY WHEN
(X)/X – Legally enforceable right to do so
– Amounts will be settled on a net basis, or the
asset and liability settled at the same time
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1. IAS 12 Income Taxes

IAS 12 Income Taxes explains the accounting treatment for current tax and deferred tax.
The accounting entry to record tax in the financial statements is:
DEBIT Tax charge (statement of profit or loss)

Tax liability (statement of financial
CREDIT position)
2. Current tax
Current tax is the amount actually payable to the tax authorities in relation to the trading
activities of the entity during the period.
IAS 12 requires any unpaid tax in respect of the current or prior periods to be recognised as a
liability.
Conversely, any excess tax paid in respect of current or prior periods over what is due should be
recognised as an asset.
3. What is deferred tax?

Deferred tax is an accounting adjustment. It is not a tax which is payable to the tax authorities.
Essentially, it is the difference between:
• The carrying amount of the asset (or liability) on the statement of financial position, eg non-
current asset, warranty provision; and
• The tax value of the asset (or liability). This is called the ‘tax base’.
4. Calculating deferred tax

Deferred tax is the tax attributable to temporary differences.
There are two types of temporary difference:
• Taxable temporary difference – tax to pay in the future – giving rise to a deferred tax liability
• Deductible temporary difference – tax saving in the future – giving rise to a deferred tax asset
If an item is never taxable or tax deductible, its tax base is deemed to be its carrying amount so
there is no temporary difference and no related deferred tax. This is a permanent difference and
does not give rise to deferred tax.
Depreciation on non-current assets is an example of a circumstance which gives rise to taxable
temporary differences.
Revaluations of non-current assets are generally not recognised for tax until the asset is sold. As
the revaluation is recognised in other comprehensive income, the associated deferred tax is also
recognised in other comprehensive income.
5. Other aspects of deferred tax

A deferred tax asset is recognised for tax losses that can be carried forward that it is probable will
be used.
Deferred tax assets and liabilities are measured at the tax rates expected to apply to the period
when the asset is realised or liability settled, based on tax rates that have been enacted by the
end of the reporting period.
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Question practice
the Workbook):
Section B Q22(b)
Section C Q44 Telenorth Co
Section C Q47 Carpati Co
Further reading
ACCA has prepared a useful technical article on deferred tax, which is available on its website
under Exam Support Resources.
Deferred Tax
www.accaglobal.com
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Activity answers
Activity 1: Current tax

The correct answer is: Expense $59,150; Liability $60,000
The tax expense will be reduced by the prior year over-provision, however the liability will
represent the amount due for the coming year.
Activity 2: Tax base

1
Carrying Temporary
amount Tax base difference Taxable or
$ $ $ deductible
7,000
Machine 8,000 (10,000 – 3,000) 1,000 Taxable
Carrying Temporary
$ $ $ deductible
Interest
receivable 1,000 Nil 1,000 Taxable
The interest has not yet been received in cash and is therefore not yet recognised for tax
purposes. The tax base of the interest receivable is therefore nil.
3
Carrying
amount Tax base Temporary Taxable or
$ $ difference deductible
Trade
receivables 10,000 10,000 Nil N/A
As the revenue is included in profit or loss and is therefore taxable in the period it is earned, the
tax base of the trade receivables is equal to the carrying amount. There is no temporary
difference as the carrying amount and tax base are equal.
4
Carrying Temporary
$ $ $ deductible
Loan receivable 1,000,000 1,000,000* Nil N/A
*The loan is not taxable and so the tax base is deemed to be the carrying amount of the loan
which is $1 million. There is no temporary difference.
Activity 3: Epsilon Co
Amortisation of the development costs over their useful life of five years should commence on 1
January 20X4. Therefore, at 31 March 20X4, the development costs have a carrying amount of
$1.52 million ($1.6m – ($1.6m × 1/5 × 3/12)) in the financial statements.
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The tax base of the development costs is nil since the relevant tax deduction has already been
claimed.
The deferred tax liability will be $380,000 ($1.52m × 25%).
Activity 4: Lecehus Co
1 The correct answer is: Other comprehensive income $70,000; Liability $30,000
Inclusions:
$’000
Gain on property revaluation 100
Deferred tax relating to other comprehensive income (Working) (30)
Other comprehensive income for the year, net of tax 70
Working
$’000
Accounting carrying amount 500
Tax base (400)
Temporary difference 100
Deferred tax liability @ 30% (30)
2 $ 70,000
The revaluation surplus is carried net of deferred tax. The balance is therefore $70,000
($100,000 surplus less $30,000 deferred tax).
Activity 5: Pargatha Co
The carrying amount of the warranty provision for accounting purposes is the $10,000
recognised.
The tax base of the provision is nil (as the amount in respect of warranty claims will not be
deductible for tax purposes until future periods when the claims are paid).
When the liability is settled for its carrying amount, the entity’s future taxable profit will be
reduced by $10,000 and so its future tax payments by $10,000 × 25% = $2,500.
The difference of $10,000 between the carrying amount ($10,000) and the tax base (nil) is a
deductible temporary difference. Pargatha Co should therefore recognise a deferred tax asset of
$10,000 × 25% = $2,500 provided that it is probable that the entity will earn sufficient taxable
profits in future periods to benefit from a reduction in tax payments.
Activity 6: Deorf Co
The correct answer is: Deferred tax asset $10,000
A deferred tax asset is recognised in 20X1 for $50,000 × 20% = $10,000:
DEBIT Deferred tax asset (SOFP) $10,000

CREDIT Deferred tax (P/L) $10,000
In 20X3 the deferred tax asset is charged to profit or loss when profits are earned that the tax
losses are used against.
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Activity 7: Awkward Co
MOVEMENT IN THE DEFERRED TAX LIABILITY FOR THE YEAR ENDED 31 DECEMBER 20X2
$’000
Deferred tax liability b/d 33
 Profit or loss charge 21
Deferred tax liability c/d 54
Workings
1 Deferred tax liability
Accounting Deferred tax

carrying Temporary liability @
amount Tax base differences 30%
$’000 $’000 $’000 $’000
20X1
Cost 1,000 1,000 – –
Depreciation
(W2) and (W3) (90) (200)
c/d
910 800 110 (33)
20X2
b/d 910 800
Depreciation
(W2) and (W3) (90) (160)
c/d 820 640 180 (54)
2 Depreciation
$1,000,000 cost – $100,000 residual value/10 years = $90,000 per annum.
3 Tax depreciation
20X1: $1,000,000 × 20% = $200,000
20X2: $800,000 carrying amount b/d × 20% = $160,000
The deferred tax liability in the statement of financial position at 31 December 20X2 will be the
potential tax on the difference between the accounting carrying amount of $820,000 and the tax
base of $640,000. The temporary difference is $180,000 and the deferred tax on the difference is
a $54,000 charge/liability.
The charge (or credit) for deferred tax in profit or loss for the year is the increase (or decrease) in
the deferred tax liability during the year. The closing deferred tax liability of $54,000 is greater
than the opening deferred tax liability of $33,000, so there is a deferred tax charge of $21,000 to
profit or loss in respect of this year.
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Activity 8: Neil Down Co
1
$
Income tax on profit before tax (liability in the statement of financial position) 45,000
Deferred taxation 16,000
Underprovision of tax in previous year ($40,500 – $38,000) 2,500
Tax on profits for 20X3 (profit or loss charge) 63,500
$
Tax payable on 20X3 profits (liability) 45,000
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Presentation of
17 published financial
statements
17
Learning objectives
On completion of this chapter, you should be able to
Prepare an entity’s statement of financial position and statement D1(a)

of profit or loss and other comprehensive income in accordance
with the structure and content prescribed within IFRS Standards
and with accounting treatments as identified within syllabus
areas A, B and C.
Prepare and explain the contents and purpose of the statement D1(b)
of changes in equity.
Indicate the circumstances where separate disclosure of material B9(c)

items of income and expense is required.
17
Exam context
The presentation of published financial statements is a key area of the Financial Reporting
syllabus and will be tested in a constructed response question in Section C of the exam. In Section
C, you will be required to prepare the statement of financial position, statement of profit or loss
and other comprehensive income and/or extracts from the statement of cash flows.
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17
Chapter overview
Presentation of published financial statements
IFRS Statement of Statement of profit

Financial financial or loss and other
statements position comprehensive income
Key sections of the statement of Key sections of the statement of

financial position profit or loss
Key section of the statement of

Revision of basic Statement of Financial statement

accounts preparation changes in equity preparation questions
Recap Key sections of the statement of

changes in equity
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1 IFRS financial statements
1.1 IAS 1 Presentation of Financial Statements
1.1.1 Scope
IAS 1 Presentation of Financial Statements applies to the preparation and presentation of general-
purpose financial statements in accordance with IFRS Standards.
1.1.2 Financial statements

A complete set of financial statements comprises:
(a) A statement of financial position at the end of the period
(b) A statement of profit or loss and other comprehensive income for the period
(c) A statement of changes in equity for the period
(d) A statement of cash flows for the period
(e) Notes, comprising a summary of significant accounting policies and other explanatory
information
(f) Comparative information in respect of the preceding period
(g) A statement of financial position at the beginning of the earliest comparative period where
an entity applies an accounting policy retrospectively or makes a retrospective restatement
of items in its financial statements, or when it reclassifies items in its financial statements.
IAS 1 also permits the use of other terms than those used in the standard, such as:
• ‘Balance sheet’ for the ‘statement of financial position’
• ‘Statement of comprehensive income’ for the ‘statement of profit or loss and other
comprehensive income’
• Income statement’ for the ‘statement of profit or loss’
Essential reading
Chapter 17, Section 1 Presentation of Financial Statements of the Essential reading provides useful
information on how information is reported in the financial statements. This includes detail on
reporting profit or loss for the year, disclosure, materiality, identification of financial statements,
the reporting period and timeliness. Review this section carefully.
Further, you must understand the type of information that is included in the notes to the financial
statements. Read Chapter 17, Section 3 Notes to the financial statements in the Essential reading
and make sure you can explain the type of information shown by way of a note.
2 Statement of financial position

2.1 Format of the statement of financial position
An example of a statement of financial position extracted from IAS 1 (Illustrative Guidance) is as
follows:
GENERIC CO – STATEMENT OF FINANCIAL POSITION AT 31 DECEMBER
20X7 20X6
$’000 $’000
Assets
Non-current assets
Property, plant and equipment XXX XXX
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20X7 20X6
$’000 $’000
Right of use assets XXX XXX
Intangible assets XXX XXX
Investments in equity instruments XXX XXX
XXX XXX
Current assets
Inventories XXX XXX
Trade receivables XXX XXX
Other current assets XXX XXX
Cash and cash equivalents XXX XXX
XXX XXX
Total assets XXX XXX
Share capital XXX XXX
Retained earnings XXX XXX
Revaluation surplus XXX XXX
Other components of equity XXX XXX
Total equity XXX XXX
Long-term borrowings XXX XXX
Deferred tax XXX XXX
Long-term provisions XXX XXX
Total non-current liabilities XXX XXX
Current liabilities
Trade and other payables XXX XXX
Short-term borrowings XXX XXX
Current portion of long-term borrowings XXX XXX
Current tax payable XXX XXX
Short-term provisions XXX XXX
Total current liabilities XXX XXX
Total liabilities XXX XXX
Total equity and liabilities XXX XXX
(IAS 1: Illustrative Guidance)
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2.2 The current/non-current distinction
Exam focus point

You should appreciate the distinction between current and non-current assets and liabilities
and the affect this has on the way they are recorded in the financial statements. OT questions
will frequently ask candidates to calculate, for example, the current portion of a lease liability
or the non-current portion of a provision. It is important that you read the question
requirement carefully to ensure that you understand whether it is the current or non-current
portion of an asset, or more commonly, a liability you are being asked to calculate.
An entity must present current and non-current assets as separate classifications on the face of
the statement of financial position. A presentation based on liquidity should only be used where it
provides more relevant and reliable information, in which case all assets and liabilities must be
presented broadly in order of liquidity. (IAS 1: para. 60)
In either case, the entity should disclose any portion of an asset or liability that is expected to be
recovered or settled after more than 12 months. For example, for an amount receivable that is due
in instalments over 18 months, the portion due after more than 12 months must be disclosed. (IAS
1: para. 61)
The IAS emphasises how helpful information on the operating cycle is to users of financial
statements. Where there is a clearly defined operating cycle within which the entity supplies
goods or services, then information disclosing those net assets that are continuously circulating
as working capital is useful. (IAS 1: para. 62)
This distinguishes them from those net assets used in the long-term operations of the entity.
Assets that are expected to be realised and liabilities that are due for settlement within the
operating cycle are therefore highlighted. (IAS 1: para. 62)
The liquidity and solvency of an entity is also indicated by information about the maturity dates
of assets and liabilities. As we will see later, IFRS 7 Financial Instruments: Disclosures requires
disclosure of maturity dates of both financial assets and financial liabilities. (Financial assets
include trade and other receivables; financial liabilities include trade and other payables.) (IAS 1:
para. 63)
Current asset: An asset should be classified as a current asset when it:

KEY
TERM • Is expected to be realised in, or is held for sale or consumption in, the normal course of the
entity’s operating cycle; or
• Is held primarily for trading purposes or for the short-term and expected to be realised
within 12 months of the end of the reporting period; or
• Is cash or a cash equivalent asset which is not restricted in its use.
All other assets should be classified as non-current assets.
(IAS 1: para. 66)
Non-current assets include tangible, intangible, operating and financial assets of a long-term
nature. Other terms with the same meaning can be used (eg ‘fixed’, ‘long-term’). (IAS 1: para. 67)
The term ‘operating cycle’ has been used several times above. The standard defines it as follows.
Operating cycle: The time between the acquisition of assets for processing and their
KEY
TERM realisation in cash or cash equivalents. (IAS 1: para. 68)
Current assets therefore include inventories and trade receivables that are sold, consumed and
realised as part of the normal operating cycle. This is the case even where they are not expected
to be realised within 12 months. (IAS 1: para. 68)
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Current assets will also include marketable securities if they are expected to be realised within 12
months after the reporting period. If expected to be realised later, they should be included in non-
current assets. (IAS 1: para. 68)
Current liabilities: A liability should be classified as a current liability when it:

KEY
TERM • Is expected to be settled in the normal course of the entity’s operating cycle; or
• Is held primarily for the purpose of trading; or
• Is due to be settled within 12 months after the end of the reporting period; or when
• The entity does not have the right at the end of the reporting period to defer settlement of
the liability for at least 12 months after the end of the reporting period.
All other liabilities should be classified as non-current liabilities.
(IAS 1: para. 69)
The categorisation of current liabilities is very similar to that of current assets. Thus, some current
liabilities are part of the working capital used in the normal operating cycle of the business (ie
trade payables and accruals for employee and other operating costs). Such items will be classed
as current liabilities, even where they are due to be settled more than 12 months after the end of
the reporting period. (IAS 1: para. 70)
There are also current liabilities that are not settled as part of the normal operating cycle, but
which are due to be settled within 12 months of the end of the reporting period. These include
bank overdrafts, income taxes, other non-trade payables and the current portion of interest-
bearing liabilities. Any interest-bearing liabilities that are used to finance working capital on a
long-term basis, and that are not due for settlement within 12 months, should be classed as non-
current liabilities. (IAS 1: para. 71)
A non-current financial liability due to be settled within 12 months of the end of the reporting
period should be classified as a current liability, even if (a) the original term was for a period
longer than 12 months and (b) an agreement to refinance, or to reschedule payments, on a long-
term basis is completed after the end of the reporting period and before the financial statements
are authorised for issue. (IAS 1: para. 72) An entity’s right to defer settlement must have substance
and must exist at the end of the reporting period. (IAS 1: para. 72A)
End of the Agreement to refinance Date financial Settlement date <12

reporting period on long-term basis statements authorised months after end of
for issue the reporting period
therefore current liability
A non-current financial liability that is payable on demand because the entity breached a
condition of its loan agreement should be classified as current at the end of the reporting period,
even if the lender has agreed after the end of the reporting period, and before the financial
statements are authorised for issue, not to demand payment as a consequence of the breach.
Condition of loan End of the Lender agrees not to Date financial

agreement breached. reporting period enforce payment resulting statements are
Non-current liability from breach authorised for issue.
becomes payable Loan shown as
on demand current liability
However, if the lender has agreed by the end of the reporting period to provide a period of grace
ending at least 12 months after the end of the reporting period within which the entity can rectify
the breach, and during that time the lender cannot demand immediate repayment, the liability is
classified as non-current.
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3 Statement of profit or loss and other comprehensive
income
3.1 Format
IAS 1 allows income and expense items to be presented either:
(a) In a single statement of profit or loss and other comprehensive income; or
(b) In two statements: a separate statement of profit or loss and statement of other
comprehensive income.
(para. 81)
The format for a single statement of profit or loss and other comprehensive income is shown as
follows in the standard. The section down to ‘profit for the year’ can be shown as a separate
‘statement of profit or loss’ with an additional ‘statement of other comprehensive income’. Note
that not all of the items that would appear under ‘other comprehensive income’ are included in
your syllabus.
Additional line items, headings and sub-totals should be presented in the statement of profit or
loss and other comprehensive income when such presentation is relevant to an understanding of
an entity’s financial performance (para. 85). Information is likely to be relevant to an
understanding of performance when it is material.
Exam focus point

In the exam, if a ‘statement of profit or loss and other comprehensive income’ is referred to,
this will always relate to the single statement format. If a ‘statement of profit or loss’ is referred
to, this relates to the statement from ‘revenue’ to ‘profit for the year’.
Exams may refer to ‘other comprehensive income’ which relates to the ‘other comprehensive
income’ section of the statement. In practice, the item of ‘other comprehensive income’ you
are most likely to meet is a revaluation surplus.
Where the phrase ‘statement of profit or loss’ is used in this Workbook, this can be taken to
refer to the profit or loss section of the full statement or the separate statement of profit or
loss.
3.2 Format of the statement of profit or loss and other comprehensive

income
An example of a statement of profit or loss and other comprehensive income given by IAS 1 is as
follows:
GENERIC CO – STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR
20X7 20X6
$’000 $’000
Revenue XXX XXX
Cost of sales XXX XXX
Gross profit XXX XXX
Other income XXX XXX
Distribution costs XXX XXX
Administrative expenses XXX XXX
Finance costs XXX XXX
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20X7 20X6
$’000 $’000
Share of profit of associates XXX XXX
Profit before tax XXX XXX
Income tax expense XXX XXX
Profit for the year from continuing operations XXX XXX
Loss for the year from discontinued operations XXX XXX
Profit for the year XXX XXX
Gains on property revaluation XXX XXX
Other comprehensive income for the year XXX XXX
Total comprehensive income for the year XXX XXX
PER alert
One of the competences required to fulfil performance objective 7 of the PER is the ability to
prepare and review financial statements in accordance with legal and regulatory
requirements. You can apply the knowledge you obtain from this section of the Workbook to
help you demonstrate this competence.
4 Statement of changes in equity

A statement of changes in equity shows the movement in the equity section of the statement of
financial position. IAS 1 requires a statement of changes in equity and therefore a full set of
financial statements includes this statement.
4.1 Format
This is the format of the statement of changes in equity as per IAS 1. For clarity, columns relating
to items not in the Financial Reporting syllabus, as highlighted in Section 3 are omitted, and the
totals are amended accordingly. (IAS 1: Illustrative Guidance)
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GENERIC CO – STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 20X7
capital
Retained
Share
earnings
Other components of equity

Revaluation
surplus
Total equity
$’000 $’000 $’000 $’000
Balance at 1 January
20X6 XXX XXX – XXX XXX
Dividends – (XXX) – – (XXX)
Total comprehensive
income for the year – XXX XXX XXX XXX
Balance at 31 December
20X6 XXX XXX XXX XXX XXX
Changes in equity for
20X7
Issue of share capital XXX – – – XXX
Dividends – (XXX) – – (XXX)
Total comprehensive
income for the year – XXX XXX – XXX
Transfer to retained
earnings – XXX (XXX) – –
20X7 XXX XXX XXX XXX XXX
Essential reading
The Essential reading includes an Illustration titled Wislon which demonstrates how a set of IAS 1
financial statements are prepared, which you may find a useful reminder of the accounts
preparation process.
5 Financial statement preparation questions

Having considered the components and presentation of financial statements, in this section we
will look at an exam-standard question on this topic.
Step 1 Read the requirements carefully. Then read the scenario. You can use the highlighter
and/or make brief notes of any key details on the scratch pad.
ice Exam 1
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You should note that the scratch pad will not be seen by the marker and does not form
part of your final answer, therefore ensure that you copy any workings or any text you
want to be seen into the spreadsheet response area.
Step 2 Enter your proforma financial statements, as specified in the requirements, into the
constructed response spreadsheet workspace. For example, you may be asked to
prepare a statement of profit or loss and other comprehensive income and/or a
statement of financial position, extracts of these statements or the extracts from the
Also, leave some space and/or set up the proforma for key workings. Remember to
clearly label your workings.
Step 3 Transfer the figures from the trial balance or the draft financial statements provided in
the question to your proforma.
Step 4 Work through the adjustments required based on the notes provided. Remember to deal
with both sides of the double entry. Balance off workings (you can use the sum function
within the spreadsheet response area for this) and transfer the figures to your proforma.
You transfer your figures either by typing the total per your working into the relevant
place in the proforma financial statement, or to avoid making a transposition error, by
typing a cell reference, eg =C6.
Workings are
clearly labelled and
cross-referenced
The sum function

has been used to
arrive at the total This has been entered as
=G4 to cross-reference
to the working
Activity 1: Mandolin Co
Mandolin Co is a quoted manufacturing company. Its finished products are stored in a nearby
warehouse until ordered by customers. Mandolin Co has performed very well in the past, but has
been in financial difficulties in recent months and has been organising the business to improve
performance.
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The trial balance for Mandolin Co at 31 March 20X3 was as follows:
$’000 $’000
Sales 124,900
Cost of goods manufactured in the year to
31 March 20X3 (excluding depreciation) 94,000
Distribution costs 9,060
Administrative expenses 16,020
Restructuring costs 121
Interest received 1,200
Loan note interest paid 639
Land and buildings (including land $20,000,000) 50,300
Plant and equipment 3,720
Accumulated depreciation at 31 March 20X2:
Buildings 6,060
Investment properties (at market value) 24,000
Inventories at 31 March 20X2 4,852
Trade receivables 9,330
Bank and cash 1,190
Ordinary shares of $1 each, fully paid 20,000
Share premium 430
Retained earnings at 31 March 20X2 28,077
Ordinary dividends paid 1,000
7% loan notes 20X7 18,250
Trade payables 8,120
Proceeds of share issue – 2,400
214,232 214,232
Additional information provided:

(1) The property, plant and equipment are being depreciated as follows:
- Buildings 5% per annum straight-line
- Plant and equipment 25% per annum reducing balance
- Depreciation of buildings is considered an administrative cost while depreciation of plant
and equipment should be treated as a cost of sale.
(2) On 31 March 20X3, the land was revalued to $24,000,000.
(3) Income tax for the year to 31 March 20X3 is estimated at $976,000. Ignore deferred tax.
(4) The closing inventories at 31 March 20X3 were $5,180,000. An inspection of finished goods
found that a production machine had been set up incorrectly and that several production
batches, which had cost $50,000 to manufacture, had the wrong packaging. The goods
cannot be sold in this condition but could be repacked at an additional cost of $20,000. They
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could then be sold for $55,000. The wrongly packaged goods were included in closing
inventories at their cost of $50,000.
(5) The 7% loan notes are ten-year loans due for repayment by 31 March 20X7. Interest on these
loan notes needs to be accrued for the six months to 31 March 20X3.
(6) The restructuring costs in the trial balance represent the cost of a major restructuring of the
company to improve competitiveness and future profitability.
(7) No fair value adjustments were necessary to the investment properties during the period.
(8) During the year, the company issued 2 million new ordinary shares for cash at $1.20 per
share. The proceeds have been recorded as ‘Proceeds of share issue’.
Required
Prepare the statement of profit or loss and other comprehensive income and statement of
changes in equity for Mandolin Co for the year to 31 March 20X3 and a statement of financial
position at that date.
Solution
Notes to the financial statements are not required, but all workings must be clearly shown.
Mandolin Co
FOR THE YEAR ENDED 31 MARCH 20X3
$’000
Revenue
Cost of sales
Gross profit
Distribution costs
Administrative expenses
Other expenses
Finance income
Finance costs
Profit before tax
Income tax expense
PROFIT FOR THE YEAR
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$’000
Gain on land revaluation
Other expenses represent the cost of a major restructuring undertaken during the period.
MANDOLIN CO
$’000
Non-current assets
Investment properties
Current assets
Inventories
Trade receivables
Cash and cash equivalents
Equity
Share capital
Share premium
Retained earnings
Revaluation surplus
7% loan notes 20X7
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$’000
Current liabilities
Trade payables
Income tax payable
Interest payable
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Mandolin Co
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 MARCH 20X3
Share Share Retained Reval’n

capital premium earnings surplus Total
$’000 $’000 $’000 $’000 $’000
Balance at 1 April 20X2
Issue of share capital
Dividends
Total comprehensive income

for the year
Balance at 31 March 20X3
Workings
1 Expenses
Cost of sales Distribution Admin Other
$’000 $’000 $’000 $’000
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2 Property, plant and equipment
Land Buildings P&E Total
$’000 $’000 $’000 $’000
Cost b/d
Accumulated depreciation
b/d
Depreciation charge for

year:
Revaluation (balancing
figure)
Carrying amount c/d
3 Inventories
$’000
Defective batch:
Selling price
Cost to complete: repackaging required
 NRV
Cost
 Write-off required
4 Share issue
The proceeds have been recorded separately in the trial balance. This requires a transfer to the
appropriate accounts:
$’000 $’000
DEBIT Proceeds of share issue

CREDIT Share capital
CREDIT Share premium
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Tutorial note. You could try working through this question using the ACCA Practice Platform to
see how you would apply your technique to in the CBE software.
Exam focus point

It is essential that you practice answering questions in the ACCA Practice Platform before
sitting your Financial Reporting exam. The ACCA Practice Platform contains past exams and
practice exams for you to attempt, or you can use the blank workspaces to answer the single
entity or group financial statement preparation questions included in this Workbook or in the
Kit.
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Chapter summary
Presentation of published financial statements
IFRS Statement of Statement of profit

Financial financial or loss and other
statements position comprehensive income
IAS 1 Presentation of Financial Key sections of the statement of Key sections of the statement of
Statements applies to the financial position profit or loss
preparation and presentation of • Non-current assets • Revenue
general purpose financial • Current assets • Cost of sales
statements in accordance with • Equity • Gross profit
IFRS • Non-current liabilities • Other income
• Current liabilities • Distribution costs
• Administrative expenses
• Other expenses
• Finance costs
• Income tax expense
Key section of the statement of

Gains/(losses) on property
revaluation
Revision of basic Statement of Financial statement

accounts preparation changes in equity preparation questions
Recap Key sections of the statement of A methodical approach is

• An asset is a resource control changes in equity important in the exam
by the business • Equity section of the SOFP
• An asset is expected to be of • Shows movement arising from:
future benefit – Dividends
• A liability is an amount owed – Share issues
by the business – Profit or loss
• Share capital is a permanent – Revaluation gains or losses
investment in the business by
its owners
• Retained earnings are
accumulated profits (less
losses)
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1. IFRS financial statements

A set of IFRS financial statements includes a statement of profit or loss and other comprehensive
income, statement of financial position, statement of changes in equity, statement of cash flows,
accounting policies and notes to the financial statements.
2. Statement financial position

In the exam, you may be asked to prepare a statement of financial position. Therefore, learning
the formats is vital in achieving a pass on this type of question. Make sure that you understand
the difference between current assets and liabilities, and non-current assets and liabilities.
3. Statement of profit or loss and other comprehensive income

Similarly, you could be asked to prepare a statement of profit or loss and other comprehensive
income in Section C of the exam. Again, check that you can draw up this proforma easily and
understand which items are classified in ‘other comprehensive income’.
4. Revision of basic accounts preparation

You will be familiar with the terms statement of financial position, assets, liabilities, share capital
and other components of equity from your Financial Accounting studies. Briefly review this section
to remind yourself of the key concepts.
5. Statement of changes in equity

This statement shows the movement in the equity section in the statement of financial position.
Ensure you are familiar with this proforma.
6. Financial statement preparation questions

In the exam, you are likely to be asked to prepare a set of IFRS financial statements (which could
include a statement of changes in equity) from a trial balance.
BPP recommends a methodical approach of familiarising yourself with the information in the
question and setting up on-screen proformas/workings, then working down the draft trial
balance, transferring figures to the face of the financial statements (directly or in brackets if
adjustments will be required) or to a working.
Having made the more straightforward entries, you can then turn your attention to adjustments.
This is consistent with our approach to preparing statement of cash flows and group financial
statements.
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Question practice
the Workbook):
Section A Q2
Section A Q3
Section C Q26 Polymer Co
Section C Q44(a)(b) Telenorth Co
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Activity answers
Activity 1: Mandolin Co
Notes to the financial statements are not required, but all workings must be clearly shown.
Mandolin Co
FOR THE YEAR ENDED 31 MARCH 20X3
$’000
Revenue 124,900
Cost of sales (W1) (94,200)
Distribution costs (W1) (9,060)
Administrative expenses (W1) (17,535)
Other expenses (W1) (121)
Finance income 1,200
Finance costs (18,250 × 7%) (1,278)
Income tax expense (976)
Gain on land revaluation 4,000
Other expenses represent the cost of a major restructuring undertaken during the period.
MANDOLIN CO
$’000
Non-current assets
Property, plant and equipment (W2) 48,262
Investment properties 24,000
72,262
Current assets
Inventories (5,180 -15 (W3)) 5,165
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$’000
Cash and cash equivalents 1,190
15,685
87,947
Equity
Share capital (20,000 + 2,000 (W4)) 22,000
Share premium (430 + 400 (W4)) 830
Retained earnings (28,077 – 1,000 + 2,930) 30,007
Revaluation surplus (3,125 + 4,000) 7,125
59,962
7% loan notes 20X7 18,250
Current liabilities
Income tax payable 976
Interest payable (1,278 – 639) 639
9,735
87,947
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Mandolin Co
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 MARCH 20X3
Share Share Retained Reval’n

$’000 $’000 $’000 $’000 $’000
Balance at 1 April 20X2 20,000 430 28,077 3,125 51,632
Issue of share capital 2,000 400 2,400
Dividends (1,000) (1,000)
Total comprehensive income

for the year – – 2,930 4,000 6,930
Balance at 31 March 20X3 22,000 830 30,007 7,125 59,962
Workings
1 Expenses
Cost of sales Distribution Admin Other
$’000 $’000 $’000 $’000
Per TB 94,000 9,060 16,020 121
Opening
inventories 4,852
Depreciation on
buildings (W2) 1,515
Depreciation on
P&E (W2) 513
Closing
inventories
(5,180 – (W3)
15) (5,165) – – –
94,200 9,060 17,535 121
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Land Buildings P&E Total
$’000 $’000 $’000 $’000
Cost b/d 20,000 30,300 3,720 54,020
b/d – (6,060) (1,670) (7,730)
20,000 24,240 2,050 46,290
Depreciation charge for

year:
• $30,300 × 5% (1,515) (1,515)
• ($3,720 – $1,670) ×
25% – – (513) (513)
20,000 22,725 1,537 44,262
Revaluation (balancing
figure) 4,000 – – 4,000
Carrying amount c/d 24,000 22,725 1,537 48,262
3 Inventories
$’000
Defective batch:
Selling price 55
Cost to complete: repackaging required (20)
 NRV 35
Cost (50)
 Write-off required (15)
4 Share issue
The proceeds have been recorded separately in the trial balance. This requires a transfer to the
appropriate accounts:
$’000 $’000
DEBIT Proceeds of share issue 2,400
CREDIT Share capital (2,000 × $1) 2,000
CREDIT Share premium (2,000 × $0.20) 400
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Reporting financial
18 performance
18
Learning objectives
Discuss the importance of identifying and reporting the results of B9(a)

discontinued operations.
Define and account for non-current assets held for sale and B9(b)
Account for changes in accounting estimates, changes in B9(d)

accounting policy and correction of prior period errors.
Discuss the principle of comparability in accounting for changes A1(g)

in accounting policies.
Explain the difference between functional and presentation B12(a)

currency and explain why adjustments for foreign currency
transactions are necessary.
Account for the translation of foreign currency transactions and B12(b)

monetary/non-monetary foreign currency items at the reporting
date.
18
Exam context
This chapter considers the IFRS Standards which deal with presentation issues, such as a change
in an accounting policy or the correction of a fundamental error which are both covered by IAS 8
Accounting Policies, Changes in Accounting Estimates and Errors. Questions covering IAS 8 are
more likely to feature in Section A or B questions. However, it could also be covered as one of the
adjustments in an accounts preparation question, or it could be relevant when considering the
reasons for difference between two entities or between two periods in an interpretation question.
IFRS 5 Non-current Assets Held for Sale and Discontinued Operations looks at how to deal with
business operations which have ceased in the year. You have already seen how to account for
non-current assets that the entity plans to continue to use. IFRS 5 considers the situation where
assets will be sold in the near future. You should note that there is a link between discontinued
operations and the disposal of a subsidiary which is covered in Chapter 11 of this Workbook. You
could be asked to prepare financial statements, or interpret financial statements, that contain a
held for sale asset or discontinued operation in Section C of the exam.
Some transactions take place in foreign currencies. IAS 21 The Effects of Changes in Foreign
Exchange Rates explains which exchange rates to use and how to translate transactions for
inclusion in the financial statements. You are likely to be asked about IAS 21 in Sections A or B,
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although you may be asked to translate some foreign currency transactions as part of a longer
Section C question.
Ensure you are familiar with the key points and practice your OT questions in order to consolidate
your knowledge and application skills in this chapter.
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18
Chapter overview
Changes in accounting policies Changes in accounting Correction of the error

estimates
Disclosure Disclosure
Disclosure
IFRS 5 Non-current Assets Held for Sale IAS 21 The Effects of

and Discontinued Operations Changes in Foreign
Exchange Rates
Non-current assets held for sale Discontinued operations
Accounting treatment Disclosure
Disclosure
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18: Reporting financial performance 425

1 IAS 8 Accounting Policies, Changes in Accounting
Estimates and Errors
This standard deals with:
• Selection and application of accounting policies
• Changes in accounting estimates
• Accounting for errors
1.1 Accounting policies

1.1.1 Definition
Accounting policies: The specific principles, bases, conventions, rules and practices applied by
KEY
TERM an entity in preparing and presenting the financial statements (IAS 8: para. 5).
An entity determines its accounting policies by applying the appropriate IFRS Standards.
In the absence of an IFRS Standard applying to a transaction, management uses its judgement to
develop and apply a policy that results in information that is relevant and that faithfully
represents what it purports to represent as outlined in the Conceptual Framework.
In making the judgement management also considers (in order of importance):
(a) IFRS Standards dealing with similar and related issues;
(b) The definitions, recognition criteria and measurement concepts outlined in the Conceptual
Framework; and
(c) The most recent pronouncements of other standard-setting bodies that use a similar
conceptual framework or accepted industry practices.
Accounting policies must be consistently applied for similar transactions, categories, other events
and conditions. The exception being if a standard requires or permits categorisation of items for
which different policies may be appropriate.
1.1.2 Change in accounting policy

A change in accounting policy is rare and is made only if:
(a) It is required by an IFRS Standard; or
(b) It results in the financial statements providing reliable and more relevant information about
the effects of transactions, other events or conditions on the entity’s financial position,
financial performance or cash flows.
The standard highlights two types of event which do not constitute changes in accounting policy:
(a) Adopting an accounting policy for a new type of transaction or event not dealt with
previously by the entity
(b) Adopting a new accounting policy for a transaction or event which has not occurred in the
past or which was not material (this includes adopting a policy of revaluation for the first time
for tangible non-current assets, which would be treated under IAS 16 (See Chapter 3 on
tangible non-current assets)
Where a new accounting standard is adopted, resulting in a change of accounting policy, IAS 8
requires any transitional provisions in the new standard to be followed. If none are given in the
standard then the general principles of IAS 8 should be followed.
1.1.3 Accounting treatment

Where the initial application of an IFRS Standard does not prescribe specific transitional
provisions, an entity applies the change retrospectively by:
(a) Restating comparative amounts for each prior period presented as if the accounting policy
had always been applied;
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(b) Adjusting the opening balance of each affected component of equity for the earliest prior
period presented; and
(c) Including the adjustment to opening equity as the second line of the statement of changes in
equity.
Where it is impracticable to determine the period-specific effects, the entity applies the new
accounting policy from the earliest period for which retrospective application is practicable (and
discloses that fact).
1.1.4 Key disclosures

(a) The nature of the change in accounting policy
(b) The reasons for the change
(c) The amount of the adjustment for the current and each prior period presented for each line
item affected
(d) The amount of the adjustment to periods before those presented
Disclosure is important to maintain the principle of comparability. Users should be able to
compare the financial statements of an entity over time and to compare the financial statements
of entities in the same line of business.
1.2 Changes in accounting estimates

1.2.1 Definition
Changes in accounting estimates: Accounting estimates are monetary amounts in financial

KEY
TERM statements that are subject to management uncertainty. (IAS 8: para. 5).
An accounting policy may be measured in a way that involves measurement uncertainty – that is
amounts that cannot be observed directly and must be estimated.
Examples of estimates that may change include:
• Loss allowances for expected credit losses (IFRS 9)
• The net realisable value of inventory (IAS 2)
• The fair value of assets or liabilities (IFRS 13)
• The depreciation expense for items of property, plant and equipment (IAS 16)
• Provisions for warranty obligations (IAS 37)
(IAS 8: para. 32)

Changes in accounting estimates relating to assets, liabilities or equity items are adjusted for in
the period of the change. All others are applied prospectively in profit or loss, ie in the current
period (and future periods if the change affects both current and future periods).
Changes in accounting estimates are not accounted for retrospectively.
The rule here is that the effect of a change in an accounting estimate should be included in the
determination of net profit or loss in one of:
(a) The period of the change, if the change affects that period only
(b) The period of the change and future periods, if the change affects both (IAS 8: para. 36)
Changes may occur in the circumstances which were in force at the time the estimate was
calculated, or perhaps additional information or subsequent developments have come to light.
An example of a change in accounting estimate which affects only the current period is the
irrecoverable debt allowance. However, a revision in the life over which an asset is depreciated
would affect both the current and future periods, in the amount of the depreciation expense.
Reasonably enough, the effect of a change in an accounting estimate should be included in the
same expense classification as was used previously for the estimate. This rule helps to ensure
consistency between the financial statements of different periods.
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The nature and amount of changes in accounting estimates that affect current and/or future
periods must be disclosed.
The materiality of the change is also relevant. The nature and the amount have a material effect,
and this should be disclosed.
1.3 Prior period errors

1.3.1 Definition
Prior period errors: Omissions from, and misstatements in, the entity’s financial statements for
KEY
TERM one or more prior periods arising from a failure to use, or misuse of, reliable information that:
(a) Was available when the financial statements for those periods were authorised for issue;
and
(b) Could reasonably be expected to have been obtained and taken into account in the
preparation and presentation of those financial statements.
(IAS 8: para. 5)
Errors may arise from:

(a) Mathematical mistakes
(b) Mistakes in applying accounting policies
(c) Oversights
(d) Misinterpretation of facts
(e) Fraud

An entity corrects material prior period errors retrospectively in the first set of financial statements
authorised for issue after their discovery by:
(a) Restating comparative amounts for each prior period presented in which the error occurred;
(b) (If the error occurred before the earliest prior period presented) Restating the opening
balances of assets, liabilities and equity for the earliest prior period presented; and
(c) Including any adjustment to opening equity as the second line of the statement of changes in
equity.
Where it is impracticable to determine the period-specific effects or the cumulative effect of the
error, the entity corrects the error from the earliest period/date practicable (and discloses that
fact).

(a) The nature of the prior period error
(b) The amount of the correction for each prior period presented for each line item affected
(c) The amount of the correction at the beginning of the earliest prior period presented
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Activity 1: IAS 8
IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors provides guidance as to
how to account for prior period errors.
Required
Which of the following options describe a prior period error?
 A material decrease in the valuation of the closing inventory resulting from a change in
legislation affecting the saleability of the company’s products.
 The discovery of a significant fraud in a foreign subsidiary resulting in a write-down in the
valuation of its assets. The perpetrators have confessed to the fraud which goes back at least
five years.
 The company has a material under provision for income tax arising from the use of incorrect
data by the tax advisers acting for the company.
 A deterioration in sales performance has led to the directors restating their methods for the
calculation of the allowance for irrecoverable debts.
Essential reading
Chapter 18 Section 1 Reporting Financial Performance of the Essential reading covers additional
examples and activities on changes in accounting policies, estimates and errors. Do familiarise
yourself with them and practice the activities.
2 IFRS 5 Non-current Assets Held for Sale and

Discontinued Operations
The objective of IFRS 5 is to require entities to disclose information about discontinued operations
and to prescribe measurement criteria applied to assets where a decision had been taken to sell
them. This enhances the ability of the primary users of financial statements to make projections
about the future of the company (profitability, cash flow, financial position, etc).
2.1 Definition
Disposal group: A group of assets to be disposed of, by sale or otherwise, together as a group
KEY
TERM in a single transaction, and liabilities directly associated with those assets that will be
transferred in the transaction. (In practice a disposal group could be a subsidiary, a cash-
generating unit or a single operation within an entity.)
Cash-generating unit: The smallest identifiable group of assets for which independent cash
flows can be identified and measured (IFRS 5: App A).
Costs of disposal: The incremental costs directly attributable to the disposal of an asset (or
disposal group), excluding finance costs and income tax expense.
Recoverable amount: The higher of an asset’s fair value less costs of disposal and its value in
use.
Value in use: The present value of estimated future cash flows expected to arise from the
continuing use of an asset and from its disposal at the end of its useful life (IFRS 5: App A).
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2.2 Classification as held for sale
Non-current assets are classified as held for sale if their carrying amount will be recovered
principally through a sales transaction rather than through continuing use.
To be classified as ‘held for sale’, the following criteria must be met:
(a) The asset must be available for immediate sale in its present condition, subject only to usual
and customary sales terms; and
(b) The sale must be highly probable.
For the sale to be highly probable, the following must apply:
(a) Management must be committed to a plan to sell the asset.
(b) There must be an active programme to locate a buyer.
(c) The asset must be marketed for sale at a price that is reasonable in relation to its current fair
value.
(d) The sale should be expected to take place within one year from the date of classification.
(e) It is unlikely that significant changes to the plan will be made or that the plan will be
withdrawn.
(IFRS 5: para. 8).
Tutorial note. Note the difference between the criteria in IFRS 5 and the criteria in IAS 36
(covered in Chapter 5 of this Workbook):
• Under IFRS 5, the carrying amount of the asset immediately before classification as held for
sale is compared to the fair value less costs of disposal.
• Under IAS 36 the carrying amount of the asset is compared to the recoverable amount
(which is the higher of fair value less costs of disposal and value in use).

A non-current asset (or disposal group) that is held for sale should be measured at the lower of its
carrying amount and fair value less costs of disposal. (IFRS 5: para. 15)
FV (less disposal costs)
Higher than Lower than

Carrying amount Carrying amount
No change Impairment loss to be recognised
If the fair value of an asset less costs of disposal is lower than the carrying amount, an
impairment loss is recorded.
• Immediately before initial classification as held for sale, the asset is measured in accordance
with the applicable IFRS Standard (eg property, plant and equipment held under the IAS 16
revaluation model is revalued).
• On classification of the non-current asset as held for sale, it is written down to fair value less
costs to sell (if less than carrying amount). Any impairment loss arising under IFRS 5 is
charged to profit or loss.
• Non-current assets classified as held for sale are not depreciated/amortised.
• Disclosure:
- As a single amount separately from other assets;
- On the face of the statement of financial position; and
- Normally as current assets
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Activity 2: Starlight Co
Starlight Co has an asset with a carrying amount of $150,000 at 1 January 20X3 held under the
cost model (cost $200,000) and being depreciated straight line over an eight-year life to a nil
residual value. At 1 July 20X3, Starlight Co classifies the asset as held for sale (and all necessary
criteria is met). At that date, it is estimated that the asset could be sold for $135,000 and that it
would cost $1,000 to secure the sale.
Required
What is the amount charged to the profit or loss on 1 July 20X3 on classification of the asset as
held for sale?
 $2,500
 $3,500
 $7,000
 $9,000
2.4 Discontinued operations

An entity should present and disclose information that enables the users of the financial
statements to evaluate the financial effects of discontinued operations and disposals of non-
current assets or disposal groups. (IFRS 5: para. 30)
2.4.1 Definition
Discontinued operation: A component of an entity that either has been disposed of or is

KEY
TERM classified as held for sale and:
(a) Represents a separate major line of business or geographical area of operations; or
(b) Is part of a single co-ordinated plan to dispose of a separate major line of business or
geographical area of operations; or
(c) Is a subsidiary acquired exclusively with a view to resale.
IFRS 5 requires specific disclosures for components meeting the definition during the accounting
period. This allows users to distinguish between operations which will continue in the future and
those which will not, and makes it more possible to predict future results.

The following disclosures apply:
On the face of the statement of profit or loss and other comprehensive income:
Single amount comprising the total of:
• The post-tax profit or loss of discontinued operations; and
• The post-tax gain or loss recognised on the remeasurement to fair value less costs to sell or on
the disposal of assets comprising the discontinued operation.
On the face of the statement of profit or loss and other comprehensive income or in the notes:
• Revenue
• Expenses
• Profit before tax
• Income tax expense
• Post-tax gain or loss on disposal of assets or on remeasurement to fair value less costs to sell
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Exam focus point
In the Financial Reporting exam, you should assume that you only need to present the single
amount on the face of the statement of profit or loss and other comprehensive income. You
can assume that the disclosure of revenue, expenses, profit before tax, income tax expense
and post-tax gain or loss is presented in the notes and does not need to be prepared unless
the requirement specifies that the note is required.
Essential reading
Chapter 18 Section 3 of the Essential reading has examples of proforma disclosure for
Activity 3: Milligan Co
MILLIGAN CO STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
YEAR ENDED 31 DECEMBER 20X1
20X1
$’000
Revenue 3,000
Cost of sales (1,000)
Gross profit 2,000
Distribution costs (400)
Administrative expenses (900)
PROFIT FOR THE YEAR 490
TOTAL COMPREHENSIVE INCOME FOR THE YEAR 530
During the year, Milligan Co ran down a material business operation with all activities ceasing on
26 December 20X1. The results of the operation for 20X1 were as follows:
20X1
$’000
Revenue 320
Cost of sales (150)
Gross profit 170
Loss before tax (50)
Income tax expense 15
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20X1
$’000
LOSS FOR THE YEAR (35)
TOTAL COMPREHENSIVE INCOME FOR THE YEAR (30)
Milligan Co recognised a loss of $30,000 on initial classification of the assets of the discontinued
operation as held for sale, followed by a subsequent gain of $120,000 on their disposal in 20X1.
These have been netted against administrative expenses. The income tax rate applicable to profits
on continuing operations and tax savings on the discontinued operation’s losses is 30%.
Required
Prepare the statement of profit or loss and other comprehensive income for the year ended 31
December 20X1 for Milligan Co complying with the provisions of IFRS 5.
Solution
20X1
$’000
Revenue
Cost of sales
Gross profit
Distribution costs
Profit before tax
Income tax expense
Profit for the year from continuing operations
Loss for the year from discontinued operations
PROFIT FOR THE YEAR
Other comprehensive income for the year, net of tax
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Note. Discontinued operations
26 December 20X1. The results of the operation were as follows:
20X1
$’000
Revenue
Cost of sales
Gross profit
Distribution costs
Loss before tax
Income tax expense
Loss after tax
Post-tax gain on remeasurement and subsequent disposal of assets

classified as held for sale
LOSS FOR THE YEAR
Other comprehensive income for the year, net of tax
Exam focus point

In Section C of the exam, you may be faced with a scenario in which a group has disposed of
one of its subsidiaries. If the subsidiary meets the definition of a discontinued operation, the
consolidated statement of profit or loss and other comprehensive income will include a
separate line showing the net of the profit or loss of the subsidiary and the gain or loss on
disposal of the subsidiary.
3 Foreign currency
An entity may trade with customers and suppliers overseas (foreign transactions). This may result
in invoices being denominated in a foreign currency. Therefore, the entity will need to translate
these invoices into its own currency in order to record the double entry in its accounting records.
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3.1 Currency concepts and definitions
There are two currency concepts:
Functional currency Presentation currency
• Currency of the primary • Can be any currency

economic environment • The currency in which
in which an entity operates the year-end financial
• The currency used for statements are presented
measurement in the • Special rules apply to
financial statements translation from functional
• Other currencies treated currency to presentation
as a foreign currency currency
Foreign currency: Foreign currency is a currency other than the functional currency of the
KEY
TERM entity (IAS 21: para. 8).
Functional currency: Functional currency is the currency of the primary economic
environment in which the entity operates (IAS 21: para. 8).
Presentational currency: Presentation currency is the currency in which the financial
statements are presented (IAS 21: para. 8).
An entity can present its financial statements in any currency (or currencies) it chooses.
Its presentation currency will normally be the same as its functional currency (the currency of
the country in which it operates).
3.2 Determining an entity’s functional currency

An entity considers the following factors in determining its functional currency:
(a) The currency:
(i) Which mainly influences sales prices for goods and services (often the currency in
which sales prices for its goods and services are denominated and settled); and
(ii) Of the country whose competitive forces and regulations mainly determine the sales
prices of its goods and services.
(b) The currency that mainly influences labour, material and other costs of providing goods or
services (will often be the currency in which such costs are denominated and settled).
The following factors may also provide evidence of an entity’s functional currency:
(a) The currency in which funds from financing activities are generated
(b) The currency in which receipts from operating activities are usually retained
3.3 Reporting foreign currency transactions in the functional currency

Where an entity undertakes a transaction which is not in its functional currency this is known as a
foreign currency transaction.
The foreign currency transaction must be translated into the entity’s functional currency before it
can be recognised in the financial statements.
3.4 Initial recognition

The entity must translate each transaction into its functional currency by applying the spot
exchange rate between the functional currency and the foreign currency at the date of the
transaction.
Note that an average rate for a period may be used as an approximation if exchange rates do not
fluctuate significantly.
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3.5 At the end of the reporting period
Some values may need to be translated at the end of the reporting period depending on the
nature of the item in the financial statements:
Item Accounting treatment

Monetary assets and liabilities Retranslated at closing rate
Non-monetary assets measured at historical Do not retranslate – these items remain at

cost (eg non-current assets, inventories) historical rate
Non-monetary assets measured at fair value Retranslate at exchange rate when the fair
value was determined
3.6 Recognition of exchange differences

Exchange differences are recognised as part of profit or loss for the period in which they arise.
Any differences that relate to items charged to other comprehensive income (OCI), such as
revaluations, should also be charged to OCI.
Activity 4: Foreign exchange
San Francisco Co, a company whose functional currency is the dollar, entered into the following
foreign currency transaction:
31.10.X8 Purchased goods from Mexico SA for 129,000 Mexican pesos
31.12.X8 Payables have not yet been paid
31.1.X9 San Francisco Co paid its payables
The exchange rates are as follows:
Pesos to $1
31.10.X8 9.5
31.12.X8 10.0
31.1.X9 9.7
Required
How would this transaction be recorded in the books of San Francisco Co as at 31 December
20X8?
Solution
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Activity 5: Foreign currency and revaluation
Tinker Co operates in A-Land and its functional currency is the A$. On 1 January 20X3, Tinker Co
purchases some land in a foreign currency for B$5,600,000. Tinker Co chooses to hold its land
under the revaluation model. On 31 December 20X3, the land is revalued to B$7,000,000.
The following exchange rates are relevant:
Date Exchange rate

1 January 20X3 A$1:B$8
31 December 20X3 A$1:B$7
Required
On 31 December 20X3, what is the accounting entry required to record the revaluation of the land
in Tinker Co’s records?
Solution
PER alert
to evaluate the effect of chosen accounting policies on the reported performance and position
of the company. Also, to demonstrate the ability to evaluate any underlying estimates on the
position of the entity.
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It can also be used to support your competency in Performance Objective 7 which requires the
ability to correct errors and to disclose them. This chapter deals with important disclosures
and you can apply the knowledge you obtain from this chapter to help to demonstrate this
competence.
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Chapter summary

• Accounting policies are the • Changes in accounting • Prior period errors are
specific principles, bases, estimates result from new omissions from, and
conventions, rules and information or new misstatements in, the entity's
practices applied by an entity developments and, financial statements for one or
in preparing and presenting accordingly, are not correction more prior periods arising from
the financial statements of errors a failure to use reliable
• Area of judgment • Examples: information that:
• Information relevant and – Allowances for doubtful (a) Was available when the
reliable debts financial statements for
– Inventory provisions those periods were
– Useful lives of non-current authorised for issue; and
Changes in accounting policies assets (b) Could reasonably be
• A change in accounting policy expected to have been
is made only if: obtained and taken into
(a) It is required by an IFRS; or Changes in accounting account in the preparation
(b) It results in the financial estimates and presentation of those
statements providing • Changes in SOFP (assets, financial statements
reliable and more relevant liabilities, equity) – adjust in • Examples
information the period of the change – Arithmetical errors
• Change applied • Changes in SOPL (income, – Mistakes in applying
retrospectively expense) – adjust in current accounting policies
– Restate comparatives (as if and future period if the change – Deliberate errors
new policy had always affects both
applied)
– Adjust opening balance for Correction of the error
each component of equity Disclosure • An entity corrects material
for the earlier period • Nature of the change prior period errors
presented; and • Quantify the change retrospectively in the first set of
– Show adjustment in SOCIE financial statements
as separate (second) line authorised for issue after their
discovery
– Restate comparative
Disclosure amounts for each prior
• Nature of the change period in which the error
• Reason for the change occurred
• Quantify the effect of the – Show adjustment in SOCIE
change as separate (second) line
Disclosure
• Nature of the change
• Quantify the effect of the
change
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IFRS 5 Non-current Assets Held for Sale IAS 21 The Effects of
and Discontinued Operations Changes in Foreign
Exchange Rates
Aids the users of the statements Discontinued operations • Functional currency: currency
to under the future of the • A major line of of the primary economic
company's operations business/geographical region environment in which the entity
of business; or operates
• Part of a single co-ordinated • Translated at spot rate at date
Non-current assets held for sale plan to dispose of a major of transaction.
To be classified as 'held for sale': line/geographical region of • Restatement at year end
business; or (closing rate) if: Monetary
(a) The asset must be available
• Subsidiary acquired for resale assets and liabilities
for immediate sale in its
• Exchange differences
present condition, subject
recognised in SOPL
only to usual and customary
Disclosure • Differences arising on items in
sales terms; and
OCI are also charged to OCI
(b) The sale must be highly • On the face of the SOPL: single
(eg revaluations)
probable amount of post-tax profit or
loss of discontinued operations
and post-tax gain/loss on any
Accounting treatment FV adjustments
• Write down NCA to FV less • On the face of the statement of
costs to sell (if less than CA) profit or loss and other
• Impairment loss charged to comprehensive income or in
SOPL the notes:
• NCA classified as 'Held for sale' – Revenue
and not depreciated/amortised – Expenses
– Profit before tax
– Income tax expense
Disclosure – Post-tax gain or loss on
• As a single amount separately disposal of assets or on
from other assets remeasurement to fair value
• On the face of the SOFP less costs to sell
• Normally as current assets
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1. Accounting Policies, Changes in Accounting Estimates and Errors

• An entity uses judgement in selecting accounting policies most relevant to its users, in
accordance with IFRS Standards.
• Changes in accounting policies can only be made where required by a standard or when they
provide relevant, more reliable information. They are accounted for retrospectively by
adjusting opening reserves.
• Changes in accounting estimates, such as a change in depreciation method, are accounted
for prospectively.
• Material prior period errors are corrected by restating the comparative figures or, if they
occurred in an earlier period, by adjusting opening reserves.
2. Non-current Assets Held for Sale and Discontinued Operations

• Non-current assets are classified as held for sale when available for immediate sale in their
current condition and the sale is highly probable. Such assets are written down to fair value
less costs to sell if lower than carrying amount, not depreciated and disclosed separately in
the statement of financial position.
• Discontinued operations are also disclosed separately. The minimum disclosure on the face of
the statement of profit or loss and other comprehensive income is the profit/loss on the
discontinued operations and any gains or losses on sale or remeasurement if classified as
held for sale.
3. Foreign currency transactions

• The functional currency is the currency of the primary economic environment. Any transaction
not in the functional currency is a foreign currency transaction.
• Transactions should be initially converted at the spot rate. Monetary balances should then be
translated at the end of the year. Non-monetary balances are not translated at the year-end.
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Question practice
the Workbook):
Section A Q7
Section B Q22(e)
Section C Q30 Hewlett Co
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Activity answers
Activity 1: IAS 8
The correct answer is: The discovery of a significant fraud in a foreign subsidiary resulting in a
write-down in the valuation of its assets. The perpetrators have confessed to the fraud which goes
back at least five years.
Response Option Explanation

A material decrease in the valuation This is not a prior period error. It will be accounted for in
of the closing inventory resulting the current period.
from a change in legislation
affecting the saleability of the
company’s products.
The discovery of a significant fraud A fraud dating back five years is a prior period error and
in a foreign subsidiary resulting in a will require to be accounted for retrospectively.
write-down in the valuation of its
assets. The perpetrators have
confessed to the fraud which goes
back at least five years.
The company has a material under This is an error in the estimated amount of income tax. It
provision for income tax arising from does not require to be adjusted retrospectively. Under
the use of incorrect data by the tax and over provisions of income tax are accounted for in
advisers acting for the company. the period in which they are first discovered.
A deterioration in sales performance The allowance for irrecoverable debts is an accounting

has led to the directors restating estimate. Any changes in the estimate are accounted
their methods for the calculation of for in the current period.
the allowance for irrecoverable
debts.
Activity 2: Starlight Co
At 1 July 20X3, the carrying amount of the asset is $137,500 ($150,000 – $200,000/8 × 6/12). Its
fair value less costs to sell is $134,000.
Therefore, a loss of $3,500 is recognised in profit or loss.
Activity 3: Milligan Co
20X1
$’000
Revenue (3,000 – 320) 2,680
Cost of sales (1,000 – 150) (850)
Gross profit 1,830
Distribution costs (400 – 120) (280)
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20X1
$’000
Administrative expenses (900 – 100) (800)
Income tax expense (210 + 15) (225)
Profit for the year from continuing operations 525
Loss for the year from discontinued operations (35)
Note. Discontinued operations

26 December 20X1. The results of the operation were as follows:
20X1
$’000
Revenue 320
Cost of sales (150)
Gross profit 170
Administrative expenses (100 + 90) (190)
Loss before tax (140)
Income tax expense (15 + (90 × 30%)) 42
Loss after tax (98)
Post-tax gain on remeasurement and subsequent disposal of assets

classified as held for sale (90 × 70%) 63
LOSS FOR THE YEAR (35)
TOTAL COMPREHENSIVE INCOME FOR THE YEAR (30)
Activity 4: Foreign exchange
$ $
31.10.X8 Purchases (129,000 / 9.50) 13,579
Payables 13,579
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$ $
31.12.X8 Payables (W) 679

Profit or loss – exchange gains 679
31.1.X9 Payables 12,900

Profit or loss – exchange losses 399
Cash (129,000 / 9.7) 13,299
Working
Payables
$
Payables as at 31.12.X8 (129,000 / 10) 12,900
Payables as previously recorded 13,579
Exchange gain 679
Activity 5: Foreign currency and revaluation

On initial recognition, the land is recorded at its spot rate at the date of the transaction (A$1:B$8)
= B$5,600,000/8 = A$700,000
The land is a non-monetary asset so would not normally be retranslated. It is only retranslated at
31 December 20X3 because it is remeasured to fair value under the revaluation model.
At the date of revaluation
A$
Revalued amount (B$7,000,000 / 7) 1,000,000
Less: Carrying amount of land (700,000)
The journal entry to record the transaction is:
$ $
DEBIT Land 300,000
CREDIT Revaluation surplus 300,000
Note that there is no need to separate out the exchange gain or loss when revaluing a foreign
currency asset.
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HB2022

Skills checkpoint 5
Interpretation skills
Chapter overview
cess skills
Exam suc
r planning
Answe
c FR skills C
n Specifi o
tio
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t i rem
or
nt
inf
erp ents
ng
reta
agi

Man
tion
l y si s
Go od
skills skills
ana
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Approach
c al
em
to Case
e ri
OTQs
an
um
ag
tn
em
en
en
t ci
Effi
Effe cti
ve writing
a nd p r
esentation
Introduction
One of the Section C questions in the Financial Reporting exam will require you to interpret the
financial statements of a single entity or a group. The question will usually require the calculation
of ratios, but your focus should be on using the information provided in the scenario to interpret
those ratios and explain the change in performance and position of the single entity or group you
are presented with.
Given that the interpretation of financial statements will feature in Section C of every exam, it is
essential that you master the appropriate technique for analysing and interpreting information
and drawing relevant conclusions in order to maximise your chance of passing the exam.
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Skills Checkpoint 5: Interpreting financial statements
Financial Reporting Skill: Interpretation
Interpreting financial statements is likely to begin with a requirement to calculate financial ratios.
Some interpretations questions will ask you to adjust draft financial information before
calculating the ratios. Note that interpretation questions will use the word processing response
area. You need to find an efficient way to process adjustments and show workings using the word
processing response area. Some questions will contain a preformatted response area that you
should complete if you are provided with one.
The preformatted response area is intended to help you to score well in the interpretations
question by reminding you to set out your workings clearly. If a preformatted response area is not
provided in your question, you should still use the approach of clearly setting out your workings
and final answer for each ratio.
Below is an example of a pre-formatted response area from the March/June 2021 exam which is
available in the ACCA Practice Platform.
Candidates were provided with a pre-formatted response area to present the required
adjustments to take account of a change in accounting policy.
This is the information that was given in This is the blank answer space in which
the question and can't be changed you should type your adjustments
Candidates were then asked to calculate ratios using the adjusted financial statements. A pre-
formatted response area was not provided for this part of the question, but you should use the
table function within the word processing software to present your answers.
You can insert a table using this function
Ensure you show your workings.

You should use the financial
statements information after
processing the adjustments.
Note that there is no option to use the spreadsheet response area in the interpretations question
and therefore no formulae are available. You can bring up the calculator function to perform your
calculations, but the marker will not be able to see what you type in the calculator, so it is not a
replacement for writing out your workings clearly.
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should comment on the difficulties of making a purchase decision based s
Clickfinancial
on 'Calculator'
statementsto launch
and the information provides in notes (1) to (5).
the calculator function
Click on the relevant buttons

on the calculator to perform
your calculation.
Click on enter to show the answer. Don't

forget to enter that into your answer in
the word processing response area.
The majority of the marks in an interpretation question will come from your commentary and
interpretation of the ratios calculated. You will not be provided with a pre-formatted response
area for this part of the question; however, you can copy key words or headings from the question
into the response area to help to give your answer structure and/or use the functions within the
word processing response area to format your answer in a professional manner that will help with
the structure and clarity to your answer. Consider adopting a format similar to the following:
Headings can be formatted using

the drop down options.
whereas Dough Co charges
the same costs to operating
expenses. These costs
1
amounted to $1.2m for Cook Heading 3 2

3
Co and $2.5m for Dough Co.

(c) Interpretation
4) The notes to the financial Operating profit margin Clear headings are used.
statements show that Cook Co
paid its directors total salaries • Dough Co has a significantly lower operating profit margin than Cook Co. This may be due to Dough Co
paying much higher salaries, which are likely to be presented in operating expenses, to its directors than
of $110,000 whereas Dough Cook Co.
Co paid its directors total
salaries of $560,000
Points made are concise,
relevant and use the information
provided in the question.
Candidates will be asked to comment on performance and position of the entity or group using
information provided in the scenario. The Financial Reporting examining team will expect you to
go beyond calculations and require you to explain your findings, offering reasons for the
movements and the results of any financial calculations with reference to the information in the
scenario. When you are interpreting the financial statements, you should consider whether
information relating to any of the following is provided in the question:
• Prices increases or decreases that may impact on margins
• The existence of competitors or new entrants to the market which puts pressure on sales or
requires promotions to be applied
• A change in supplier, wage rises for employees or new legislation which has increased cost of
sales or operating expenses and impacts on margins
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Skills Checkpoint 5: Interpretation skills 449

• Any one off expenses such as restructuring costs which can have a significant impact on ratios
in a year
• Consideration of the impact of any changes in accounting policies or changes in estimates on
the financial statements and how they may affect those ratios
• Revaluations of assets which will increase the asset base and impact on return on assets and
return on capital employed
• Differences in the way in which an entity purchases its assets, for example, using cash, taking
a loan or leasing
• Any large purchases or sales of assets shortly before year end
• The types of inventory held and what is normal for that type of inventory in terms of holding
periods/turnover
• Consideration of the impact of the acquisition or disposal of a subsidiary on group results
• Consideration of the timing of an acquisition or disposal; was it at the start of the year and
therefore a whole years results are included, or part way through the year in which case the
results are pro-rated?
• Was the subsidiary acquired/sold also a supplier of customer and how does that impact on
margins?
STEP 1: Read and analyse the requirement.

Read the requirement carefully to see what calculations are required and how many
marks are set for the calculation and how many for the commentary.
Work out how many minutes you have to answer each sub-requirement.
STEP 2: Read and analyse the scenario.

Identify the type of company you are dealing with and how the financial topics in
the requirement relate to that type of company. As you go through the scenario,
you should be highlighting key information which you think will play a key role in
answering the specific requirements.
STEP 3: Plan your answer.

You will have calculated the ratios and understand the performance and position of
the company. You must now plan the points you will make in interpreting the ratios.
Read through the information in the scenario and identify the points that help you
to explain the movement in ratios. Using each ratio as a heading, create a bullet
point list of the relevant points.
STEP 4: Type your answer.

You should now take the bullet point list created at the planning stage and expand
the points, remembering to use information given in the scenario and to avoid
generic explanations.
As you write your answer, explain what you mean – in one (or two) sentence(s) –
and then explain why this matters in the given scenario. This should result in a
series of short paragraphs that address the specific context of the scenario.
Exam success skills

In the analysis of the Bengal Co question, we will focus on the following exam success skills and in
particular:
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• Good time management. The exam will be time pressured and you will need to manage it
carefully to ensure that you can make a good attempt at every part of every question. You will
have 3 hours in the exam, which works out at 1.8 minutes per mark, or 36 minutes for a 20-
mark question. You can break this down further when you see how many ratios you are
required to discuss. If there are, for example, four ratios, you should try to allocate your time
equally amongst them in order that your answer is balanced.
• Managing information. There is a lot of information to absorb in this question and the best
approach is active reading. Firstly, you should identify any specific ratios required. The
majority of marks will be for the interpretation of the ratios and it is important that you
understand how the information in the scenario helps to explain the ratios calculated.
• Correct interpretation of the requirements. There are two parts to the Bengal question and the
first part has two sub-requirements (the calculation of ratios and their interpretation). Make
sure you analyse the requirement carefully so you understand how to approach your answer.
• Answer planning. Everyone will have a preferred style for an answer plan. For example, it may
be bullet-pointed lists or creating notes on your scratch pad within the exam software. Choose
the approach that you feel most comfortable with or, if you are not sure, try out different
approaches for different questions until you have found your preferred style. You will typically
be awarded 1 mark per relevant, well explained point so you should aim to generate sufficient
points to score a comfortable pass.
• Efficient numerical analysis. The most effective way to approach this part of the question is to
use the table function within the word processing response area to present your workings and
show the ratios calculated. Showing your workings is important, as if you make a mistake, the
Examining team can award marks for method or following the number through in your
explanation. If a preformatted response is provided in the exam, ensure you use it when
answering the relevant requirement.
• Effective writing and presentation. Use headings and sub-headings in your answer and write
in full sentences, ensuring your style is professional. Ensuring that all sub-requirements are
answered and that all issues in the scenario are addressed will help you obtain maximum
marks.
Skill Activity
STEP 1 Read the requirement carefully to see what calculations are required and how many marks are set for the
calculation and how many for the commentary.
Work out how many minutes you have available to answer each sub requirement.
Required
(a) Comment on the performance (including

addressing the shareholder’s observation) and
financial position of Bengal Co for the year ended
31 March 20X1. Up to five marks are available for
the calculation of appropriate ratios. (15 marks)
(b) Explain the limitations of ratio analysis. (5 marks)

(Total = 20 marks)
There are two parts to this question. The first part is asking for you to analyse the performance of
Bengal Co, including the calculation of appropriate ratios.
When you read the scenario, consider which ratios would be appropriate. As only five marks are
available for the calculation of the ratios, you should not spend any longer than nine minutes on
this element of the question.
This will leave the remaining ten marks from Part (a) requiring interpretation of the ratios which
you have calculated and any remaining conclusions that you reached from reading the scenario.
This is demonstrating your application and interpretation skills.
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Part B of the question is worth five marks and should be based upon your knowledge of ratio
analysis, tying your answer, where possible, to the scenario. Again, be strict on your timekeeping
here as you should only spend nine minutes on this part.
The question is worth 20 marks, so you should spend no longer than 36 minutes on this question.
STEP 2 Read and analyse the scenario.
Identify the type of company you are dealing with and how the financial topics in the requirement relate to
that type of company. As you go through the scenario you should be highlighting key information which
you think will play a key role in answering the specific requirements.
Chapter 20 of this Workbook gives the six different

types of scenario that you may come across in the
exam. Briefly, these are:
(a) Comparison of one entity over two periods
(b) Comparison of two entities over one period
(c) Comparison of an entity with sector averages
(d) Analysis of consolidated financial statements

(acquisition of a subsidiary)
(e) Analysis of consolidated financial statements

(disposal of a subsidiary)
(f) Analysis of cash flow information
Ensure you are familiar with these different types of

question and think about them when reading the
requirement in the exam.
The question, Bengal Co, is adapted from a previous

exam question. Read through the scenario carefully,
highlighting any areas which may suggest a problem or
a benefit. This is a question worth 20 marks, so you
have 36 minutes to attempt it.
This is a comparison of one entity over two periods type

of question.
Bengal Co is a public company. Its most recent financial

statements are shown below:
STATEMENTS OF PROFIT OR LOSS FOR THE YEAR

ENDED 31 MARCH
20X1 20X0
$’000 $’000
Revenue (Note 1) 25,500 17,250
Cost of sales (14,800) (10,350)
Gross profit (Note 2) 10,700 6,900
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20X1 20X0
$’000 $’000
Finance costs (Note 3) (650) (100)
Profit before taxation 5,250 3,500
Income tax expense (Note 4) (2,250) (1,000)
Notes.
1 Increase in revenue 48%.
2 Increase in gross profit is 55%, compared to revenue, this is suggesting efficiency during production.
3 Rise in finance costs (there is a significant rise in loans on the SOFP too). Consider interest cover and
reasons why the loan may have been obtained.
4 Income tax increased by 125% in 20X1. Profit before tax increased by 50%. What could be the cause?
STATEMENTS OF FINANCIAL POSITION AS AT 31 MARCH
20X1 20X0
$’000 $’000 $’000 $’000
Non-current assets
Intangible assets (Note 1) 6,200 -
15,700 5,400
Current assets
Inventories (Note 2) 3,600 1,800
Cash and cash equivalents - 4,000
Non-current assets held for
sale 2,000 8,000 - 7,200
Total assets 23,700 12,600

Equity
Retained earnings (Note 3) 4,500 2,250
9,500 7,250
5% loan notes 2,000 2,000
8% loan notes (Note 4) 7,000 -
Current liabilities
Bank overdraft (Note 5) 200 -
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20X1 20X0
$’000 $’000 $’000 $’000
Trade payables 2,800 2,150
Current tax payable 2,200 5,200 1,200 3,350
Total equity and liabilities 23,700 12,600
Notes.
1 What are the intangible assets? Why the significant rise year on year? Consider potential problems
here such as incorrect capitalisation of R&D costs.
2 Increase in inventories and trade receivables, suggesting possible liquidity issues. Compare increase in
receivables with increase in revenue.
3 Increase in shares, has this been from a bonus issue (no cash flow) or rights issue (cash flow)? Increase
in shares used to fund capital growth.
4 Increase in loans, again suggesting cash for capital growth.
5 Bank overdraft, possible liquidity issues?
Additional information:
(a) Bengal Co acquired the assets of another business

during the year. It has identified that some of the
assets are surplus to requirements and have been
18
IFRS 5, Non-Current Assets Held for
classified as ‘held for sale’18 at 31 March 20X1. It
Sale and Discontinued Operations
expects that it will take some time for the remaining
assets to be fully integrated into its current
business. There were no disposals of assets.
(b) Depreciation of property, plant and equipment for

the year ended 31 March 20X1 was $640,000.
A disappointed shareholder has observed that although

revenue during the year has increased by 48% (8,250 /
17,250 × 100), profit for the year has only increased by
20% (500 / 2,500 × 100).
Required
(a) Comment on the performance (including

addressing the shareholder’s observation) and
financial position of Bengal Co for the year ended
31 March 20X1. Up to five marks are available for 19
Ensure you stick to your time here: 27
the calculation of appropriate ratios. (15 marks)19 minutes (with 9 marks for the ratio
calculation only)
(b) Explain the limitations of ratio analysis. (5 marks)20 20
Ensure you spend no more than 9
(Total = 20 marks) minutes on this part.
STEP 3 Plan your answer
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Ensure your answer is balanced in terms of identifying the potential benefits and limitations of topics that
are being discussed or recommended.
You only have 36 minutes to answer this 20-mark question, however, taking a couple of minutes to
plan your answer will ensure you have a structure.
Consider the main elements of the scenario in the light of the requirements which you must
complete. Here a plan has been sketched using a mind map (or spidergram). This exact format
may be difficult to recreate in the exam software, but you will see that it is really just a collection
of bullet pointed lists. Those lists can then be expanded when it comes time to write the final
answer. Ideas for what should be included in each bulleted list can be pulled from the structure of
the requirement which are added to by comments from the review of the scenario.
Performance = SOPL
• Revenue increase/profit for
year increase Calculation of
• Finance cost increase suitable ratios
• Income tax charge increase 5 marks = 9 minutes
Financial position = SOFP Comment on the performance (including Compare revenue

addressing the shareholder's observation) and profit
• Increase in debt and equity,
result in increase in and financial position of Bengal Co for the • Revenue increase
non-current assets year ended 31 March 20X1. Up to five year on year
• Working capital position marks are available for the calculation of • Compare profit
(working capital cycle) appropriate ratios. (15 marks) year on year
• Put ratios in
appendix
Gearing & liquidity ratios Shareholders asking the question –

• Increase in loan – interest
shareholders interest?
cover ratio? • ROCE ratio?
• Gearing ratio? • Dividends?
Explain the limitations of ratio analysis. (5 marks)

• Difference in calculation
• Comparison between companies – different accounting policies
• Valuation of assets – different policies
• Seasonality of trading
Required
(a) The requirement for Part (a) has been looked at in

great detail, and following the review of the
scenario, already some ideas about potential issues
have been noted (liquidity, gearing, increase in
non-production and selling costs, such as finance
and income tax).
(b) The requirement for Part (b) is simpler but again,

already some notes have been made to get at least
four out of five marks here:

Difference in calculation
Comparison between companies – different accounting policies
Valuation of assets – different policies
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Seasonality of trading
Besides the plan which generates ideas, you will need to ensure that you have a brief introduction
(because it is the shareholder who needs the question answering) and a conclusion to summarise
your findings.
STEP 4 Write your answer
As you write your answer, try wherever possible to apply your analysis to the scenario, instead of simply
writing about the financial topic in generic, technical terms. As you write your answer, explain what you
mean – in one (or two) sentence(s) – and then explain why this matters in the given scenario. This should
result in a series of short paragraphs that address the specific context of the scenario.
One recurring complaint which the Examining team

make during their exam reports is that the students do
not refer their interpretation answers back to the
scenario. As a result of this, the answers are often
generic and can lack focus on the main points to be
answered in the question.
Make your point and then give a suitable and plausible

reason (taking your inspiration from the scenario) that
may explain the increase or decrease.
Let’s have a look at the sample answer given for this

question:
Required
(a) Overview
(Give your parts of the answer subheadings and titles to

show you have structure to your answer.)
It is correct that revenue has increased by 48% while

profit for the year has only increased by 20%.
However, on closer inspection, we can see that this is to

a large degree attributable to the tax charge for the
year. The tax charge was 28.6% of the profit before tax
in the year ended 31.3.20X0 and 42.8% of the profit
before tax in the year ended 31.3.20X1.
21
State any limitations in your analysis,
We do not have a breakdown21 of the tax charge but it
but highlight the problems this can give.
could include underpayments in previous years, which
distorts the trading results.
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Performance
A better comparison between the two years is the profit

before tax % and the gross profit %. Both of these are
higher in 20X1 than in 20X0.
The shareholders will also be interested in the ROCE.

There has been a significant increase in capital
employed during the year ended 31.3. 20X1.
Bengal Co has acquired nearly $13 million in tangible

and intangible assets, financed from cash reserves and
a new issue of 8% loan notes.
22
State figures to show you are referring
An additional $2 million22 of non-current assets have
to the scenario.
been reclassified as held for sale. This is consistent with
the fact that Bengal Co has taken over the assets of
another business and is disposing of the surplus assets.
23
Referencing the scenario to make the
Bengal Co23 has identified that it may take some time
answer relevant to the question.
for the assets to be fully integrated into its current
business, hence it may take time to show a return and
the ROCE does show a significant drop in 20X1.
However, if we disregard the loan capital and look at the

ROE we can see a considerable increase in 20X1.
Position/Gearing 24
Don’t just state that there is an
24 increase in loan capital, explain how it
The increase in loan capital does have significance for
affects their returns (or company profits,
shareholders. The interest charge has increased from such as increase in finance costs).
$100,000 to $650,000, which reduces the amount

available for dividend.
Gearing has increased significantly. The rate that

Bengal Co has to offer to loan note holders has already
increased from 5% to 8%. If it required further
borrowing, with this high gearing, it would have to pay
substantially more.
Shares in Bengal Co have become a riskier investment.

One indicator of this is the interest cover, which has
fallen from 36 times to 9 times.
The acquisition could presumably have been financed

from a share issue or share exchange, rather than loan
capital. However, this would have diluted the return
available to shareholders.
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Liquidity
The area in which there is most cause for concern is

liquidity.
As we can see from the statement of financial position,

cash and cash equivalents have fallen by $4.2 million
and the company is now running an overdraft.
It has tax to pay of $2.2 million and this will incur

penalties if it is not paid on time.
25
When quoting ratios, give plausible,
The current ratio25 has declined from 2.1:1 to 1.5:1 and reasonable explanations for reasons why
the change may have occurred.
this is including the non-current assets held for sale as
part of non-current assets.
The quick ratio, excluding inventory and non-current

assets held for sale, indicates the immediate cash
situation and this shows a fall from 1.6:1 to 0.46:1.
Bengal Co needs to remedy this by disposing of the

non-current assets held for sale as soon as possible and
selling off surplus inventory, which may have been
acquired as part of the acquisition.
Fazit
(Ensure you have a conclusion to your analysis – you

will get marks even for a very short conclusion)
Overall, the shareholder should be reassured that

Bengal Co is profitable and expanding. The company
has perhaps overstretched itself and significantly raised
its gearing, but it is to be hoped that the investment will
bring in future returns.
This is no doubt the picture the company wants to give

to shareholders, which is why it has paid a dividend in
spite of having very little cash with which to do so.
(b) While ratio analysis is a useful tool, it has a number

of limitations, particularly when comparing ratios
for different companies.
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Some ratios can be calculated in different ways. For
instance, gearing can be expressed using debt as a
proportion of debt and equity or simply debt as a
proportion of equity. Ratios can be distorted by
inflation, especially where non-current assets are
carried at original cost.
Ratios are based upon financial statements which may

not be comparable due to the adoption of different
accounting policies and different estimation techniques.
For instance, whether non-current assets are carried at
original cost or current value will affect ROCE, as will
the use of different depreciation rates. In addition,
financial statements are often prepared with the key
ratios in mind, so may have been subject to creative
accounting. The year-end values also may not be
representative of values during the year, due to
seasonal trading.
The word processing response area would be used to

answer this question in the Financial Reporting exam.
Remember to use some of the toolbar functions
available within the software to help to present a more
professional answer. The following are likely to be useful.
Bold, underline and italics can help

you to emphasis important points
The drop down feature can help Bullet points or numbered lists can help to
you to quickly format headings present your work clearly. Ensure you write in
and sub-headings full sentences even when bullet points are used.
26
Ratios26 Ratios are kept in a separate appendix.
20X1 20X0
Net profit % (note) (3,000/25,500) / (2,500/17,250) 11.8% 14.5%
Net profit % (pre-tax) (5,250/25,500) / (3,500/17,250) 20.6% 20.3%
Gross profit % (10,700/25,500) / (6,900/17,250) 42% 40%
ROCE (5,900/18,500) / (3,600/9,250) 31.9% 38.9%
ROE (3,000/9,500) / (2,500/7,250) 31.6% 34.5%
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20X1 20X0
Gearing (9,000/9,500) / (2,000/7,250) 94.7% 27.6%
Interest cover (5,900/650) / (3,600/100) 9 times 36 times
Current ratio (8,000/5,200) / (7,200/3,350) 1.5:1 2.1:1
Quick ratio (2,400/5,200) / (5,400/3,350) 0.5:1 1.6:1
In the word processing response area, you should create

a table using the following function:
Table
Table properties You should select the number of

Delete table rows and columns based on what
Cell
is required for your answer
Row
Column 4x8
You can always add extra rows and

columns at a later point if you realise
you have missed something
Once you have created the table, ensure that you add
appropriate column headings and clearly label your
rows in order that the marker can understand your
calculations and how they have been arrived at.
Make sure you include headings and labels

to explain the numbers you are presenting
Note. There are 9 ratios calculated here. You would only need 5 of these at most, as only 5 marks
are available. Do not waste your time providing ratios that are not asked for or are not relevant to
the scenario and the requirement as you will not score credit.

below for the Bengal Co activity to give you an idea of how to complete the diagnostic.
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Good time management Did you spend time reading and planning?
Ensure you allocate your writing time on Part (a)spending
around nine minutes on the calculation of ratios, with 18
minutes discussing them and five minutes on Part (b)?
Managing information Ensure you highlight or underline useful information and make
notes in the margins where appropriate.
Think about the impact of each issue or ratio on the
performance or position of the company.
Ensure you answer the query posed by the shareholder.
Answer planning Check that your plan covered all parts of the question.
Make sure you generate enough points to score a pass.
Correct interpretation of the Ensure you analyse the requirements and address all aspects
requirements in your answer.
Efficient numerical analysis Use the preformatted response area provided or create a table
in the spreadsheet response area to show your calculations,
including all workings, clearly.
Effective writing and Use headings and sub-headings, and consider using the drop
presentation down options within the word processing software to format
them.
Write in full sentences and use professional language.
Extended bullet points are acceptable.
Answer all the requirements.
Structure your answer with the assistance of a draft plan.
Most important action points to apply to your next question – Remember that you are asked
to interpret the ratios using the information in the scenario, not to explain what the ratio
means in generic terms.
Summary
For a question requiring you to explain the impact on a specified ratio, the key to success is to
think of the formula of the ratio. Then you need to think about the double entry and the impact it
has on the numerator and/or denominator and therefore the overall ratio.
However, this is a very broad syllabus area that could generate many different types of questions
so the approach in this Skills Checkpoint will have to be adapted to suit the specific requirements
and scenario in the exam. The basic five steps for answering any FR question will always be a
good starting point:
(a) Time (1.8 minutes per mark)
(b) Read and analyse the requirement(s)
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(c) Read and analyse the scenario
(d) Prepare an answer plan
(e) Write up your answer
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Earnings per share
19
19
Learning objectives
Earnings per share (eps) B9(e)

• Calculate the eps in accordance with relevant IFRS Standards
(dealing with bonus issues, full market value issues and rights
issues).
• Explain the relevance of the diluted eps and calculate the
diluted eps involving convertible debt and share options
(warrants).
• Explain why the trend of eps may be a more accurate C3(d)(i) and (ii)
indicator of performance than a company’s profit trend and
the importance of eps as a stock market indicator.
• Discuss the limitations of using eps as a performance
measure.
19
Exam context
Earnings per share (eps) is a commonly reported performance measure. It is widely used by
investors as a measure of a company’s performance and is of particular importance for
comparing the results of an entity over time and for comparing the performance of one entity
against another. It also allows investors to compare against the returns obtainable from loan stock
and other forms of investment. It is important in the Financial Reporting exam that you can
calculate basic and diluted eps, and that you can interpret why changes or differences in eps
may have occurred. You could be examined on eps as an OT question in Section A or B of the
exam, or in Section C of the exam you could be asked to calculate eps after preparing the
statement of profit or loss in an accounts preparation question or be asked to interpret eps in an
interpretation question.
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19
Chapter overview
Earnings per share
Basic eps
Objective Calculation
Definitions Weighted average number of shares outstanding
Presentation
Diluted eps Eps as a performance measure
Issue Importance of the eps measure
Calculation of diluted eps =

Limitations of eps
Convertible debt
Share options and warrants
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1 Basic earnings per share (eps)
1.1 Objective
The objective of IAS 33 Earnings per Share is to provide a basis for the comparison of the
performance of different entities in the same period and of the same entity in different accounting
periods. The standard prescribes methods for determining the number of shares to be included in
the calculation of earnings per share and other amounts per share and specifies their
presentation. Disclosure of eps is only required for entities with shares which are publicly traded.
Ordinary shares: ‘An equity instrument that is subordinate to all other classes of equity
KEY
TERM instruments’. (IAS 33: para. 5)
Potential ordinary share: ‘A financial instrument or other contract that may entitle its holder to
ordinary shares’. (IAS 33: para. 5)
Options, warrants and their equivalents: ‘Financial instruments that give the holder the right
to purchase ordinary shares’. (IAS 33: para. 5)
Financial instrument: ‘Any contract that gives rise to both a financial asset of one entity and a
financial liability or equity instrument of another entity’. (IAS 32: para. 11)
Equity instrument: ‘Any contract that evidences a residual interest in the assets of an entity
after deducting all of its liabilities’. (IAS 32: para. 11)
Dilution: ‘A reduction in earnings per share or an increase in loss per share resulting from the
assumption that convertible instruments are converted, that options or warrants are exercised,
or that ordinary shares are issued upon the satisfaction of specified conditions’. (IAS 33: para.
5)
1.2 Presentation
Both basic and diluted eps are shown on the face of the statement of profit or loss and other
comprehensive income with equal prominence whether the result is positive or negative for each
class of ordinary shares and period presented.
1.3 Calculation
The basic eps calculation is:
Earnings
eps = cents
Weighted average no. of equity shares outstanding during the period
1.3.1 Earnings
Earnings is profit or loss for the period attributable to ordinary equity holders of the parent,
which is the consolidated profit after deducting:
• Income taxes
• Non-controlling interests
• Preference dividends (on preference shares classified as equity)*
*As you may recall from Chapter 12, redeemable preference shares are treated as financial
liabilities and their dividends as a finance cost, which will already have been deducted in arriving
at the consolidated profit. (IAS 33: paras. 12–14)
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19: Earnings per share 465

Activity 1: Calculation of earnings
An extract from Apricot’s consolidated statement of profit or loss for the year ended 31 December
20X9 is as follows:
$’000
Profit for the year attributable to:
Non-controlling interests 1,000
8,000
On 1 January 20X9, Apricot issued 500,000 $1 6% non-cumulative irredeemable preference

shares. A dividend of 6% was declared on these shares in the year to 31 December 20X9.Apricot
also had in issue for the full year 900,000 $1 5% redeemable preference shares. All preference
dividends were paid in full on 31 December 20X9.
Required
Calculate the earnings figure that should be used in the basic eps calculation for the year ended
31 December 20X9.
 $6,925,000
 $6,955,000
 $6,970,000
 $7,000,000
1.4 Weighted average number of equity shares outstanding during the

period
Where there are share issues in the year, a calculation is required to determine the weighted
average number of shares outstanding in the period. The nature of the calculation depends on the
way in which the new shares were issued.
1.4.1 Changes in the number of equity shares
Share issues
Issue at full market price Bonus issue Rights issue
Increase in earnings No effect on earnings Some effect on earnings

therefore use weighted therefore apply effect therefore treat as issue at
average number of shares retrospectively including full market price followed
(no retrospective effect) restatement of comparatives by bonus issue
1.4.2 Issue at full market price

Where an issue of shares is made at full market price, the company ought to generate additional
profits, as it has extra funds to generate profits from. However, if the issue was not at the
beginning of the year, this will need to be time apportioned to reflect the fact that the company
will have only been able to generate extra profits from the extra funds for part of the year.
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Illustration 1: Time apportionment
Murray Co has a year end of 31 December 20X2. On 1 October 20X2, it issued 300,000 shares at
full market price. The share capital before the share issue was 600,000 shares.
Required
Calculate the weighted average number of shares that should be used in the basic earnings per
share calculation for the year ended 31 December 20X2.
Solution
Weighted number of shares:
Date Narrative No. shares Time period Weighted average

1.1.X2 b/d 600,000 × 9/12 450,000
Issue at full market
1.10.X2 price 300,000
900,000 × 3/12 225,000

675,000
(IAS 33: para. 20, Illustrative Example 2)
1.4.3 Bonus issue

Bonus issues (sometimes known as scrip issues) involve ordinary shares being issued to existing
shareholders for no additional consideration. The number of ordinary shares has increased
without an increase in resources. (IAS 33: para. 27)
The company cannot therefore be expected to generate the same eps, which causes problems
with comparability between periods. This problem is solved by adjusting the number of ordinary
shares outstanding before the event for the proportionate change in the number of shares
outstanding as if the event had occurred at the beginning of the earliest period reported. (IAS 33:
para. 28)
A bonus fraction is calculated to make this adjustment. The numerator in the bonus fraction is the
new number of shares after the bonus issue has taken place. The denominator is the number of
shares before the bonus issue.
Example – Bonus issues

Fabio Co undertook a 1:1 bonus issue on 1 January 20X2. The numerator in the bonus fraction is
therefore 2 (the 1 original share, plus the 1 from bonus issue). The denominator is the original 1
share. The bonus fraction is therefore:
20X2 20X1
Assets (eg cash) $100,000 $100,000
Earnings $20,000 $20,000
Shares 200,000 100,000
eps 10c 20c
To make eps comparable, we need to restate the 20X1 figure as if it had the same share capital as
20X2, ie $20,000 / 100,000 × 2/1.
This is algebraically the same as restating the previous eps by the reciprocal of the bonus
fraction, ie 20c × 1/2 = 10c.
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Activity 2: Bonus issue
Greymatter Co has a year end of 31 December 20X2. It had 400,000 shares in issue until 30
September 20X2 when it made a bonus issue of 100,000 shares. Its earnings for 20X2 were
$80,000 and its eps 20X1 was $0.1875.
Required
Calculate the eps for 20X2 and the restated figure for 20X1.
Solution
1.4.4 Rights issue

A rights issue involves the issue of ordinary shares to existing shareholders at a discount to their
market price. The rights issue therefore includes both an issue of some shares at full market price
and a bonus element which must be adjusted for. (IAS 33: para. 27(b))
Rights issue (at below

current market price)
Some full market price Some bonus

shares issue shares
Include for the number of Treat as though they had

months they were in issue always been in issue for
(weighted average) all of current year and
prior year (restate
number of shares using
the bonus faction)
A bonus fraction which must be applied in respect of the bonus shares is calculated as:
Fair value per share immediately before exercise of rights

Theoretical ex rights price (TERP)
It is applied to all periods (eg months) prior to the issue.
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Theoretical ex-rights price (TERP) is calculated as:
Fair value of all outstanding shares + total received from exercise of rights
No. shares outstanding prior to exercise + no. shares issued in exercise
Illustration 2: Calculating the bonus fraction
Monty Co makes a rights issue on a 1 for 4 basis. Monty Co’s share price immediately before
exercise of rights is $10 and the rights price is $6.50.
Required
Calculate the bonus fraction.
Solution
$
4 @ 10 = 40.00
1 @ 6.50 6.50
5 46.50
TERP = $46.50 /5 = $9.30
Bonus fraction = 10 / 9.3

To restate comparatives, use reciprocal 9.3 / 10
Essential reading
Chapter 19, Section 2 of the Essential reading provides the procedure that you should apply when
a rights issue has been made in the year. It also includes an activity which gives another
opportunity to practise the rights issue calculations.
Activity 3: Basic eps
On 1 January 20X1, Saunders Co had 2,000,000 ordinary shares in issue.

On 30 April 20X1, Saunders Co issued, at full market price, 270,000 ordinary shares.
On 31 July 20X1, a rights issue of 1 for 10 @ $2.00 was made. The fair value of the shares on the
last day before the issue of shares from the rights issue was $3.10.
Finally, on 30 September 20X1, Saunders Co made a 1 for 20 bonus issue.
Profit for the year was $400,000.
The reported eps for the year ended 31 December 20X0 was 18.6c.
Required
1 What is the weighted average number of shares for 31 December 20X1?
 2,455,921
 2,266,388
 2,431,508
 2,346,509
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2 What is the earnings per share for the year ended 31 December 20X1?
 17.6c
 17.0c
 16.5c
 16.3c
3 What is the restated earnings per share for the year ended 31 December 20X0?
 20.2c
 18.3c
 17.1c
 18.9c
2 Diluted eps
2.1 The issue
Basic eps is calculated by comparing earnings with the number of shares currently in issue. If an
entity has a commitment to issue shares in the future, for example on the exercise of options or
the conversion of loan stock, this may result in a change to the basic eps. IAS 33 refers to such
commitments as ‘potential ordinary shares’, defined as ‘a financial instrument or other contract
that may entitle its holder to ordinary shares’ (IAS 33: para. 5).
Diluted eps shows how basic eps would change if potential ordinary shares (such as convertible
debt) become ordinary shares. It is therefore a ‘warning’ measure of what may happen in the
future for current ordinary shareholders.
When the potential shares are actually issued, the impact on basic eps will be twofold:
Impact on basic eps
The number of shares will increase There may be a change in earnings

eg lower interest charges
2.2 Calculation of diluted eps

To calculate diluted eps, we assume that all of the potential ordinary shares were converted into
ordinary shares at the beginning of the period (or the actual date of issue, if later), and at the
most advantageous rate for the holder of the potential ordinary shares (ie the rate that gives the
maximum dilution). (IAS 33: para. 36)
2.3 Convertible debt

Convertible debt gives rise to potential ordinary shares as the debt instruments may be converted
to equity at some point in the future.
2.3.1 Earnings
Earnings is adjusted for the interest or preference dividends which would be ‘saved‘ if conversion
into ordinary shares took place. Interest on convertible debt attracts tax relief. This tax relief will
be lost on conversion of the debt into ordinary shares, therefore, the net increase in earnings
(which is an after-tax figure) is the interest less the tax relief.
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Earnings $
Basic earnings X
Add back saving on interest on debt, net of income tax ‘saved’ X
X
2.3.2 Number of shares

The number of ordinary shares is the weighted average number of ordinary shares calculated for
basic eps, plus the maximum number of ordinary shares that would be issued on conversion into
ordinary shares.
No. of shares Number

Basic weighted average X
Add additional shares on conversion (using terms giving maximum dilution
available after the year-end) X
Diluted number X
(IAS 33: paras. 33, 36 & 39)
Activity 4: Diluted eps – convertible debt
Acorn Co had the same 10 million ordinary shares in issue on both 1 April 20X1 and 31 March
20X2. On 1 April 20X1, the company issued 1.2 million $1 units of 5% convertible loan stock. Each
unit of loan stock is convertible into four ordinary shares on 1 April 20X9 at the option of the
holder. The following is an extract from Acorn Co’s statement of profit or loss and other
comprehensive income for the year ended 31 March 20X2:
$’000
Profit before interest and tax 980
Finance cost on 5% convertible loan stock (60)
Income tax at 30% (276)
Required
What is the diluted earnings per share for the year ended 31 March 20X2?
 4.76c
 4.64c
 4.35c
 6.86c
2.4 Share options or warrants

Options and warrants are potential ordinary shares as the holders may convert the option or
warrant to shares at some point in the future, provided the exercise price is less than the market
value of the shares. In order to calculate diluted eps, the number of potential ordinary shares is
split into two parts (IAS 33: paras. 45 & 46):
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Potential ordinary shares
(options or warrants)
Shares that would have been issued Shares that are treated as having
+
if the cash received on exercise of been issued for no consideration
the option / warrant had been used to
buy shares at average market price
for the period
Ignore as they have Add to the number of shares in

no dilutive effect issue to calculate diluted eps
2.4.1 Calculation
No of shares under option X

No that would have been issued at average market price (AMP) [(no of options × exercise
price)/AMP] (X)
 No of shares treated as issued for nil consideration X
It is only the shares deemed to have been issued for no consideration which are added to the
number of shares in issue when calculating diluted eps (shares issued at full market price have no
dilutive effect). There is no impact on earnings.
Activity 5: Diluted eps – options
Galaxy Co has a profit for the year of $3 million for the year. 1.4 million ordinary shares were in
issue during the year.
Galaxy Co also had 250,000 options outstanding for the whole year with an exercise price of $15.
The AMP of one ordinary share during the period was $20.
Required
What is the diluted eps?
 $2.05
 $1.89
 $2.14
 $1.88
Essential reading
Chapter 19, Section 3 of the Essential reading contains a further activity which will allow you to
practise calculating diluted eps.
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3 Earnings per share as a performance indicator
3.1 Importance of the eps measure
• Earnings per share may be a better indication than profit of the financial performance of an
entity as it considers changes in capital during the period, ie new capital can only generate a
return from the date it is paid into the company.
• Earnings per share is considered a key stock market indicator and is quoted in the financial
press.
• Earnings per share is important because of its role in the price/earnings (p/e) ratio. This is
probably the most important ratio for analysis work due to the ability to compare different
companies and its use as a ‘value for money’ measure.
3.2 Limitations of eps

• Earnings per share is based on historical, not prospective, data, and so is an indication of past
rather than future performance.
• The diluted eps figure is a theoretical calculation. Markets do not necessarily react in the same
way.
• The official eps definition includes one-off income/expense which distorts the eps figure.
Additional eps measures are permitted, however they must be disclosed in the notes to the
financial statements, not on the face of the statement of profit or loss and other
Essential reading
Chapter 19, Section 4 of the Essential reading provides further information relating to the
disclosure of eps and Section 5 on alternative ways of presenting the eps figure.
Exam focus point

The Financial Reporting Examining team have commented that candidates often struggle with
the calculation of diluted eps. Ensure that you practice questions on diluted eps and
understand how to account for both convertible debt and options.
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Chapter summary
Earnings per share
Basic eps
Objective Calculation
• Improve comparison between entities and over Earnings
• Basic EPS =
periods Weighted average no. of equity shares
• Applies to listed companies only outstanding during the period
• Earnings is profit attributable to ordinary
shareholders of the parent ie consolidated profit
Definitions after:
• Ordinary shares – equity instrument subordinate to – Income taxes
all other classes of equity instruments – Non-controlling interests
• Potential ordinary shares – financial instrument – Preference dividends on preference shares
that may entitle its holder to ordinary shares. classified as equity
• Financial instrument – contract that gives a
financial asset of one entity and a financial liability
or equity instrument of another entity. Weighted average number of shares outstanding
• Equity instrument – any contract that evidences a • Full market price:
residual interest in the assets of an entity after – Time apportion share issues in the year
deducting all of its liabilities. • Bonus issue:
• Dilution – A reduction in earnings per share or an Number of shares after bonus issue
increase in loss per share – Bonus fraction =
Number of shares before bonus issue
– Use bonus fraction retrospectively in current year
– Fraction = no shares after/no shares before
Presentation
– Use reciprocal to restate comparative
Basic and diluted EPS shown on face of SPLOCI with
• Rights issue:
equal prominence Fair value per share immediately
– Bonus fraction = before exercise of rights
for rights issue Theoretical ex-rights price (TERP)
– Use bonus fraction retrospectively in current year
– Fraction = FV before rights/TERP
– Use reciprocal to restate comparative
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Diluted eps Eps as a performance measure
Issue Importance of the eps measure

A 'warning' measure of what may happen in the • May be a better indication than profit as it
future if potential ordinary shares are converted considers changes in capital
to shares • Considered a key stock market indicator and is
quoted in the financial press
• It has a role in the price/earnings (P/E) ratio
Calculation of diluted eps
Assume that all of the pos are converted into ordinary
shares at the beginning of the period and at the most Limitations of eps
advantageous rate • Based on historical data and so is an indication of
past performance
• Diluted EPS figure is theoretical
Convertible debt • Includes one-off income/expense which distorts the
Earnings EPS figure
Basic earnings X
Add back: interest net of tax (or preference
dividend) X
Diluted earnings X
No. of shares
Basic weighted average number of shares X
Add additional (max) shares on conversion X
Diluted number of shares X
Share options and warrants

No. of shares
Basic weighted average number of shares X
Add shares deemed issued for nil consideration (W1) X
Diluted number of shares X
Working 1
No. shares under option X
Less no. that would have been issued at average
market price X
No. of shares deemed issued for nil consideration X
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1. Basic eps
Basic eps is calculated as earnings/weighted average number of equity shares outstanding during
the period.
Earnings is consolidated profit after tax, non-controlling interest and preference dividends (on
redeemable preference shares).
The weighted average number of shares is adjusted for issues in the period. Share issues may be:
• Issued at full market value – include pro-rata
• Bonus issues – calculate bonus fraction and apply it retrospectively
• Rights issue – separate into shares paid for at full value and bonus issue; calculate the bonus
fraction and apply it retrospectively
2. Diluted eps
Diluted eps represents a ‘warning’ measure of how eps would change if ‘potential ordinary shares’
were converted into shares. Both earnings and the number of shares are adjusted for the effects
of the conversion of debt into shares. The number of shares is adjusted for the effects of share
options/warrants into shares.
3. Eps as performance measure

Eps is an important financial indicator and is used in the price/earnings (p/e) ratio which is used to
assess the health of and to value companies.
It also has limitations because it is based on historical data and includes one-off items of income
and expense.
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Question practice
the Workbook):
Section A Q17
Section C Q41 Alpha Co
Section C Q44 Telenorth Co
Section C Q48 Pilum Co
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Activity answers
Activity 1: Calculation of earnings

The correct answer is: $6,970,000
This is the $7,000,000 profit attributable to the owners of the parent less $30,000 (500,000 × $1 ×
6%) dividends on the non-cumulative irredeemable preference shares as they are classified as
equity.
$’000
Profit for the year attributable to the owners of the parent 7,000
Less: Preference dividends on preference shares classified as equity (500,000 × 6%) (30)
6,970
The irredeemable preference shares are classified as equity as there is no obligation to pay the
dividends or repay the principal. Therefore, the dividends on the preference shares need to be
deducted from the profit for the year attributable to the owners to the parent to arrive at earnings
relating to ordinary shareholders.
However, the redeemable preference shares are classified as a financial liability as there is an
obligation to pay the dividends and to repay the principal. Therefore, the dividends on these
shares are treated as a finance cost so have already been deducted in arriving at the profit for
the year figure. As such, there is no need to deduct them when calculating earnings.
Activity 2: Bonus issue
20X2
Earnings $80,000
Shares at 1 January 400,000

Bonus issue 100,000
500,000
eps ($80,000 / 500,000) $0.16
The number of shares for 20X1 must also be adjusted if the figures for eps are to remain
comparable.
The eps for 20X1 is therefore restated as:
$0.1875 × 400,000/500,000 = $0.15

1
1 The correct answer is: 2,431,508
Workings
1 Weighted average number of shares
Bonus Weighted
Date Narrative Shares Time fraction average
× (3.10/3.00
(W2)) ×
1.1.20X1 2,000,000 × (4/12) (21/20) 723,333
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Bonus Weighted
× (3.10/3.00
Full market 270,000/2,2 (W2)) ×
30.4.20X1 price 70,000 × (3/12) (21/20) 615,738
Rights issue 227,000/2,4
31.7.20X1 (1/10) 97,000 × (2/12) × (21/20) 436,975
Bonus issue 124,850/2,6
30.9.20X1 (1/20) 21,850 × (3/12) 655,462
2 TERP
$
10 @ $3.10 31.00
1 @ $2.00 2.00
11 33.00
33/11 = $3.00
2 The correct answer is: 16.5c
Eps for year ended 31.12.X1 = $400,000 / 2,431,508 (W) = 16.5c
3 The correct answer is: 17.1c
Restated eps for year ended 31.12.20X0
18.6c × 3.00/3.10 × 20/21 = 17.1c
Activity 4: Diluted eps – convertible debt

The correct answer is: 4.64c
Earnings
$
Basic 644,000
Interest saving, net of tax 1,200,000 @ 5% × 70% 42,000
686,000
Number of shares
Basic 10,000,000
On conversion (1,200,000 × 4) 4,800,000
14,800,000
Diluted eps = $686,000 / 14,800,000 = 4.64c
Activity 5: Diluted eps – options

The correct answer is: $2.05
Diluted EPS
Number of shares under option 250,000
No that would have been issued at average market price [(250,000 × (187,500)
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$15)/$20]
 No of shares treated as issued for nil consideration 62,500
Diluted EPS = $3,000,000 / (1,400,000 + 62,500) = $2.05
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Interpretation of
20 financial statements
20
Learning objectives
Define and compute relevant financial ratios. C2(a)
Explain what aspects of performance specific ratios are intended C2(b)

to assess.
Analyse and interpret ratios to give an assessment of an C2(c)

entity’s/group’s performance and financial position in
comparison with:
(i) previous period’s financial statements
(ii) another similar entity/group for the same reporting period
(iii) industry average ratios
Interpret financial statements (including statements of cash C2(d)

flows) together with other financial information to give advice
from the perspectives of different stakeholders.
Interpret financial statements (including statements of cash C2(e)

flows) together with other financial information to assess the
performance and financial position of an entity.
Discuss how the use of current values affects the interpretation of C2(f)
financial statements and how this would compare to using
historical cost.
Indicate other information, including non-financial information, C2(g)

that may be of relevance to the assessment of an entity’s
performance and financial position
20
Exam context
Interpretation questions can be examined in either Section A, B or C of the Financial Reporting
exam. One of the 20-mark questions in Section C of the exam will require you to interpret the
financial statements, and other information, of either a single entity or a group. The Financial
Reporting Examining team has stated that ‘although candidates will be expected to calculate
various accounting ratios, Financial Reporting places emphasis on the interpretation of what
particular ratios are intended to measure and the impact that consolidation adjustments may
have on any comparisons of group financial statements. The financial statements that require
interpretation will include the Statement of Profit or Loss, the Statement of Financial Position and
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the Statement of Cash Flows’. Therefore, the focus of this chapter and your study should be on
interpretation rather than the calculation of ratios.
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20
Chapter overview
Interpretation of financial statements
Analysis and interpretation Financial ratios Interpretation
Ratio analysis vs interpretation Categories Approach to analysing

Profitability ratios
Interpretation questions
in the exam
Short term liquidity
and efficiency
Stakeholder perspectives
Long-term liquidity/gearing
Investors' ratios
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20: Interpretation of financial statements 483

1 Analysis and interpretation
1.1 Ratio analysis v interpretation
1.1.1 Ratio analysis
Calculating ratios may highlight unusual results or clarify trends, but they are simply a starting
point to understand how an entity has changed over time or how it compares to another entity or
to industry averages.
It is important that you can:
• Identify which ratios should be calculated in different circumstances, depending on what area
of the business you want to understand more about; and
• Accurately calculate ratios using the primary financial statements
However, the identification and calculation of ratios is unlikely to be worth many marks in the FR
exam, the focus must be on interpretation.
1.1.2 Interpretation
Interpretation involves using the ratios calculated, the financial statements provided and
information within a scenario to explain your understanding of the performance and position of
an entity in the period.
For ratios to be useful, comparisons must be made – on a year-to-year basis, or between
companies. On their own, they are useless for any sensible decision-making. It is important that
you use information you are provided with about an entity to draw conclusions as to why a ratio
has changed or is different to another entity.
It is important that you understand what the ratio is intended to show in order to explain it
correctly.
Exam focus point

The Financial Reporting Examining team has stated that the following scenarios may be asked
in the interpretation question:
• Comparison of one entity over two periods
• Comparison of two entities over the same period
• Comparison of an entity with industry averages
• Analysis of consolidated financial statements – acquisition of a subsidiary
• Analysis of consolidated financial statements – disposal of a subsidiary
• Analysis of cash flow information
Further detail on each of these scenarios is covered later in this chapter.
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2 Financial ratios
2.1 Categories of ratios
Profitability Short term liquidity and efficiency
• Return on capital employed • Current ratio
• Net (operating) profit margin • Acid-test ratio
• Asset turnover • Inventory holding period
• Return on equity • Receivables collection period
• Gross profit margin • Payables payment period
Long term liquidity/Gearing Investors' ratios

• Gearing • Dividend yield
• Interest cover • Dividend cover
• p/e ratio
2.2 Profitability ratios

2.2.1 Return on capital employed
Formula to learn
PBIT
ROCE = × 100
Capital Employed
PBIT = profit before interest and tax. It is often referred to internationally as IBIT (income before
interest and tax) and may also be called operating profit.
Capital employed = debt + equity = TALCL (total assets less current liabilities). It represents the
debt and equity capital that is used by the company to generate profit.
Return on capital employed (ROCE) measures how efficiently a company uses its capital to
generate profits. A potential investor or lender should compare the return to a target return or a
return on other investments/loans. It is impossible to assess profits or profit growth properly
without relating them to the amount of funds (capital) that were employed in making the profits.
Therefore, ROCE is a very important profitability ratio as it allows the profitability of different
companies or time periods to be compared.
When considering changes in ROCE year to year or differences between entities, consider looking
PBIT and capital employed separately to understand if transactions or events that you are made
aware of in the scenario impact on both the numerator and denominator in the same way. If a
transaction only impacts profit, or only impacts capital employed, that would affect the ROCE for
that company/period.
The following are reasons why ROCE might differ between years or companies.
(a) Type of industry (a manufacturing company will typically have higher assets and therefore
lower ROCE than a services or knowledge-based company)
(b) Age of assets (old assets have a lower carrying amount resulting in low capital employed and
high ROCE)
(c) Leased assets versus asset purchased outright for cash (a leased asset results in recognition
of a lease liability, a proportion of which will appear as a non-current liability, increasing
capital employed and reducing ROCE; whereas an asset purchased with surplus cash will
have no impact on capital employed)
(d) Timing of the purchase of assets (eg if assets are purchased at the year-end, capital
employed will increase but there will have been no time to increase profits yet, so ROCE is
likely to fall).
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(e) Assets held under the revaluation model versus assets held under the cost model (an upwards
revaluation results in recognition of a revaluation surplus which increases capital employed
whilst higher depreciation will result in a lower PBIT; a decrease in the numerator and an
increase in the denominator will cause ROCE to fall)
Illustration 1: ROCE
Maroon Co has PBIT of $1.64 million and capital employed of $32.85 million at 31 December 20X5.
Its ROCE for 20X5 has, therefore, been calculated as 5.0%, a significant decrease on the ROCE
for 20X4 of 6.8%.
Further information has revealed that Maroon Co purchased $10 million of non-current assets on
20 December 20X5. Maroon Co fully financed the purchase using a bank loan taken out on the
same date.
Required
Discuss the reasons for the decrease in ROCE.
Solution
The timing of the purchase of the asset, just before the year-end means that the machine will not
have been able to impact profit/returns. We have the situation where the denominator (capital
employed) has increased by $10 million without any corresponding increase in the numerator
(return). Without the $10 million loan, the ROCE would have been 7.2% ($1.64m / ($32.65m –
$10m)), which is actually a slight improvement on the 20X4 ROCE.
It is important that you read the information given on the question carefully and consider the
interactions between increases and decreases to profit/return and capital employed in the light of
the business’s performance for the year. Taking ROCE as a standalone figure does not give the
user of the financial statements the whole picture.
We often sub‑analyse ROCE, to find out more about why the ROCE is high or low, or better or
worse than last year. There are two factors that contribute towards a return on capital employed:
ROCE = Net profit margin × asset turnover

2.2.2 Net (operating) profit margin
Formula to learn
PBIT
Net profit margin = × 100
Revenue
Net (operating) profit margin considers how much of an entity’s sales are converted to profit.
There is no right or wrong net profit margin that an entity should achieve and what is ‘normal’ will
vary by industry and by company based on the target market of that company. It is important
that you consider volume of sales as well as the net profit margin. For example, a company that
makes a profit of 25c per $1 of sales is making a bigger return on its revenue than another
company making a profit of only 10c per $1 of sale. However, if the high margin is because sales
prices are high, there is a strong possibility that the volume of sales will be low and, therefore,
revenue may be depressed, and so the asset turnover will be lower.
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2.2.3 Asset turnover
Formula to learn
Revenue
Asset turnover =
Capital employed
Asset turnover is a measure of how well the assets (total assets less current liabilities) of a business
are being used to generate sales. For example, if two companies each have capital employed of
$100,000 and Company A makes sales of $400,000 per annum whereas Company B makes sales
of only $200,000 per annum, Company A is making a higher revenue from the same amount of
assets (twice as much asset turnover as Company B) and this will help A to make a higher return
on capital employed than B. Asset turnover is expressed as ‘x times’ so that assets generate x
times their value in annual sales. Here, Company A’s asset turnover is four times and B’s is two
times.
Activity 1: Return on Capital Employed
Extracts from the financial statements of Burke for the year ended 31 December 20X1 are shown
below:
EXTRACT FROM THE STATEMENT OF PROFIT OR LOSS
$’000
Gross profit 300
Finance cost (10)
Tax (70)
EXTRACT FROM THE STATEMENT OF FINANCIAL POSITION
$’000
Non-current assets 550
Equity
Share capital 200
Share premium 40
Retained earnings 500
Required
Calculate Burke’s return on capital employed for the year ended 31 December 20X1. Give your
answer as a percentage to one decimal place.
%
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Solution
2.2.4 Return on equity
Formula to learn
Profit after tax and preference dividends

Return on equity =
Ordinary share capital + reserves
Whilst the return on capital employed looks at the overall return on the long-term sources of
finance, return on equity focuses on the return for the ordinary shareholders.
Return on equity gives a more restricted view of capital than ROCE, but it is based on the same
principles. ROE is not a widely used ratio, however, because there are more useful ratios that give
an indication of the return to shareholders, such as earnings per share, dividend per share,
dividend yield and earnings yield, which are described later.
2.2.5 Gross profit margin
Formula to learn
Gross profit
Gross profit margin = × 100
Revenue
The gross profit margin measures how well a company is running its core operations.
Depending on the format of the statement of profit or loss, you may be able to calculate the gross
profit margin as well as the net profit margin. Gross profit margin is a measure of the profit
generated from an entity’s sales. Looking at the two profit margins together can be quite
informative. If two entities have a similar net profit margin but a different gross profit margin, it
may be that they classify expenses differently which causes the inconsistency. For example, one
company might present the depreciation on its machinery in cost of sales, which will reduce the
gross profit margin. Another company might present the depreciation on its machinery as an
administrative expense and therefore report a higher gross profit margin. When it comes to
calculating the net profit margin, where the depreciation is presented does not make a difference.
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There may be various reasons for a change in gross profit margin, but it is important to note that
a change in sales volume alone will not necessarily affect gross margin as the same proportionate
change would be expected in cost of sales. However, if an increase in sales volume is achieved by
offering customers a bulk buy discount, this will cause the gross margin to fall.
The following factors could explain the movement in gross margin between years or companies:
(a) Change in sales price
(b) Change in sales mix
(c) Change in purchase price and/or production costs (eg due to discounts/efficiencies)
(d) Inventory obsolescence (written off through cost of sales)
Activity 2: Profitability ratios
The following information is available for two potential acquisition targets. The entities have
similar capital structures and both operate in the manufacturing sector.
Fulton Hutton
Revenue $460m $420m
Gross profit margin 25% 14%
Net profit margin 10% 9%
Required
Which TWO of the following statements give realistic conclusions that could be drawn from the
above information? Tick the correct answers.
 Hutton has sourced cheaper raw materials than Fulton.
 Fulton operates its production process more efficiently than Hutton with less wastage and
more goods produced per machine hour.
 Hutton operates in the low price end of the market but incurs similar manufacturing costs to
Fulton.
 Fulton’s management exercises better cost control of the entity’s non-production overheads
than Hutton’s management.
 Hutton has access to cheaper interest rates on its borrowings than Fulton.
2.3 Short term liquidity and efficiency

2.3.1 Current ratio
Formula to learn
Current assets
Current ratio =
Current liabilities
Current ratio is a measure of a company’s ability to meet its short-term obligations using its
current assets. The idea behind this is that a company should have enough current assets that
give a promise of ‘cash to come’ to meet its future commitments to pay off its current liabilities.
Obviously, a ratio in excess of one should be expected. Otherwise, there would be the prospect
that the company might be unable to pay its debts on time. In practice, a ratio comfortably in
excess of one should be expected, but what is ‘comfortable’ varies between different types of
businesses.
Companies are not able to convert all their current assets into cash very quickly. In particular,
some manufacturing companies might hold large quantities of raw material inventories, which
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must be used in production to create finished goods inventory. These might be warehoused for a
long time or sold on lengthy credit terms. Some companies produce or manufacture products that
necessarily have to be stored for a long period of time, such as certain chemical and
pharmaceutical products. In such businesses, where inventory turnover is slow, most inventories
are not very ‘liquid’ assets, because the cash cycle is so long. For these reasons, we calculate an
additional liquidity ratio, known as the quick ratio or acid test ratio.
2.3.2 Quick (acid-test) ratio
Formula to learn
Current assets - inventories

Quick ratio (acid test) =
Current liabilities
This ratio should ideally be at least one for companies with a slow inventory turnover. For
companies with a fast inventory turnover, a quick ratio can be comfortably less than one without
suggesting that the company could be in cash flow trouble.
Both the current ratio and the quick ratio offer an indication of the company’s liquidity position,
but the absolute figures should not be interpreted too literally. It is often theorised that an
acceptable current ratio is 1.5 and an acceptable quick ratio is 0.8, but these should only be used
as a guide. Different businesses operate in very different ways. A supermarket group for example
might have a current ratio of 0.52 and a quick ratio of 0.17. Supermarkets have low receivables
(people do not buy groceries on credit), low cash (good cash management), medium inventories
(high levels of inventories but quick turnover, particularly in view of perishability) and very high
payables. Contrast this with, for example, a luxury sofa manufacturer is likely to have a higher
current ratio (to cover the time to make the sofas as well as holding sufficient materials on hand).
What is important is the trend of these ratios. From this, one can easily ascertain whether liquidity
is improving or deteriorating. If a supermarket has traded for the last ten years (very successfully)
with current ratios of 0.52 and quick ratios of 0.17, then it should be supposed that the company
can continue in business with those levels of liquidity. If, in the following year, the current ratio
were to fall to 0.38 and the quick ratio to 0.09, then further investigation into the liquidity situation
would be appropriate. It is the relative position that is far more important than the absolute
figures.
Do not forget the other side of the coin either: A current ratio and a quick ratio can get bigger
than they need to be. A company that has large volumes of inventories and receivables might be
over‑investing in working capital, and so tying up more funds in the business than it needs to. This
would suggest poor management of receivables (credit) or inventories by the company.
Activity 3: Liquidity
Which of the following independent options is the most likely cause of the movement in Robbo’s
current ratio?
20X3 20X2
Current ratio 2.1 2.4
Tick the correct answer.

 Replacement of an overdraft with a long-term loan
 A decrease in the length of credit terms offered by suppliers
 As issue of five-year bonds
 A significant write down of obsolete inventory
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Essential reading
Chapter 20 Section 1 of the Essential reading provides more information on liquidity and the cash
cycle.
2.3.3 Inventory holding period
Formula to learn
Inventories
Inventory holding period = × 365 days
Cost of sales
This indicates the average number of days that items of inventory are held for. This is a measure
of how vigorously a business is trading. A lengthening inventory holding period from one year to
the next indicates:
(a) A slowdown in demand/trading; or
(b) A build-up in inventory levels, perhaps suggesting that the investment in inventories is
becoming excessive
Generally, the lower the inventory holding period (ie the fewer days that an entity holds its
inventory) the better, assuming the inventory is being sold at a profit, however several aspects of
inventory holding policy have to be balanced. An entity must hold enough inventory to satisfy
demand, and therefore must consider:
(a) Lead times
(b) Seasonal fluctuations in orders
(c) Alternative uses of warehouse space
(d) Bulk buying discounts
(e) Likelihood of inventory perishing or becoming obsolete
2.3.4 Receivables collection period
Formula to learn
Trade receivables
Receivables collection period = × 365 days
Credit revenue
The receivables collection period tells us how long, on average, it takes a company to collect
payment from credit customers. Note that any cash sales should be excluded from the revenue
denominator. This ratio only uses credit sales as they generate trade receivables. The trade
receivables are not the total figure for receivables in the statement of financial position, which
includes prepayments and non‑trade receivables. The trade receivables figure will be itemised in
an analysis of the receivable total, in a note to the accounts.
The estimate of the accounts receivable collection period is only approximate.
(a) The value of receivables in the statement of financial position might be abnormally high or
low compared with the ‘normal’ level the company usually has.
(b) Sales revenue in the statement of profit or loss is exclusive of sales taxes, but receivables in
the statement of financial position are inclusive of sales tax. We are not strictly comparing like
with like.
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Sales made to other companies are usually made on ‘normal credit terms’ of payment within, say,
30 days. A collection period significantly in excess of this might be representative of poor
management of funds of a business. However, some companies must allow generous credit terms
to win customers.
The type of company is also important: A retail company will have the majority of its sales made
with immediate payment (such as shops, online sales where the customer pays prior the goods
being despatched). A wholesaler or distribution company is more likely to offer credit terms; for
example, a wholesaler will sell its range of toys to a retail store offering 30–60 day credit terms.
Exporting companies in particular may have to carry large amounts of receivables, and so their
average collection period might be well in excess of 30 days.
It is important to give reasons specific to the example in the exam, as noting a company with few
trade receivables may be implicit of the type of company rather than them being particularly
good at credit collection.
The trend of the collection period over time is probably the best guide. If the collection period is
increasing year on year, this is indicative of a poorly managed credit control function (and
potentially, therefore, a poorly managed company). Also, this may affect credit being offered to it
in the longer-term, which would mean paying for its supplies up front (or ‘proforma’) which would
put an increased pressure on the cash flow.
2.3.5 Payables payment period
Formula to learn
Trade payables
Payables payment period = × 365 days
Credit purchases
The payables payment period tells us how long, on average, it takes a company to pay its credit
suppliers. The payables payment period It is rare to find purchases disclosed in published
accounts and so cost of sales serves as an approximation. The payment period often helps to
assess a company’s liquidity; an increase is often a sign of lack of long‑term finance or poor
management of current assets, resulting in the use of extended credit from suppliers, increased
bank overdraft and so on.
2.4 Working capital cycle

The working capital cycle includes cash, receivables, inventories and payables. It effectively
represents the time taken to purchase inventories, then sell them and collect the cash. The length
of the cycle is determined using the above ratios:
Buy Inventory Sell Receivables Receive cash

inventories holding period inventories collection period from receivables
Payables Working
payment period capital cycle
Pay payables
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Activity 4: Working capital ratios
Tungsten Co has the following working capital ratios:
20X9 20X8
Receivables collection period 75 days 50 days
Payables payment period 30 days 45 days
Inventory holding period 42 days 35 days
Required
Which TWO of the following statements are correct?
 Tungsten Co’s liquidity and working capital has improved in 20X9.
 Tungsten Co is receiving cash more quickly from customers in 20X9 than in 20X8.
 Tungsten Co is suffering from a worsening liquidity situation in 20X9.
 Tungsten Co is paying its suppliers more quickly in 20X9 than in 20X8.
2.5 Gearing and long-term liquidity

2.5.1 Gearing
Formulas to learn
Debt
Gearing = × 100
Debt + Equity
Interest bearing debt

Gearing = × 100
Interest bearing debt + Equity
Gearing or leverage is concerned with a company’s long‑term capital structure. We can think of
a company as consisting of non-current assets and net current assets (ie working capital, which is
current assets minus current liabilities). These assets must be financed by long‑term capital of the
company, which is one of two things:
(a) Issued share capital which can be divided into:
(i) Ordinary shares plus other equity (eg reserves)
(ii) Non-redeemable preference shares (unusual)
(b) Long-term debt including redeemable preference shares
Preference share capital is normally classified as a non-current liability in accordance with IAS 32
(AG35), and preference dividends (paid or accrued) are included in finance costs in profit or loss.
There is no absolute limit to what a gearing ratio ought to be. A company with a gearing ratio of
more than 50% is said to be high‑geared (whereas low gearing means a gearing ratio of less than
50%). Many companies are high geared, but if a high geared company is becoming increasingly
high geared, it is likely to have difficulty in the future when it wants to borrow even more, unless it
can also boost its shareholders’ capital, either with retained profits or by a new share issue.
Gearing is, amongst other things, an attempt to quantify the degree of risk involved in holding
equity shares in a company, risk both in terms of the company’s ability to remain in business and
in terms of expected ordinary dividends from the company. The problem with a highly geared
company is that by definition there is a lot of debt. Debt generally carries a fixed rate of interest
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(or fixed rate of dividend if in the form of preference shares), hence there is a given (and large)
amount to be paid out from profits to holders of debt before arriving at a residue available for
distribution to the holders of equity. The more highly geared the company, the greater the risk
that little (if anything) will be available to distribute by way of dividend to the ordinary
shareholders.
Activity 5: Gearing
The following is an extract from the statement of financial position of Fleck Co:
$’000
Equity
Share capital 200
Share premium 50
Total equity 720
Long-term borrowings 300
Redeemable preference shares 100
Deferred tax 20
Warranty provision (not discounted) 60
Total non-current liabilities 480
Required
What is the gearing ratio for Fleck (calculated as interest bearing debt/(interest bearing debt +
equity))?
Give your answer as a percentage to one decimal place.
%
Essential reading
Chapter 20 Section 2 of the Essential reading provides discussion of the impact of a high or low
gearing ratio.
The debt ratio is another ratio that considers capital structure, though is less commonly used than
gearing. The debt ratio is also discussed in Chapter 20 Section 2 of the Essential reading.
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2.5.2 Interest cover
Formula to learn
PBIT
Interest cover =
Finance cost
The interest cover ratio shows whether a company is earning enough profits before interest and
tax to pay its interest costs comfortably, or whether its interest costs are high in relation to the size
of its profits, so that a fall in PBIT would then have a significant effect on profits available for
ordinary shareholders.
An interest cover of two times or less would be low, and should really exceed three times before the
company’s interest costs are to be considered within acceptable limits.
2.6 Investors’ ratios

2.6.1 Dividend yield
Formula to learn
Dividend per share

Dividend yield = × 100
Share price
Dividend yield is the return a shareholder is currently expecting on the shares of a company.
(a) The dividend per share is taken as the dividend for the previous year.
(b) If the share price is quoted ‘ex-div’, that means that the share price does not include the right
to the most recent dividend.
Shareholders look for both dividend yield and capital growth.
2.6.2 Dividend cover
Formula to learn
Earnings per share (eps)

Dividend cover =
Dividend per share
Dividend cover shows the proportion of profit for the year that is available for distribution to
shareholders that has been paid (or proposed) and what proportion will be retained in the
business to finance future growth. A dividend cover of two times would indicate that the
company had paid 50% of its distributable profits as dividends, and retained 50% in the business
to help to finance future operations. Retained profits are an important source of funds for most
companies, and so the dividend cover can in some cases be quite high.
A significant change in the dividend cover from one year to the next would be worth looking at
closely. For example, if a company’s dividend cover were to fall sharply between one year and the
next, it could be that its profits had fallen, but the directors wished to pay at least the same
amount of dividends as in the previous year, so as to keep shareholder expectations satisfied.
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2.6.3 Price/earnings (P/E) ratio
Formula to learn
Share price
Price/Earnings (P/E) ratio =
Earnings per share
A high P/E ratio indicates strong shareholder confidence in the company and its future, eg in
profit growth, and a lower P/E ratio indicates lower confidence.
The P/E ratio of one company can be compared with the P/E ratios of:
• Other companies in the same business sector
• Other companies generally
It is often used in stock exchange reporting where prices are readily available.
3 Interpretation
3.1 Approach to interpretation
• Identify user and format required for solution
• Read question and analyse data
- Look for obvious changes/differences in the figures (no ratio calculations yet, but can
consider % movements year on year)
• Calculate key ratios as required by the question
• Write up your answer summarising performance and position:
- Structured using your categories
- Comment on main features first
- Then bring in relevant ratios to support your arguments
- Suggest reasons for key changes
- Use any information given in the question!
• Reach a conclusion
Exam focus point

The Financial Reporting Examiners’ reports – for example, the July 2020 Examiners’ report and
the March/June 2021 Examiners’ report consistently make the same comments on the reasons
for candidates’ poor performance in the Section C interpretations question. Remember these
key points that are made in the Examiners’ reports:
• Depth of answer – candidates should not simply say that a ratio has increased or
decreased without providing an explanation of the underlying reasons for the movement.
Candidates are providing answers that are too brief and do not expand on their initial
observations.
• Address the requirements – many candidates do not address the requirements, either
leaving sections unanswered or not reading the requirements carefully enough to fully
understand what is being asked. Candidates are reminded that only points that are
relevant to the requirements will score marks.
• Use the scenario – candidates routinely ignore the information provided in the scenario
and provide textbook answers that explain what a ratio is. The aim of the interpretation
questions is to display that students are able to deal with the information given and
provide a good analysis of realistic scenarios. These answers cannot simply be rote learned
and copied from notes.
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• Calculations – candidates generally score well in the calculation of ratios but must show
workings to support their final answer, particularly where they are asked to redraft figures
and recalculate ratios.
• Structure of answer – candidates often write in one block of text which can be difficult to
follow and lead to confused explanations. Candidates are advised to use separate
headings for each ratio calculated to help to give structure to their answers.
3.2 Interpretation scenarios in the exam

The Financial Reporting examining team has produced several technical articles to help students
improve their performance in this area. You should read the articles titled ‘Tell me a story’, ‘How to
improve your answer to FR interpretation questions‘ and ‘Financial statements interpretation‘
which can be found on the ACCA website (www.accaglobal.com). The articles clearly indicate
that there are six different types of interpretation question you may be faced with in Section C of
the exam. Key points relating to each type of question are provided in the sections below.
3.2.1 Comparison of one entity over two periods

You may be asked to compare the same entity over two accounting periods. Rather than saying
that ratio has increased or decreased, you should state whether it has improved or deteriorated
and you must offer possible reasons for the movements based on information within the scenario.
Some of the reasons for change across two period may include:
• A change in product mix, perhaps due to new competitors entering the market or because of
changes in societal demands, which may impact on gross profit margin, operating profit
margin (if, for example, an advertising campaign is launched to promote the new product),
receivables collection period (if, for example, new customers are gained or existing customers
need to be offered extended credit terms to ensure their continued custom), payables payment
period (if, for example, new suppliers are being used to fulfil the change in product mix)
• The acquisition of major new property, plant and equipment which will impact on asset
turnover, operating profit margin (as a result of additional depreciation), return on capital
employed. The financing of the new asset is also important as there will be a negative impact
on cash flows if the acquisition is in cash, but an impact on interest cover if the asset is
acquired using a lease or a loan.
• The disposal of major property, plant and equipment, which will likely result in a gain or loss on
disposal which will have an impact on operating profit margin, as well as asset turnover and
return on capital employed.
You should consider one-off events that could skew the comparison (eg an impairment loss that
has increased expenses and therefore reduced the operating profit margin). If these exist, it may
be valuable to strip these out of the accounting numbers and recalculate the ratios to show the
underlying position for comparison.
3.2.2 Comparison of two entities in the same period

You may be presented with, or asked to calculate, the ratios for two competitor firms and asked to
compare their performance or decide which is more suitable to target for acquisition. You should
consider whether there are any differences in accounting policies which might skew the
comparison (accounting for non-current assets at cost vs fair value is often a key reason for
return on assets or return on equity differences). There may also be useful information about
which areas of the market the company targets (for example, a company that sells luxury goods
is likely to have a higher gross profit margin than a discount retailer within the same industry) or
information about significant customers.
3.2.3 Comparison of an entity with the sector averages

Similar to the comparison of two entities discussed above, candidates should give consideration to
the fact that different entities in the sector will have different margins as they target different
ends of the market. Also firms may have different year-ends which could skew the comparison,
particularly if there is, for example, seasonal trade which impacts on eg, receivables and
inventories balances at year-end. Finally, consider if the entity in question has different
accounting policies to the rest of the sector.
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3.2.4 Analysis of consolidated financial statements – acquisition of a subsidiary
Consolidated financial statements will have group-related issues and therefore the interpretation
must focus on different issues to that of a single entity. In the situation where there is an
acquisition of a subsidiary, the results will not be comparable year on year and discussion must
focus on the impact of the acquisition. This may include:
• The acquired subsidiary might have different margins or operate at a different sector.
• Some transactions such as intra-group sales or unrealised profits will need to be eliminated. If
the parent previously transacted with the entity that it has now acquired, this means that
revenue and profits reported in the single entity financial statements are now cancelled as
they are intragroup.
• There may be one-off fees associated with the acquisition that impact on the operating profit
margin.
• The subsidiary acquired may have different payment terms for its receivables and payables
which impact on the collection and payment periods.
• Shares or other capital issued to acquire the subsidiary may impact the gearing ratio.
• The accounting policies of the parent and subsidiary may be different. Again, be alert to one
company accounting for its non-current assets at cost and the other at fair value.
Date of acquisition
Start of the year Mid year End of the year
Consolidated statement of CSPLOCI will include results CSPLOCI will not include the
profit or loss will include of subsidiary post acquisition results of subsidiary whereas
results of subsidiary for the whereas the CSFP will include the CSFP will include all
whole year and the all assets and liabilities of the assets and liabilities of the
consolidated statement of subsidiary. This means that subsidiary. As such, students
financial position will ratios that use elements of must reflect that the increase
include all assets and both performance (CSPLOCI) in assets and liabilities of the
liabilities of the subsidiary. and position (CSFP) will be group will not have
There is therefore complex to interpret. generated additional results
consistency between the Students should reflect on in the period, which will skew
CSPLOCI and CSFP and this within their interpretation. the ratios.
discussion can focus on For example, if a subsidiary is
the impact of the acquired six months into the
acquisition as above. year, then only six months
revenue will be included, but
the entire receivables balance
will be included within the
statement of financial
position. This would give a
false impression of the
receivables collection period.
3.2.5 Analysis of consolidated financial statements – disposal of a subsidiary

Similar to some of the comments noted for the acquisition of a subsidiary above, there may be
one off items relating to the disposal which impact mainly on the profitability ratios such as
professional fees or redundancy costs. Students should also consider whether there has been any
gain or loss on the disposal.
Students should also discuss that if a subsidiary has been disposed during the year (regardless of
whether mid-way through the year or at year-end), then the CSPLOCI will contain the results of
the subsidiary up until the date of disposal whereas the CSFP will not contain any assets or
liabilities of the subsidiary since it has been disposed. Therefore, similar to as noted above, this
creates a mismatch which should be discussed when interpreting changes or movements.
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3.2.6 Analysis of cash flow information
Interpreting the statement of cash flows requires a different approach from students as they will
not be able to base their answer on any ratios calculated. You should analyse the three sections
of the statement of cash flows separately:
Cash generated from operations
This shows how much cash the business can generate from its core activities. The cash generated
from operations figure is effectively the cash profit from operations. Students need to use the
SPLOCI and SFP to interpret and explain the movements, but also information in the scenario If,
for example, you were told in the scenario that the company had changed its credit terms offered
to customers, now offering 60 days instead of 30 days, it would be expected that the cash
generated from operations might decrease as the entity will have collected less cash from its
sales.
Cash generated / used in investing activities
These cash in/outflows are one-off items and it is likely that information about these will be
provided in the scenario. Students should be careful about saying whether cash generated from
investing activities is good or bad. Consider the situation where a company is forced to sell assets
and rent them back in order to generate cash flow to allow it to continue to trade. This is likely to
mean that the cash generated from investing activities increases in the period, but is clearly not a
sign that the entity has performed well.
Cash generated / used in financing activities
Similar to investing activities, cash flows are likely to be one-off in nature. Where there has been,
for example, a new loan which increases cash generated from financing activities, this may be
positive for the company if the proceeds from the loan are used to invest in new assets (which you
should be able to link to cash used in investing activities), but negative for the company if the
proceeds are needed to allow the company to continue trading.
(Amended from ‘Tell me a story’, from www.accaglobal.com)
3.2.7 Analysis of other (including non-financial) information

Our discussion so far has focused on the analysis of the primary financial statements. It is
possible that other information, including non-financial information, may provide useful insights
into the company or group. Examples include:
• The notes to the financial statements – may contain useful information such as an entity’s
accounting policies which may help to identify, for example, that one entity uses the cost
model for property, plant and equipment whilst another entity uses the revaluation model
• Management commentary – whilst you are not required to understand the detail of what
should be included in the Management commentary in the Financial Reporting syllabus, you
should be aware that such narrative information produced by the directors can provide
insights into an entity’s strategy, the market sector in which it operates, any key changes in
the business in the current year, its most significant resources and risks, which may help you to
understand and explain changes in an entity’s ratios or how it differs from another entity
• Social and environmental reports – an entity’s commitment to sustainability and meeting
climate change targets may help to explain changes in its operating policies or why different
returns and margins to other similar entities
3.3 Stakeholder perspectives

There are a number of stakeholders in an entity. To provide a useful analysis, an assessment of
the stakeholder’s needs is necessary when tackling any interpretation question. Each stakeholder
has differing needs.
Stakeholder Potential interest

(a) Shareholders • Performance of management during the year
• Decision to buy, hold or sell shares
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Stakeholder Potential interest
(b) Potential investors • Future growth and profit potential
• Investment decision
(c) Banks and capital providers • Ability to pay existing interest and loan capital
• Decision whether to grant further loans
(d) Employees • Company stability as an employer

• Wage negotiation
(e) Management • Weak performing areas that need attention

• Whether targets met
(f) Suppliers • Creditworthiness as a customer
(g) Government • Statistics

• Decision whether to award a grant
Activity 6: Single entity interpretation
1 This question has been adapted from the June 2015 exam.
Yogi Co is a public company and extracts from its most recent financial statements are
provided below:
STATEMENTS OF PROFIT OR LOSS FOR THE YEAR ENDED 31 MARCH
20X5 20X4
$’000 $’000
Revenue 36,000 50,000
Cost of sales (24,000) (30,000)
Profit from sale of division (Note (a)) 1,000 -
STATEMENTS OF FINANCIAL POSITION AS AT 31 MARCH
20X5 20X4
$’000 $’000 $’000 $’000
ASSETS
Non-current assets
- 2,000
16,300 21,000
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20X5 20X4
$’000 $’000 $’000 $’000
Current assets
Cash and cash equivalents 1,500 -
6,200 8,200
EQUITY AND LIABILITIES

Equity
13,000 14,000
10% loan notes 4,000 8,000
Current liabilities
Bank overdraft - 1,400
Trade and other payables 4,300 3,100
Current tax payable 1,200 2,700
5,500 7,200
The ratios of Yogi Co for 20X4 (as reported) are as follows:
Gross profit margin 40.0%

Operating profit margin 23.6%
Return on capital employed
(profit before interest and tax / (total assets – current liabilities) 53.6%
Asset turnover 2.27 times
Notes.
1 On 1 April 20X4, Yogi Co sold the net assets (including goodwill) of a separately operated
division of its business for $8 million cash on which it made a profit of $1 million. Yogi Co
had to make some of the staff who worked in this division redundant from that date. This
transaction required shareholder approval and, in order to secure this, the management of
Yogi Co offered shareholders a dividend of 40 cents for each share in issue out of the
proceeds of the sale. The trading results of the division which are included in the statement
of profit or loss for the year ending 31 March 20X4 above are shown in the ‘Trading results
of the division’ table below.
2 A new competitor entered the market on 1 April 20X4 which is competing aggressively on
price. In response to the new competitor, Yogi Co applied discounts to select products and
undertook a major television advertising campaign to raise its brand awareness.
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3 Yogi Co had a delivery agreement with a major courier which expired on 30 June 20X4.
Yogi Co entered into a new contract with effect from 1 July 20X4 at a price 20% higher
than the previous agreement.
4 Yogi Co had to write of a significant amount of inventory in January 20X5 due to storage
issues. The company was not able to make an insurance claim in respect of the wasted
inventory.
5 The directors of Yogi Co are considering revaluing its property for the first time on 1 April
20X5 but they are not sure what the impact of a revaluation will be on Yogi Co’s ratios.
$’000
Revenue 18,000
Gross profit 8,000
Distribution costs (1,000)
Administrative expenses (1,200)
Profit before interest and tax 5,800
Required
Calculate the equivalent ratios for Yogi Co:
(1) For the year ended 31 March 20X4, after excluding the contribution made by the division
that has been sold; and
(2) For the year ended 31 March 20X5, excluding the profit on the sale of the division. You
should ignore the effects of taxation on the profit on the sale.
2 Comment on the comparative financial performance and position of Yogi Co for the year
ended 31 March 20X5.
Solution
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3.4 Groups interpretation
Activity 7: Group interpretation
Below are extracts from the consolidated statement of profit or loss for the Advent Group for the
year ended 31 December 20X4 and individual statement of profit or loss for Advent Co for the
year ended 31 December 20X3. Advent Co operates as an online-only book retailer, which is a
highly competitive market in which customers expect books to be sold at a discount to their
recommended retail price. During 20X4, it ceased advertising on TV and instead relies on social
media and word of mouth.
20X4 20X3
(Advent Group) (Advent Co individual)
$’000 $’000
Revenue 24,280 19,924
Cost of sales (13,740) (11,814)
Operating expenses (3,100) (6,010)
Profit from operations 7,440 2,100

On 1 September 20X4, Advent Co sold all of its shares in Elf Co, its only subsidiary, for $6.16
million. Elf Co operates a small chain of high street bookstores. All of its stores are held as right of
use assets under lease agreements.
In order to compare Advent Co’s results for the years ended 20X3 and 20X4, the results of Elf Co
need to be eliminated from the above consolidated statement of profit or loss for 20X4. Although
Elf Co was correctly accounted for in the group financial statements for the year ended 31
December 20X4, a gain on disposal of Elf Co of $1.26 million is currently included in operating
expenses. This reflects the gain which should have been shown in Advent Co’s individual financial
statements.
In the year ended 31 December 20X4, Elf Co had the following results:
$m
Revenue 8.25
Cost of sales 3.75
Operating expenses 3.00
Finance costs 0.66
During the period from 1 January 20X4 to 1 September 20X4, Advent Co sold $0.64 million of
books to Elf Co after applying a reduced mark-up of 25% on cost. Elf Co had sold all of these
goods on to third parties by 1 September 20X4. The sales continued in the period after disposal
with Advent Co applying its normal arms’ length mark-up of 40%.
Elf Co previously used space in Advent Co’s warehouse, which Advent Co did not charge Elf Co
for. Since the disposal of Elf Co, Advent Co has begun to charge Elf Co the market rate to rent the
space, recording the rental income in operating expenses.
The following ratios have been correctly calculated based on the above financial statements:
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20X4 20X3
(Advent Group) (Advent Co individual)
Gross profit margin 43.4% 40.7%
Operating margin 30.6% 10.5%
Interest cover 8.4 times 2.6 times
Required
1 Remove the results of Elf Co and the gain on disposal of the subsidiary to prepare a revised
statement of profit or loss for the year ended 31 December 20X4 for Advent Co only.
2 Calculate the equivalent ratios to those given for Advent Co for 20X4 based on the revised
statement of profit or loss.
3 Using the ratios calculated in part (2) and those provided in the question, comment on the
performance of Advent Co for the years ended 31 December 20X3 and 20X4.
Solution
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PER alert
Technical performance objective P08 requires you to Analyse and Interpret Financial Reports.
Completion of this chapter will allow you to achieve the following four elements from this
objective:
(a) Assess the financial performance and position of an entity based on financial statements
and disclosure notes.
(b) Evaluate the effect of chosen accounting policies on the reported performance and
position of an entity.
(c) Evaluate the effects of fair value measurements and any underlying estimates on the
reported performance and position of an entity.
(d) Conclude on the performance and position of an entity identifying relevant factors and
make recommendations to management.
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Chapter summary
Interpretation of financial statements
Analysis and Financial ratios

interpretation
Ratio analysis vs Categories Short term liquidity and efficiency

interpretation • Profitability • Current ratio =
• Ratio analysis starting • Short-term liquidity and efficiency Current assets
point to understanding • Long-term liquidity/gearing Current liabilities
changes in entity or • Investors' ratios
between entities Measures a company's ability to pay
• Interpretation involves its current liabilities out of its current
using ratios and Profitability ratios assets
information about • Return on capital employed = • Quick ratio (or acid test) =
entity to explain Current assets − Inventories
Profit before interest and taxation
changes/differences × 100% Current liabilities
Capital employed
Measure of how efficiently a Removes inventory (the least liquid
company uses capital to generate asset) from current assets
profits • Inventory holding period (or
• Net (operating) profit margin = inventory days) =
Inventories
Profit before interest and taxation × 365 days
× 100% Cost of sales
Revenue
Measure of how an entity converts The average number of days
revenue to profit inventories are held by a company
before being sold to customers
• Asset turnover =
• Receivables collection period (or
Revenue
receivables days) =
Capital employed
Trade receivables
Measure of how efficiently the × 365 days
Revenue
company is using its capital to
generate revenue The average number of days it takes
to receive payment from credit
• Return on equity =
customers
Profit after tax and preference dividends
Ordinary share capital + reserves
× 100% • Payables payment period (or
payables days) =
Return for ordinary shareholders
Trade payables
• Gross profit margin = × 365 days
Cost of sales
Gross profit
× 100% The average number of days it takes
Revenue
the company to pay its suppliers for
goods purchased on credit
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Financial ratios continued Interpretation
Long-term liquidity/gearing Approach to analysing financial statements

• Gearing
1. Identify the user
Long-term debt
Debt/(Debt + Equity) = × 100% 2. Read question and analyse data
Long-term debt + Equity
3. Calculate key ratios
Measure of the long-term financial stability of 4. Write up your answer, discussing performance
the company and position
• Interest cover = 5. Consider the limitations of analysis and identify
any areas where further information is needed
Profit before interest and tax
6. Reach a conclusion
Interest expense
The number of times a company could pay its
interest out of its profit from operations Interpretation questions in the exam
• Comparison of a single entity over time
• Comparison of two entities in the same period
Investors' ratios • Comparison of the entity with the sector
• Dividend yield = • Analysis of groups – acquisition of subsidiary
Dividend per share • Analysis of groups – disposal of subsidiary
% • Interpretation of the statement of cash flows
Share price
A measure of the return an investor expects on a
company's shares Stakeholder perspectives
• Dividend cover = Assessment of stakeholder's needs is necessary when
Profit for the year tackling an interpretation question
Dividends
How easily a company can afford to pay its
dividend out of its current profit
• Price/earnings (P/E) ratio =
Share price
EPS
Indicates shareholder confidence in the company
and its future
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1. Analysis and interpretation

Ratios are a starting point to performing financial analysis but performing ratio analysis and
simply explaining what each ratio means is not interpretation. Interpretation requires you to use
what you know about the company/companies to explain the movements in ratios year on year or
between different entities.
However, performing ratio analysis and simply explaining what each ratio means is not
interpretation. Interpretation requires you to use what you know about the company/companies
to explain the movements in ratios year on year or between different entities.
2. Financial ratios
It is important that you learn the categories of ratio (profitability, short-term liquidity and
efficiency, long-term liquidity/gearing, investors’ ratios), understand the ratio definitions and what
the ratio is trying to tell you, learn the formulae and know how to apply them in questions.
3. Interpretation
You must use the information in the scenario to suggest possible reasons why a ratio has moved in
the period or is different to another entity. You should not simply describe the ratio, nor simply
state that a ratio is good or bad. Try to find relevant points that help you explain the performance
and position.
Interpretation of group financial statements requires you to consider the impact of an acquisition
or disposal on the ratios. Consider that there may be inconsistency between the information in
the consolidated statement of profit or loss and the consolidated statement of financial position
depending on the timing of the acquisition or sale.
Each section of the statement of cash flows should be interpreted separately. You should avoid
saying a cash inflow is good and a cash outflow is bad without understanding the reason for the
cash flow.
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Question practice
the Workbook):
Section C Q35 Hever Co
Section C Q49 Biggerbuys Co
Section C Q50 Webster Co
Section C Q51 Xpand Co
Further reading
There are articles in the Exam Resources section of the ACCA website which are relevant to the
topics covered in his chapter and would be useful to read:
Tell me a story
Performance appraisal
www.accaglobal.com
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Activity answers
Activity 1: Return on Capital Employed

30 %
ROCE is calculated as PBIT/capital employed = (230 + 10) / 800 = 30%
Activity 2: Profitability ratios

• Fulton operates its production process more efficiently than Hutton with less wastage and
more goods produced per machine hour.
• Hutton operates in the low price end of the market but incurs similar manufacturing costs
to Fulton.
Greater efficiency would reduce Fulton’s cost of sales and lead to a higher gross profit margin.
A lower selling price with similar manufacturing costs would lead to Hutton having a lower gross
profit margin.
Activity 3: Liquidity
The correct answer is: A significant write down of obsolete inventory
This would cause inventory and, therefore, current assets to decrease, which would cause the
current ratio to decrease. The other answers result in the current ratio being unchanged or
increasing.
Replacement of an overdraft with a long-term loan would increase current assets (more cash) and
decrease current liabilities (no overdraft) which would increase the current ratio.
A decrease in the length of credit offered would result in a decrease in trade payables and a
corresponding decrease in cash, so no overall impact on the current ratio.
Issuing bonds would result in a cash inflow (increase of current assets) which would also increase
the current ratio.
Activity 4: Working capital ratios

• Tungsten Co is suffering from a worsening liquidity situation in 20X9.
• Tungsten Co is paying its suppliers more quickly in 20X9 than in 20X8.
This is true because the current ratio has fallen, customers are taking longer to pay, inventory is
taking longer to sell and Tungsten Co is paying its suppliers more quickly.
Activity 5: Gearing
35.7 %
Gearing ratio = (300 + 100) / ((300 + 100) + 720) × 100 = 35.7%

Note. Long-term borrowings and redeemable preference shares are included in debt as they are
both interest-bearing. However, no interest is payable on deferred tax or the warranty provision,
so these are excluded from debt.

1 Calculation of equivalent ratios (figures in $’000):
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20X4 20X5 20X4
excl. profit per
excl. division on sale question
Gross profit margin
20X4 (excl. division) ((20,000 – 8,000)/(50,000
– 18,000) × 100)
20X5 (excl. profit on sale) (12,000 / 36,000 × 100) 37.5% 33.3% 40.0%
Operating profit margin
20X4 (excl. division) ((11,800 – 5,800)/32,000) ×
100)
20X5 (excl. profit on sale) ((4,300 + 400 –
1,000)/36,000 × 100)) 18.8% 10.3% 23.6%
Return on capital employed (ROCE)
20X4 (excl. division) ((11,800 – 5,800)/(29,200 –
7,200 – 7,000) × 100
20X5 (excl. profit on sale) ((4,300 + 400 – 1,000)
/ (13,000 + 4,000 – 1,000)) 40.0% 23.1% 53.6%
Asset turnover (32,000/15,000) 2.13 times 2.21 times 2.27 times
The capital employed in the division sold at 31 March 20X4 was $7 million ($8 million sale
proceeds less $1 million profit on sale).
The figures for the calculations of 20X4’s adjusted ratios (ie excluding the effects of the sale of
the division) are given in brackets; the figures for 20X5 are derived from the equivalent figures
in the question, however, the operating profit margin and ROCE calculations exclude the profit
from the sale of the division (as stated in the requirement) as it is a ‘one off’ item.
2 The most relevant comparison is the 20X5 results (excluding the profit on disposal of the
division) with the results of 20X4 (excluding the results of the division), otherwise like is not
being compared with like.
Profitability
Although comparative sales have increased (excluding the effect of the sale of the division) by
$4 million (36,000 – 32,000), equivalent to 12.5%, the gross profit margin has fallen
considerably (from 37.5% in 20X4 down to 33.3% in 20X5) and this deterioration has been
compounded by the sale of the division, which was the most profitable part of the business
(which earned a gross profit margin of 44.4% (8/18)). The increase in sales indicates that Yogi
Co has responded well to the threat created by the new competitor entering the market. This
may be due to the advertising campaign or the discounts offered on specific products. The
discounts will partially explain the decrease in the gross profit margin, as does the write off of
inventory which would cause an increase in cost of sales without a corresponding increase in
revenue. The deterioration of the operating profit margin (from 18.8% in 20X4 down to 13.1% in
20X5) is largely due to poor gross profit margins, but operating expenses are proportionately
higher (as a percentage of sales) in 20X5 (23.0% compared to 18.8%) which has further
reduced profitability. The higher operating expenses are likely to be the result of the
redundancy costs associated with the sale of the division and the costs associated with the
advertising campaign. The gain made on the sale of the division will however offset against
these additional operating costs and without having all of the information regarding the
amount of the costs, it is difficult to conclude on the impact of each on the operating
expenses.
Yogi Co’s performance as measured by ROCE has deteriorated dramatically from 40.0% in
20X4 (as adjusted) to only 27.6% in 20X5. As the net asset turnover has remained broadly the
same at 2.1 times (rounded), it is the fall in the operating profit which is responsible for the
overall deterioration in performance. If Yogi Co was to revalue its property at the start of the
following year, all else being equal, the ROCE will decline further. This is due to the additional
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depreciation on the revalued asset which would decrease operating profit and the increase in
capital employed due to the revaluation surplus that would be recognised.
Other issues
It is very questionable to have offered shareholders such a high dividend (half of the disposal
proceeds) to persuade them to vote for the disposal. At $4 million ($4,000 + $3,000 – $3,000,
ie the movement on retained earnings or 10 million shares at 40 cents) the dividend represents
double the profit for the year of $2 million ($3,000 – $1,000) if the gain on the disposal is
excluded. Another effect of the disposal is that Yogi Co appears to have used the other $4
million (after paying the dividend) from the disposal proceeds to pay down half of the 10%
loan notes. This has reduced finance costs and interest cover; interestingly, however, as the
finance cost at 10% is much lower than the 20X5 ROCE of 21.8%, it will have had a detrimental
effect on overall profit available to shareholders.
Summary
In retrospect, it may have been unwise for Yogi Co to sell the most profitable part of its
business at what appears to be a very low price. It has coincided with a remarkable
deterioration in profitability (not solely due to the sale) and the proceeds of the disposal have
not been used to replace capacity or improve long-term prospects. By returning a substantial
proportion of the sale proceeds to shareholders, it represents a downsizing of the business.
Activity 7: Group interpretation

1 Adjusted P/L extracts:
$’000
Revenue (24,280 – 5,500 (8,250 × 8/12) + 640 (intra-group)) 19,420
Cost of sales (13,740 – 2,500 (3,750 × 8/12)) [see Note] (11,240)
Gross profit 8,180
Operating expenses (3,100 – 2,000 (3,000 × 8/12) + 1,260 profit on disposal) (2,360)
Profit from operations 5,820
Finance costs (890 – 440 (660 × 8/12)) (450)
Tutorial note. Originally, the intra-group sale resulted in $0.64 million sales and $0.512
million costs of sales. These amounts were recorded in the individual financial statements of
Advent Co. On consolidation, the $0.64 million turnover was eliminated – this needs to be
added back. The corresponding $0.512 million COS consolidation adjustment is technically
made to Elf Co’s financial statements and so can be ignored here.
2 Ratios of Advent Co, eliminating impact of Elf Co and the disposal during the year
20X4
recalculate Working (see
d P/L above) 20X4 original 20X3
Gross profit margin 42.1% 8,180/19,420 43.4% 40.7%
Operating margin 30.0% 5,820/19,420 30.6% 10.5%
Interest cover 12.9 times 5,820/450 8.4 times 2.6 times
3 Gross profit margin

The underlying margin made by Advent Co has increased in 20X4 compared to 20X3,
although it is decreased slightly after the removal of Elf Co’s results. It is likely that Elf Co’s
could achieve a better gross profit margin as bookstores are under slightly less pressure to sell
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books at a discount compared to Advent Co as an online retailer. It may also be that Elf Co’s
gross profit margin was artificially inflated by obtaining cheap supplies from Advent Co (as a
result of Advent Co charging a lower mark up on the intra company sales). The gross margin
of Advent Co is likely to improve going forward as it sells goods to Elf Co at its normal mark up
after disposal.
Operating margin
The operating margin appears to have increased significantly on the prior year. It must be
noted that this contains the profit on disposal of Elf Co, which results in a one-off boost.
Removing the impact of the Elf Co gain on disposal still shows that the margin is improved
significantly on the prior year (4,360 (5,620 – 1,260)/19,420 = 22.5%). The improvement is likely
due to ceasing TV advertising which can be expensive. Advent Co will also have benefitted
from charging Elf Co market rates to rent the warehouse since disposal and this benefit is
expected to continue going forward.
Interest cover
Initially, the interest cover has shown significant improvement in 20X4 compared to 20X3, as
there has been a significant increase in profits. With the results of Elf Co stripped out, the
interest cover is even better, indicating that Elf Co incurred significant finance costs, perhaps
due to being highly geared or incurring leasing costs on its premises.
Fazit
Elf Co seems to have been a profitable company, although it did incur a significant amount of
interest costs. However, some of these profits may have been derived from favourable terms
with Advent Co, such as cheap supplies and free warehouse rental. The results of Advent Co
should improve in future periods, as it has continued to trade with Elf Co at its normal mark up
and earns income on renting its warehouse. A full year’s income will be included in future
periods.
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Limitations of financial
21 statements and
interpretation techniques
21
Learning objectives
Indicate the problems of using historic information to predict C1(a)

future performance and trends.
Discuss how financial statements may be manipulated to C1(b)

produce a desired effect (creative accounting, window dressing).
Explain why figures in a statement of financial position may not C1(c)

be representative of average values throughout the period for
example, due to:
(i) seasonal trading
(ii) major asset acquisitions near the end of the accounting period
Explain how the use of consolidated financial statements might C1(d)

limit interpretation techniques.
Discuss the limitations in the use of ratio analysis for assessing C3(a)
corporate performance.
Discuss the effect that changes in accounting policies or the use C3(b)
of different accounting polices between entities can have on the
ability to interpret performance.
21
Exam context
In Chapter 20, we looked at how the calculation of ratios and the interpretation of financial
statements is useful for understanding the position and performance of an entity. In this chapter,
we will consider the reasons why relying on the financial statements can be problematic. Financial
statements are intended to give a fair presentation of the financial performance of an entity over
a period and its financial position at the end of that period. The Conceptual Framework and the
IFRS Standards are there to ensure, as far as possible, that they do. However, there are a number
of reasons why the information in financial statements should not just be taken at face value. The
content of this chapter is important when attempting a Section C question that requires the
interpretation of a single entity or a group.
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21
Chapter overview
Limitations of financial statements and interpretation techniques
Limitations of IAS 24 Related Limitations of

financial statements Party Disclosures interpretation techniques
Problems with Definitions Limitations of ratio analysis

historical information
Disclosure requirements Other factors

Creative accounting
Possible effect of related

party transactions on
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1 Limitations of financial statements
1.1 Problems of historical financial information
The information within the financial statements is historical, as it reflects the performance and
position of the entity for a prior period. Using historical financial information can be problematic
for decision making:
• Financial data quickly becomes out of date and does not necessarily reflect the current
operating conditions of an entity.
• There is no guarantee that trends in historical data will continue and they cannot be reliably
used to predict future performance.
• A change in company strategy may have occurred since the financial data was published.
Similarly, a change in management since the results were published can lead to different
market expectations about the future.
1.1.1 Historical cost basis

As was covered in Chapter 1, historical cost is a permitted measurement basis under the
Conceptual Framework. The impact on the accounting ratios of, for example, a cost vs valuation
accounting policy for non-current assets was discussed in Chapter 20. The use of historical cost
can be particularly misleading when attempting to predict future performance.
Illustration 1: Problems with historic cost
Lanark Co holds its property, which was purchased 20 years ago, at a cost of £100,000. The
property has been depreciated on the straight line basis and has a remaining useful life of five
years. Lanark Co’s competitor is Alloa Co which acquired new property in the current year at a
cost of £1,000,000. The property has an estimated useful life of 40 years. Alloa Co used a loan to
finance the purchase of the property.
Required
Discuss the impact of measuring property at historical cost on the financial statements of Lanark
Co and Alloa Co.
Solution
The impact on the statement of financial position is likely to be relatively easy to arrive at. Lanark
Co will have a much lower asset value of $20,000 ($100,000 × 5/25 years remaining) due to
having an aged asset that is carried at historical cost. When considering a ratio such as return on
assets, Lanark Co would report a better return than that of Alloa Co due to the low carrying
amount of the property. Alloa Co had to acquire appropriate funding to make the purchase, and
the large loan increases capital employed and therefore decreases Alloa Co’s ROCE.
The impact on the statement of profit or loss and other comprehensive income can be more
difficult to determine. Lanark Co will have depreciation of just $4,000 per annum ($100,000/25
years) whereas Alloa Co will have depreciation of $25,000 per annum ($1,000,000 / 40 years).
This will impact on operating profit and therefore decrease Alloa Co’s margins and ROCE. Alloa
Co will also have a finance cost in respect of the loan which will impact on interest cover. The
information provided about the property held by each company is therefore essential to
understanding a number of ratios that could be calculated for each company.
1.2 Creative accounting

We have seen throughout this Workbook that there is flexibility over the accounting policy that an
entity chooses to apply (for example, cost v revaluation of property, plant and equipment) and
that judgement and estimates have to be applied (for example, in determining the amount of a
warranty provision). As a result, there is some flexibility in how certain balances and transactions
are accounted for, which can give rise to creative accounting. Creative accounting is where
management use accounting methods to work in their favour to achieve a desired effect.
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21: Limitations of financial statements and interpretation techniques 517

1.2.1 Pressure from investors
Listed companies produce their financial statements with one eye on the stock market and, where
possible, they like to produce financial statements which show analysts what they are expecting
to see, for example:
• Steady growth in profits
• Stable dividends
• No key ratio changes for improvement in ratios
This is often supported by the directors who may have bonus targets based on achieving certain
sales or profit targets that are aligned to investor expectations.
1.2.2 Examples of creative accounting techniques

• Removing peaks and troughs or achieving a desired profit target
- Provisions subsequently reversed
- Cut off manipulation, eg invoicing in advance to boost revenue
- Selling an asset pre-year end to realise a profit and repurchasing it post-year to end
• Reducing apparent gearing
- Window dressing, eg paying back a loan just before the year end, but taking it out again at
the beginning of the next year
The opportunities for creative accounting have decreased over recent years.
Essential reading
In Chapter 20, we discussed the importance of taking account of issues such as intragroup
trading, seasonal trading and the timing of asset acquisitions when interpreting changes or
differences in ratios. Chapter 21, Section 1 of the Essential reading covers these issues in more
detail.
2 IAS 24 Related Party Disclosures

Related party relationships and transactions are a normal feature of business. However, it is
important that the users of financial statements are made aware of their impact on the financial
statements. There is a presumption that transactions and balances reflected in the financial
statements have been entered into on an arm’s length basis, unless it is disclosed otherwise. ‘Arm’s
length’ means on the same terms as could have been negotiated with an external party, in which
each side bargained knowledgeably and freely, unaffected by any relationship between them.
2.1 Definitions
Related party (IAS 24): A person or entity that is related to the entity that is preparing its
KEY
TERM financial statements (the ’reporting entity’).
(a) A person or a close member of that person’s family is related to a reporting entity if that
person:
(i) Has control or joint control over the reporting entity;
(ii) Has significant influence over the reporting entity; or
(iii) Is a member of the key management personnel of the reporting entity or of a parent
of the reporting entity
(b) An entity is related to a reporting entity if any of the following conditions apply:
(i) The entity and the reporting entity are members of the same group (which means
that each parent, subsidiary and fellow subsidiary is related to the others).
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(ii) One entity is an associate* or joint venture* of the other entity (or an associate or
joint venture of a member of a group of which the other entity is a member).
(iii) Both entities are joint ventures* of the same third party.
(iv) One entity is a joint venture* of a third entity and the other entity is an associate of
the third entity.
(v) The entity is a post-employment benefit plan for the benefit of employees of either
the reporting entity or an entity related to the reporting entity.
(vi) The entity is controlled or jointly controlled by a person identified in (a).
(vii) A person identified in (a)(i) has significant influence over the entity or is a member of
the key management personnel of the entity (or of a parent of the entity).
(viii) The entity, or any member of a group of which it is a part, provides key
management personnel services to the reporting entity or the parent of the reporting
entity.
*including subsidiaries of the associate or joint venture
(IAS 24: para. 9)
2.1.1 Close members of family

Close members of the family of a person are defined as ‘those family members who may be
expected to influence, or be influenced by, that person in their dealings with the entity,’ (IAS 24:
para. 9) and include:
• That person’s children and spouse or domestic partner;
• Children of that person’s spouse or domestic partner; and
• Dependants of that person or that person’s spouse or domestic partner.
In considering each possible related party relationship, attention is directed to the substance of
the relationship, and not merely the legal form.
2.1.2 Entities that are not related parties

The following are not necessarily related parties:
(a) Two entities simply because they have a director or other member of key management
personnel in common, or because a member of key management personnel of one entity has
significant influence over the other entity;
(b) Two venturers simply because they share point joint control over a joint venture
(c) Entities such as providers of finance, trade unions, public utilities, and departments and
agencies of a government, simply by virtue of their normal dealings with an entity (even
though they may affect the freedom of action of an entity or participate in its decision-
making process); and
(d) A customer, supplier, franchisor, distributor, or general agent with whom an entity transacts a
significant volume of business, simply by virtue of the resulting economic dependence.
(IAS 24: para. 11)
2.2 Disclosure requirements

IAS 24 requires transactions with related parties to be disclosed. An entity must disclose the
following:
(a) The name of its parent and, if different, the ultimate controlling party, irrespective of whether
there have been any transactions.
(b) Total key management personnel compensation (broken down by category)
(c) If the entity has had related party transactions:
(i) Nature of the related party relationship
(ii) Information about the transactions and outstanding balances, including commitments
and bad and doubtful debts necessary for users to understand the potential effect of the
relationship on the financial statements
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No disclosure is required of intragroup related party transactions in the consolidated financial
statements.
Items of a similar nature may be disclosed in aggregate, except where separate disclosure is
necessary for understanding purposes.
2.3 Possible effect of related party transactions on the financial statements

When interpreting financial statements and you are aware that there have been related party
transactions, you must consider what the effect of that transaction is on the financial statements,
particularly:
(a) Higher or lower revenue and profit due to artificial prices on transactions with related parties
(b) Costs or savings due to different terms and conditions other than prices (eg lost interest due
to longer credit periods given to related parties)
(c) Revenue that would not occur without the influence of the related party
(d) Loans to or from related parties at preferential interest rates which would impact on finance
costs/finance income
Exam focus point

The impact of related party transactions will be relevant when a parent has acquired or sold a
subsidiary that it trades with. If, for example, a key customer is purchased and becomes a
subsidiary, the effects of any sales to that customer and any unrealised profits within
inventory at year end will be eliminated on consolidation. This will have an impact on the
margins earned by the group. You should also consider whether there is a different pricing
structure for group companies, for example, good are sold to other group companies at a
mark up of 10% whereas goods sold externally have a mark up of 30% applied.
3 Limitations of interpretation techniques

3.1 Limitations of ratio analysis
In Chapter 20, we saw that ratio analysis was the starting point to understanding the
performance and position of an entity. We have to be aware that the usefulness of ratio analysis
is limited by distorting factors. For example:
• Inflation when comparing to previous years that will increase sales prices and costs in the
current year. If, for example, there has been an inflationary increase in the cost of purchasing
goods for resale but the entity has decided not to increase its sales price in the year, the gross
profit margin and net profit margin would be lower in the current year than in prior years.
• Different accounting policies/classifications when comparing to different companies. This was
discussed in Chapter 20 when we considered the impact on ROCE and asset turnover of
adopting the revaluation, rather than cost model, for non-current assets.
• The financial statements are highly aggregated and the lack of information/breakdown of
information means that ratio analysis can be of limited value for decision making.
• Year-end figures are not necessarily representative of the position of the entity over the
period. Consider, for example, an entity that is holding a large quantity of inventory at its
year-end date in preparation for an increase in seasonal trade.
• Related party transactions, as discussed in Section 2 above, make the ratios incomparable
with other companies. Remember that IAS 24 requires disclosure of related party transactions
but the effect of the transactions will remain in the financial statements.
• Different companies in the same business may have different risk profiles or specific factors
affecting them, making industry comparisons less meaningful.
• Where financial statements are manipulated through creative accounting, as discussed in
Section 1 above, this is often done to improve key ratios, which can distort comparisons.
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3.1.1 Limitations of ratio analysis in group scenarios
When analysing group scenarios, is it important to be aware of the limitations that are specific to
consolidated financial statements. Many of these are extensions of the points made above.
• It may not be possible to directly compare ratios in group scenarios in which there is an
acquisition or disposal of a subsidiary during the period. It is essential that you reflect on the
impact of such an acquisition or disposal when discussing any ratios calculated.
• The timing of an acquisition or disposal during the period will have an impact on the
consolidated statement of financial position (CSFP) and consolidated statement of profit or
loss and other comprehensive income (CSPLOCI). The CSPLOCI is pro-rated and will therefore
include the profits of a subsidiary post-acquisition (for a subsidiary acquired) or pre-disposal
(for a subsidiary disposed of) if there is a mid-year acquisition or disposal. The CSFP will
include all of the assets and liabilities of an acquired subsidiary and none of the assets and
liabilities of a subsidiary disposed of. Ratios that involve the interaction of the CSPLOCI and
CSOFP such as return on capital employed will be distorted by the mis-match.
• Comparing performance year on year will be difficult if the subsidiary operates in a different
market sector or sells different product types to the parent.
• The acquisition or disposal may result in one off costs, such as legal fees, which can distort the
information presented.
• If the acquisition or disposal is settled in cash, there will be a significant impact on the net
assets and liquidity.
3.2 Non-financial factors
Activity 1: Limitations of ratio analysis
Which THREE are valid limitations of ratio analysis of published financial statements?
 Published financial statements are frequently unreliable as a result either of fraud or of error
on the part of management.
 Published financial statements contain estimates such as depreciation.
 There are no prior year figures to compare to current year figures.
 Accounting policies may vary between companies, making comparisons difficult.
 The nature and character of a business may change over time, making strictly numerical
comparisons misleading.
 The nature of the industry may be volatile, making intercompany comparison within the
industry misleading.
Activity 2: Interpreting asset turnover ratio
An analyst is comparing the non-current asset turnover ratios of two listed businesses engaged in
similar activities. The non-current asset turnover ratio of one entity is almost 50% higher than that
of the other entity, and she concludes that the entity with the higher non-current asset turnover
ratio is utilising its assets far more effectively.
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Required
Which THREE of the following suggest this conclusion might not be valid?
 One entity revalues its properties and the other entity holds its assets under the historical cost
model.
 One entity buys its assets for cash and the other entity leases its assets under long-term
leases for all, or substantially all, the asset’s useful life.
 One entity has assets nearing the end of their useful life, whilst the other entity has recently
acquired new assets.
 One entity depreciates its assets over a much shorter useful life than the other entity.
 One entity pays a higher rate of interest on its borrowings than the other.
 One entity has significantly higher gearing than the other.
PER alert
to identify inconsistencies between information in the financial statements of an entity and
accompanying narrative reports. You can apply the knowledge you obtain from this chapter
to help to demonstrate this competence.
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Chapter summary
Limitations of financial statements and interpretation techniques
Limitations of IAS 24 Related Limitations of

financial statements Party Disclosures interpretation techniques
Problems with historical Definitions Limitations of ratio analysis

information Related party is a person or Consider the impact of:
• Reflects performance and entity that is related to the entity • Inflation
position in the past by being • Different accounting policies
– Not necessarily predictive of (a) A person or a close member • Lack of detailed information
future performance of that person's family • Year end figures not being
– No guarantee that trends (b) An entity that is related to representation of balances
continue another entity throughout the year
– Entities may change strategy • Related party transactions
• Historical cost accounting • The impact of different risk
widely used Disclosure requirements profiles
– Can be misleading when (a) The name of its parent and • Manipulation of financial
trying to predict future the ultimate controlling party statements
irrespective of whether there
have been any transactions
Creative accounting (b) Total key management Other factors
• Options in accounting policies, personnel compensation Factors other than the financial
judgements and estimates (c) If the entity has had related statements may be relevant:
allows flexibility party transactions: • How technologically advanced
• Entities under pressure from (i) Nature of the related is the company?
investors to report certain party relationship • What are its environmental
results (ii) Information about the policies?
– Profit smooth over time transactions and • What is the reputation of
– Sales/profit growth as outstanding balances management and as an
expected employer?
– No large changes in ratios • What is its mission statement?
Possible effect of related party
transactions on financial
statements
• Higher or lower revenue and
profit due to artificial prices
• Costs or savings due to
different terms and conditions
• Revenue that would not occur
without the influence of the
related party
• Loans to or from related
parties at preferential interest
rates
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1. Limitations of financial statements

Financial statements are limited in their usefulness due to the fact that the information is historic
and does not necessarily help to predict future performance. There is also the possibility that
careful selection of accounting policies, estimates and judgements means that the entity has
applied creative accounting techniques, which may present the performance and position of the
entity in the best light or to meet market expectations.
2. Related party transactions

Related party transactions are a normal part of business, but the users of financial statements
assume that an entity carries out transactions at an arm’s length unless information is disclosed
to the contrary. IAS 24 requires related party relationships, transactions and balances to be
disclosed.
3. Limitations of interpretation techniques

The techniques we use to interpret financial data may also be limited due to, for example, the
impact of inflation, different accounting policies for accounting for similar transactions, year-end
figures not being representative of averages for the year or related party transactions distorting
the reported information.
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Question practice
the Workbook):
Section C Q41 Alpha Co
Further reading
Performance appraisal
www.accaglobal.com
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Activity answers
Activity 1: Limitations of ratio analysis

• Published financial statements contain estimates such as depreciation.
• Accounting policies may vary between companies, making comparisons difficult
• The nature and character of a business may change over time, making strictly numerical
comparisons misleading.
‘Published financial statements are frequently unreliable as a result either of fraud or of error on
the part of management’ may be the case, but this is offset by the statutory requirement for them
to represent a true and fair view, and by the fact that most investment decisions (for example)
would involve an element of due diligence work to ensure that the accounts could, in fact, be
relied upon.
‘There are no prior year figures to compare to current year figures’ is incorrect because in
published financial statements, comparatives must be shown.
The following are problems associated with inter-temporal analysis (ie analysis of the same
company, over time):
• Changes in the nature of the business
• Unrealistic depreciation rates under historical cost accounting
• The changing value of the currency unit being reported
The following are problems associated with cross-sectional analysis (ie analysis of different
companies, at the same time):
• Different degrees of diversification
• Different production and purchasing policies
• Different financing policies
• Different accounting policies
• Different effects of government incentives
Although the nature of the business being volatile will impact the accounts, the volatility will affect
all companies within the industry and thus ratio analysis will still be useful/meaningful to assess
relative performance.
Activity 2: Interpreting asset turnover ratio

• One entity revalues its properties and the other entity holds its assets under the historical
cost model.
• One entity has assets nearing the end of their useful life, whilst the other entity has
recently acquired new assets.
• One entity depreciates its assets over a much shorter useful life than the other entity.
All of these would cause the value of non-current assets to be comparatively higher in one of the
entities, thus causing a difference to the asset turnover ratio. Whether an entity buys assets for
cash or leases assets under a long-term lease, has no impact on the non-current asset turnover
ratio because in both instances, the entity will record an asset in its statement of financial
position.
If one entity had purchased its assets for cash and the other under short-term leases (less than 12
months), that would impact asset turnover as, under a short-term lease (less than 12 months), no
asset is recorded in the statement of financial position.
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Neither interest nor borrowings feature in the asset turnover ratio, so the rate of interest an entity
pays is not relevant this year.
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Statement of cash flows
22
22
Learning objectives
Prepare a statement of cash flows for a single entity (not a group) D1(c)
in accordance with relevant IFRS Standards using the indirect
method.
Interpret financial statements (including statements of cash C2(d)

flows) together with other financial information to give advice
from the perspectives of different stakeholders.
Interpret financial statements (including statements of cash C2(e)

flows) together with other financial information to assess the
performance and financial position of an entity.
Compare the usefulness of cash flow information with that of a C3(c)

statement of profit or loss or statement of profit or loss and other
22
Exam context
You should be familiar with how to prepare a statement of cash flows from your previous studies.
Financial Reporting builds on your previous knowledge by looking in more depth at some of the
key calculations and introducing the interpretation of the statement of cash flows. In the Financial
Reporting exam, you may be asked to prepare extracts from the statement of cash flows of a
single entity or interpret a statement of cash flows in a Section C question. The 2022–23 syllabus
emphasises the importance of being able to analyse and interpret a statement of cash flows and
therefore you must be prepared for an interpretation question in this area. The calculation of key
cash flows or insights gained from interpretation may be tested in the OT Questions in Section A
or B of the exam.
22
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Chapter overview
IAS 7 Formats Interpretation of Cash flow

Statement statement of ratio
of Cash Flows cash flows
Key terms Key sections of the Analysis points Provides a useful

statement of cash flows indicator of a company's
cash position
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1 IAS 7 Statement of Cash Flows
Statement of cash flows: A primary financial statement that explains how an entity’s cash
KEY
TERM balance has changed during the year. It shows how an entity has generated and used cash
during the period.
2 Introduction
The purpose of the statement of cash flows is to show the effect of a company’s commercial
transactions on its cash balance.
It is thought that users of accounts can readily understand cash flows, as opposed to statements
of profit or loss and other comprehensive income and statements of financial position which are
subject to the effects of accounting policy choices and accounting estimates.
It has been argued that ‘profit’ does not always give a useful or meaningful picture of a
company’s operations. Readers of a company’s financial statements might even be misled by a
reported profit figure.
Shareholders might believe that if a company makes a profit for the period, of say, $100,000 then
this is the amount which it could afford to pay as a dividend. Unless the company has sufficient
cash in the business which is available to make a dividend payment, the shareholders’
expectations would be wrong.
Cash flows are used in investment appraisal methods such as net present value and hence a
statement of cash flows gives potential investors the chance to evaluate a business.
2.1 Objective of IAS 7 Statement of Cash Flows

The aim of IAS 7 is to provide information to users of financial statements about the entity’s ability
to generate cash and cash equivalents, as well as indicating the cash needs of the entity. The
statement of cash flows provides historical information about cash and cash equivalents,
classifying cash flows between operating, investing and financing activities.
2.2 Scope
A statement of cash flows is a primary financial statement. All types of entity can provide useful
information about cash flows as the need for cash is universal, whatever the nature of their
revenue-producing activities. Therefore, all entities are required by the IAS 7 to produce a
2.3 Benefits of cash flow information

The use of statements of cash flows is very much in conjunction with the other primary financial
statements. Users can use the information in the statement of cash flows to gain further
appreciation of the change carrying amounts of property, plant and equipment, of the entity’s
financial position (liquidity and solvency) and the entity’s ability to adapt to changing
circumstances by affecting the amount and timing of cash flows. A statement of cash flows
enhances comparability as cash flows are not affected by differing accounting policies used for
the same type of transactions or events.
Cash flow information is of a historical nature but it can be used as an indicator of the amount,
timing and certainty of future cash flows. Past forecast cash flow information can be checked for
accuracy as actual figures emerge. The relationship between profit and cash flows can be
analysed as can changes in prices over time.
2.4 Definitions
The standard provides the following definitions.
Cash: Comprises cash on hand and demand deposits.

KEY
TERM
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22: Statement of cash flows 531

Cash equivalents: Short-term, highly liquid investments that are readily convertible to known
amounts of cash and which are subject to an insignificant risk of changes in value.
Cash flows: Inflows and outflows of cash and cash equivalents.
Operating activities: The principal revenue-producing activities of the entity and other
activities that are not investing or financing activities.
Investing activities: The acquisition and disposal of long-term assets and other investments
not included in cash equivalents.
Financing activities: Activities that result in changes in the size and composition of the
contributed equity and borrowings of the entity.
(IAS 7: para. 6).
2.5 Cash and cash equivalents

The standard expands on the definition of cash equivalents (IAS 7: para. 7): they are not held for
investment or other long-term purposes, but rather to meet short-term cash commitments. To fulfil
the above definition, an investment’s maturity date should normally be within three months from
its acquisition date and there should be insignificant risk of changes in value. It would usually be
the case then that equity investments (ie shares in other companies) are not cash equivalents. An
exception would be where preferred shares were acquired with a very close maturity date.
Loans and other borrowings from banks are classified as financing activities (IAS 7: para. 8). In
some countries, however, bank overdrafts are repayable on demand and are treated as part of an
entity’s total cash management system. In these circumstances an overdrawn balance will be
included in cash and cash equivalents. Such banking arrangements are characterised by a
balance which fluctuates between overdrawn and credit.
Movements between different types of cash and cash equivalent are not included in cash flows.
The investment of surplus cash in cash equivalents is part of cash management, not part of
operating, investing or financing activities (IAS 7: para. 9).
3 Formats
IAS 7 Statement of Cash Flows allows two possible layouts for the statement of cash flows in
respect of operating activities:
(a) The indirect method, where profit before tax is reconciled to operating cash flow
(b) The direct method, where the cash flows themselves are shown
You will only be examined on the indirect method in your Financial Reporting exam.
Exam focus point

The Financial Reporting syllabus makes it clear that you could be asked to prepare extracts
from the statement of cash flows for a single entity using the indirect method only. This is
largely assumed knowledge from your earlier studies and it is therefore important that you
refresh your knowledge of how to prepare the statement of cash flows in preparation for the
exam.
Essential reading
Chapter 22 Sections 1 and 2 of the Essential reading recap your knowledge of the preparing a
statement of cash flows with an Activity on this topic using the indirect method.
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3.1 Sections of the statement of cash flows
As is shown in the ‘Proforma – indirect method’ statement of cash flows below, IAS 7 requires cash
flows to be presented under each of the following headings:
• Cash flows from operating activities
• Cash flows from investing activities
• Cash flows from financing activities
3.2 Operating activities

Cash flows from operating activities are primarily derived from the principal revenue producing
activities of the entity. Therefore, they generally result from the transactions or other events that
enter into the determination of profit or loss.
The amount of cash flows arising from operating activities is a key indicator of the extent to which
the operations of the entity have generated sufficient cash flows to repay loans, maintain the
operating capability of the entity, pay dividends and make new investments without recourse to
external sources of finance.
3.3 Investing activities

The cash flows included in this section are those related to the acquisition or disposal of any non-
current assets or trade investments together with returns received in cash from investments, ie
dividends and interest.
This section shows the extent of new investment in assets which will generate future income and
cash flows.
3.4 Financing activities

Financing cash flows comprise receipts from or repayments to external providers of finance in
respect of principal amounts of finance. Examples of financing cash flows are:
• Cash proceeds from issuing shares
• Cash proceeds from issuing loan notes, loans, notes, bonds, mortgages and other short- or
long-term borrowings
• Cash repayments of amounts borrowed
• Dividends paid to shareholders
• Lease liability payments (repayment of principal portion only)
In order to calculate such figures, the closing statement of financial position figure for long-term
debt or share capital and share premium is compared with the opening position for the same
items. The effects of any non-cash flow changes to share capital (eg bonus issues) must also be
taken into account.
3.5 Indirect method – proforma

This is an example of a completed statement of cash flows which has been prepared using the
indirect method.
XYZ CO
STATEMENT OF CASH FLOWS (INDIRECT METHOD) FOR YEAR ENDED 20X7
$m $m
Cash flows from operating activities
Profit before taxation 3,390
Adjustments for:
Depreciation 380
Amortisation 75
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$m $m
Profit on sale of property, plant and equipment (5)
Investment income (500)
Interest expense 400
3,740
Decrease in inventories 1,050
Increase in trade and other receivables (500)
Decrease in trade payables (1,740)
Cash generated from operations 2,550
Interest paid (270)
Income taxes paid (900)
Net cash from operating activities 1,380
Cash flows from investing activities

Purchase of property, plant and equipment (800)
Purchase of intangible assets (100)
Proceeds from sale of equipment 20
Interest received 200
Dividends received 200
Net cash used in investing activities (480)
Cash flows from financing activities

Proceeds from issue of share capital 250
Proceeds from long-term borrowings 250
Payment of lease liabilities (90)
Dividends paid (1,200)
Net cash used in financing activities (790)
Net increase in cash and cash equivalents 110
Cash and cash equivalents at beginning of year 120
Cash and cash equivalents at end of year 230
3.6 Direct method

The direct method is the preferred approach of IAS 7 as it shows information not available
elsewhere in the financial statements. This is outside of scope in your syllabus, but you need to be
aware of its existence.
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Exam focus point
In the March 2020 exam, candidates were asked to prepare extracts from the statement of
cash flows. The Examiner’s Report commented that the requirement to prepare extracts from
the SCF (investing and financing activities) was omitted by a significantly large number of
candidates. For those that did attempt this part of the question, the dividend paid was often
correctly included as a deduction from financing activities. It is worth noting that when buying
new assets such as investments or a brand, this will result in cash outflow that should be
recognised in investing activities. The requirement to prepare extracts from the SCF is common
in this style of question and is something that candidates need to work on and improve.
Activity 1: Thorstved Co
Below are the statements of financial position for Thorstved Co at 31 December 20X7 and 31
December 20X8 and the statement of profit or loss and other comprehensive income for the year
20X8 20X7
$’000 $’000
ASSETS
Non-current assets
Property, plant and equipment 798 638
Development costs 110 92
908 730
Current assets
Inventories 313 280
Trade receivables 208 186
Cash 111 4
632 470

Equity
$1 ordinary shares 220 200
Share premium 140 80
Revaluation surplus 42 –
Retained earnings 599 570
1,001 850
4% loan notes 250 100
Deferred tax 76 54
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20X8 20X7
$’000 $’000
Provision for warranties 30 26
356 180
Current liabilities
Trade payables 152 146
Current tax payable 26 24
Interest payable 5 –
183 170
$’000
Revenue 1,100
Cost of sales (750)
Gross profit 350
Expenses (247)
Finance costs (10)
Profit on sale of equipment 7
Income tax relating to gain on property revaluation (18)
Notes.
1 Depreciation of property, plant and equipment during 20X8 was $54,000 and deferred
development expenditure amortised was $25,000.
2 Proceeds from the sale of equipment were $58,000, giving rise to a profit of $7,000. No other
items of property, plant and equipment were disposed of during the year.
3 Finance costs represent interest paid on the loan notes. New loan notes were issued on 1
January 20X8.
4 The company revalued its property at the year end. Company policy is to treat revaluations
as realised profits when the asset is retired or disposed of.
Required
1 Calculate the cash paid to acquire property, plant and equipment for inclusion in the investing
activities section of the statement of cash flows.
2 Prepare the financing activities section for inclusion in the statement of cash flows.
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Solution
1
Property, plant & equipment

$’000
b/d
Depreciation/amortisation
SPLOCI – OCI
Non-cash additions
Disposals
Cash paid/(rec’d) β
c/d
Cash flows from financing activities $’000 $’000
Proceeds from share issue (W1)
Proceeds from issue of loan notes (W2)
Dividends paid (W1)
Net cash used in financing activities
Workings
1 Equity
Share capital/ share

premium Retained earnings
$’000 $’000
b/d
Profit or loss
Non-cash
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$’000 $’000
Cash (paid)/rec’d β
c/d
2 Loan notes
$’000
b/d
SPLOCI – P/L
– OCI
Non-cash
c/d
Essential reading
An activity which requires the preparation of the full statement of cash flows for Thorstved Co is
included in the Essential Reading.
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4 Interpretation of statement of cash flows
4.1 Introduction
IAS 7 was introduced to enable users to evaluate an entity’s ability to generate cash and cash
equivalents and of its needs to utilise those cash flows.
While the statement of cash flows clearly shows the overall cash inflow or outflow for the period,
and the closing position of cash and cash equivalents, the individual lines of the statement of cash
flow can be analysed to give users detailed information on how the entity has performed during
the period, and the areas which have generated significant cash inflows and outflows.
Exam focus point

Recent Examiner’s Reports have consistently stated that students do not perform well in the
Section C interpretation question, mainly due to not addressing the requirements or not using
the information in the scenario to explain ratios calculated or changes in the financial
statements. This point extends to interpretation of the statement of cash flows. You must
understand what each section of the statement of cash flows represents, but making generic
statements about, for example, what the cash flow from operating activities section shows, will
not score credit in the exam. You must make more specific points based on the scenario you
are presented with.
As has been seen, the statement of cash flows consists of three main areas. It is important to
understand what the cash flows from operating activities, investing activities and financing
activities tell us about the business’ activities.
Operating The cash flow from operating activities figure should ideally be positive. If it is
activities positive then the business will be generating funds from its core activities, which
suggests that it is more likely to be a viable entity. The ‘quality’ of profit it
considered to be better (in that profit will turn to cash in the short term) if the
cash generated from operating activities figure is equal to or greater than to
the operating profit in the statement of profit or loss.
A healthy business would also expect to pay the interest and tax charge from
the cash generated from operations. Any cash inflow that remains after the
payment of interest and tax is considered ‘free cash’ which can be used, for
example, to purchase property, plant and equipment or pay dividends.
When you are analysing the cash flows relating to operating activities, it is
important to consider the movements in working capital.
• An increase in trade receivables may result in cash flow problems for an
entity. Consider whether there are genuine reasons for an increase in trade
receivables that may help to explain an increase, such as taking on a major
new customer on extended credit terms. A decrease in trade receivables is
favourable if it is the result of better credit management but not if it is a
result of decreased amounts of revenue.
• An increase in inventories is also generally problematic in terms of cash
flows, but again consider whether there are specific reasons for this such as
bulk buying close to the year end to take advantage of a discount offered
by a supplier.
• An increase in trade payables is positive from a cash flow perspective, but
the reasons must be understood. If an entity is simply taking advantage of
supplier credit terms, it makes sense from a working capital perspective to
increase payables. However, if the increase is due to poor working capital
management or a lack of cash available to make payments, this is a
concern and may cause problems for the going concern of the entity and
for supplier relations.
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Investing Analysis of investing activities relies on an understanding of an entity’s business
activities model and aims. If the business is seeking growth, there may well be a net cash
used in investing activities to reflect the amounts spent on, for example, the
purchase of property, plant and equipment, intangible assets or investments. If
the business has a lack of cash, it may resort to selling its property, plant and
equipment in order to generate short-term cash inflows.
Investment income will also be recorded in this section and therefore, interest
received or dividends received may feature here.
Financing Again, to understand cash flows from or used in financing activities requires an
activities understanding of an entity’s challenges and aims. An entity that is growing and
investing in assets may require to raise cash flows by issuing new shares or
receiving loans from its bank. Whilst cash inflows from the proceeds of
financing are positive in the year they are received, you should reflect on the
impact on the entity of having to pay interest and make capital repayments in
the longer term.
An entity that has acquired right of use assets through lease agreements
rather than purchasing assets using cash will have an outflow in respect of the
payment of lease obligations. An entity with a surplus of cash may use it to pay
back any borrowings.
4.2 Relationship between profit and cash

It is important to appreciate that it is wrong to try to assess the health of a reporting entity solely
on the basis of a single indicator. When analysing cash flow data, the comparison should not just
be between cash flows and profit, but also between cash flows over a period of time (say three to
five years).
Cash is not synonymous with profit on an annual basis, but you should also remember that the
‘behaviour’ of profit and cash flows will be very different. Profit is smoothed out through accruals,
prepayments, provisions and other accounting conventions. This does not apply to cash, so the
cash flow figures are likely to be ‘lumpy’ in comparison. You must distinguish between this
‘lumpiness’ and the trends which will appear over time.
The relationship between profit and cash flows will vary constantly. Note that healthy companies
do not always have reported profits exceeding operating cash flows. Similarly, unhealthy
companies can have operating cash flows well in excess of reported profit. The value of
comparing them is in determining the extent to which earned profits are being converted into the
necessary cash flows.
Profit is not as important as the extent to which a company can convert its profits into cash on a
continuing basis. This process should be judged over a period longer than one year. The cash
flows should be compared with profits over the same periods to decide how successfully the
reporting entity has converted earnings into cash.
Illustration 1: Tabba Co
Here is an example of how the position and performance of a company can be analysed using the
statement of financial position, profit or loss extracts and the statement of cash flows.
The following draft financial statements relate to Tabba Co, a private company:
STATEMENTS OF FINANCIAL POSITION AS AT:
30 September 20X5 30 September 20X4

$’000 $’000 $’000 $’000
Non-current assets
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30 September 20X5 30 September 20X4
$’000 $’000 $’000 $’000
Current assets
Accrued income: Insurance claim 1,500 1,200
Cash and cash equivalents 850 nil
8,000 5,650
Equity
Share capital ($1 each) 6,000 6,000
Revaluation surplus Nil 1,600
Retained earnings 2,550 850
8,550 8,450
Non–current liabilities
Lease liabilities 2,000 1,700
6% loan notes 800 nil
10% loan notes nil 4,000
Deferred tax 200 500
Government grants 1,400 900
4,400 7,100
Current liabilities
Bank overdraft nil 550
Government grants 600 400
Lease liabilities 900 800
Current tax payable 100 5,650 1,200 5,900
STATEMENT OF PROFIT OR LOSS EXTRACT FOR THE YEAR ENDED 30 SEPTEMBER 20X5
$’000
Operating profit before interest and tax 270
Interest expense (260)
Interest receivable 40
Income tax credit 50
Note. The interest expense includes interest payable in respect of lease liabilities.
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STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 30 SEPTEMBER 20X5
$’000 $’000
Profit before taxation 50
Adjustments for:
Depreciation 2,200
Profit on disposal of PPE (Note (a)) (4,600)
Release of grant (250)
Increase in insurance claim receivable (300)
Investment income (40)
(2,680)
(Increase) decrease in inventories (700)
(Increase) decrease in trade & other receivables (500)
Increase (decrease) in trade payables 1,100
Cash used in operations (2,780)
Interest paid (260)
Income taxes paid (1,350)
Net cash outflow from operating activities (4,390)
Proceeds of grants 950
Proceeds of disposal of property 12,000
Purchase of property, plant and equipment (2,900)
Net cash from investing activities 10,090
Proceeds of loan (6% loan received) 800
Repayment of loan (10% loan repaid) (4,000)
Payments under leases (1,100)
Net cash used in financing activities (4,300)
Net increase in cash and cash equivalents 1,400
Opening cash and cash equivalents (550)
Closing cash and cash equivalents 850
Additional information
(1) Tabba Co sold its factory for its fair value $12 million on 30 September 20X5. The transaction
met the criteria to be recognised as a sale of IFRS 15. Under the terms of the sale, Tabba Co
will immediately lease the factory back over a period of 10 years. The accountant of Tabba
Co has derecognised the factory and has recorded the gain on sale in profit or loss. They
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have not accounted for the lease. Some of the proceeds were used to make a loan repayment
which was overdue.
(2) Property plant and equipment includes plant acquired under lease contacts entered into
during the year which gave rise to right-of-use assets of $1.5 million. The initial measurement
of the right-of-use asset was equal to the present value of the future lease payments on
commencement of the lease.
(3) Tabba Co entered into a significant contract with a supermarket chain in August 20X5. The
supermarket chain purchased a large quantity of goods during September 20X5 on extended
credit terms. The supermarket chain is expected to place another large order in October 20X5
and Tabba Co has begun to store inventory to meet the demand.
(4) Tabba Co has received a letter from one of its key suppliers indicating that it will cease
supply if outstanding invoices are not settled on a timely basis.
Required
Using the information above, comment on the change in the financial position of Tabba Co during
the year ended 30 September 20X5.
Note. Note that you are not required to calculate any ratios.
Solution
Changes in Tabba Co’s financial position
The statement of cash flows reveals a healthy overall increase in cash of $1.4 million. However,
Tabba Co has a net cash outflow from its operating activities and therefore its going concern
status must be in doubt.
To survive and thrive, businesses must generate cash from their operations, but Tabba Co used
cash in its operations totalling $2.78 million despite reporting an operating profit of $270,000. The
main reason Tabba Co was able to report a profit was because of the one-off $4.6 million surplus
on disposal of the factory. The sale of the factory appears to meet the criteria of a sale and
leaseback transaction and therefore has not been accounted for correctly. An adjustment is
required to recognise the right of use asset in respect of the rights retained, the lease liability and
to adjust the gain on the sale to reflect only the gain on the rights transferred. The cash proceeds
would not change and are stated correctly in the statement of cash flows. The fact that the
transaction took place immediately before the year end and the incorrect accounting treatment
implies that the ‘sale’ is an attempt to window dress the financial statements. The gain on rights
retained and the cash inflow are non-recurring transactions which in the future will be replaced
by interest expenses and repayments of lease liabilities which will have a negative impact on cash
flows.
Furthermore, were it not for the disposal proceeds of $12 million from the sale of its factory, Tabba
Co would be reporting a $10.6 million net decrease in cash. Tabba Co will not be able to sell the
factory for cash in the coming year, therefore, it seems likely that the forthcoming period will see
a large outflow of cash unless Tabba Co’s trading position improves.
Despite the apparent downturn in trade, Tabba Co’s working capital balances (inventories, trade
receivables and trade payables) have all increased in the year. We must consider the reasons for
this and the potential implications for the company in the longer term. The receivables and
inventory have both increased but appear to be due to the new contract with the supermarket
chain. The supermarket chain has been offered extended credit terms and the company has
begun to store inventory to meet future demands. This has a negative impact on cash flow in the
short term, but is likely to generate future profit and positive cash flows in the future. The increase
in trade payables is an indication that the directors are managing a lack of short-term cash
inflows by delaying their payments to suppliers. This policy is not sustainable, as is evidenced by
the letter from the supplier suggested that it will cease to supply. The ongoing viability of Tabba
Co relies on managing its working capital to allow it to make payments to supplies when they fall
due.
The income tax paid of $1.35 million in relation to the previous period is high. This suggests that
Tabba Co’s fall from profitability has been swift and steep. It is important to note that a company
would expect its cash flow from operations to cover its mandatory payments of interest and tax.
HB2022

Tabba Co is not in the position to do this and will need to fund these payments from other
sources.
There are some good signs though. Investment in non-current assets has continued with both
cash purchases and right of use assets acquired under lease agreements. The acquisition of
assets using leases may indicate a lack of cash available to purchase the asset outright and will
result in future payments of interest (operating activities) and capital (investing activities)
repayments which will have a negative impact on cash. The use of lease agreements is not
necessarily a bad sign though and may be a very sensible way to acquire assets to expand the
business when cash is not available.
Some of the disposal proceeds have been used to redeem the expensive $4 million 10% loan which
was overdue. The fact that the loan repayments were overdue furthers the suggestion that the
company is not managing its cash position well and is finding it difficult to make payments as
they fall due. The repayment is non-recurring in nature and will therefore not be required in future
periods. The loan seems to have been partially replaced with a smaller and cheaper $800,000 6%
loan. This will have a positive impact on the amount of interest paid, but the reasons for taking the
loan and the repayment terms need to be understood.
It is noted that Tabba Co has a large liability in respect of government grants. If Tabba Co fails to
comply with the terms and conditions of the grant, it will become repayable, which will have
negative cash flow implications. It is also noted that Tabba Co did not pay an ordinary dividend in
the year. That decision was appropriate in the current year given the cash outflows, however the
payment of a dividend may be expected in the future.
Tabba Co’s recovery may depend on whether the circumstances causing the slump in profits can
be addressed and the company is able to generate an operating cash inflow in the near future.
The statement of cash flows has, however, highlighted some serious issues for the shareholders to
discuss with the directors at the annual general meeting.
4.3 Question practice

Having seen the analysis of changes in a company’s financial position in an illustration, you
should attempt the activity which follows.
Activity 2: Interpretation of a cash flow for Emma Co
Set out below are the financial statements of Emma Co.

STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 DECEMBER 20X2
$’000
Revenue 2,553
Gross profit 739
Other income: interest received 25
Finance costs (75)
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STATEMENTS OF FINANCIAL POSITION AS AT 31 DECEMBER
20X2 20X1
$’000 $’000
Assets
Non-current assets
Investments – 25
Current assets
Inventories 150 102
Short-term investments 50 –
Cash and cash equivalents 2 1
Total assets 1,222 948
20X2 20X1
Equity and liabilities $’000 $’000
Equity
Share capital ($1 ordinary shares) 200 150
Share premium account 160 150
Revaluation surplus 100 91
Long-term loan 130 50
Environmental provision 40 -
Current liabilities
Trade and other payables 127 119
Bank overdraft 85 98
Taxation 120 110
Total equity and liabilities 1,222 948
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STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DECEMBER 20X2
$’000 $’000
Depreciation charge 90
Loss on sale of property, plant and equipment 13
Profit on sale of non-current asset investments (5)
Interest expense (net) 50
(Increase)/decrease in inventories (48)
(Increase)/decrease in trade receivables (75)
Increase/(decrease) in trade payables 8
333
Interest paid (75)
Dividends paid (80)
Tax paid (130)
Net cash from operating activities 48
Payments to acquire property, plant and equipment (161)
Payments to acquire intangible non-current assets (50)
Receipts from sales of property, plant and equipment 32
Receipts from sale of non-current asset investments 30
Net cash flows from investing activities (124)
Issue of share capital 60
Long-term loan 80
Net cash flows from financing 140
Increase in cash and cash equivalents 64
Cash and cash equivalents at 1.1.X2 (97)
Cash and cash equivalents at 31.12.X2 (33)
The following information is available:

(1) Emma Co is a growing business that sells craft materials to wholesale customers. It was set
up using second-hand equipment which the owners are now seeking to replace over a five-
year period. New assets have been acquired in cash, partially financed by the issue of shares
which was taken up by friends and family of the director. Emma Co does not have any lease
arrangements but may consider the use of these in the future.
(2) Emma Co has payment terms of 60 days but prefers to pay its suppliers more quickly to
ensure it maintains good relationships with them. It offers 45 days credit to its customers but
does not operate a credit control department to manage its collections.
(3) Emma Co has received a significant order for merchandise which is due to be dispatched
shortly after the year end.
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Working capital movements
Inventory Receivables Payables

$’000 $’000 $’000
B/d 102 315 119
Increase (decrease) 48 75 8
C/d 150 390 127
Required
Refer to the financial statements and additional information relating to Emma Co.
Using the information referenced above, and calculating any relevant ratios, comment on the
change in the financial position of Emma Co during the year ended 30 September 20X5.
Solution
Activity 3: Financial adaptability
The following is an extract from the statement of cash flows of Quebec Co for the year ended 31
December 20X1:
$m
Cash flows from operating activities 600
Cash flows from investing activities (800)
Cash flows from financing activities (200)
Net decrease in cash and cash equivalents (400)
Cash and cash equivalents at the beginning of the period 100
Cash and cash equivalents at the end of the period (300)
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Required
Based on the information provided, which of the following independent statements would be a
realistic conclusion about the financial adaptability of Quebec Co for the year ended 31
December 20X1?
 The failure of Quebec Co to raise long-term finance to fund its investing activities has resulted
in a deterioration of Quebec Co’s financial adaptability and liquidity.
 Quebec Co must be in decline as there is a negative cash flow relating to investing activities.
 The management of Quebec Co has shown competent stewardship of the entity’s resources
by relying on an overdraft to fund the excess outflow on investing activities not covered by the
inflow from operating activities.
 The working capital management of Quebec Co has deteriorated year on year.
5 Cash flow ratio

As we have seen earlier in the course, accounting ratios can be used to appraise and
communicate the position and prospects of a business by assessing whether the ratios that have
been calculated indicate a strength or weakness in the company’s affairs.
The cash flow ratio can be used to evaluate a company’s net cash inflow to its total debts.
Net cash inflow

× 100
Total debt
(a) Net cash inflow from operating activities is the amount of cash which the company has
coming into the business from its operations. A suitable figure for net cash inflow can be
obtained from the statement of cash flows.
(b) Total debts are short‑term and long‑term payables, including provisions. A distinction can be
made between debts payable within one year and other debts and provisions.
This ratio is expressed as a percentage.
A company needs to be earning enough cash from operations to be able to meet its foreseeable
debts and future commitments, and the cash flow ratio, and changes in the cash flow ratio from
one year to the next, provide a useful indicator of a company’s cash position.
Illustration 2: Cash flow ratio
For the year ended 31 December 20X2, Emma Co’s net cash inflow is $48,000 and its total debt is
$502,000.
Required
Calculate Emma Co’s cash flow ratio as at 31 December 20X2. State your answer to 1 decimal
place.
Solution
Net cash inflow from operating activities 48,000
= × 100 = 9.6%
Total debt 502,000
Note. Note that to provide useful information in respect of the company, this ratio would need to
be compared to the cash flow ratio calculated using prior year financial information, budget
and/or industry benchmarks.
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6 Advantages and disadvantages of cash flow accounting
6.1 The advantages of cash flow accounting
The advantages of cash flow accounting are:
(a) Survival in business depends on the ability to generate cash. Cash flow accounting directs
attention towards this critical issue.
(b) Cash flow is more comprehensive than ‘profit’ which is dependent on accounting policy
choices and accounting estimates.
(c) Creditors (long- and short-term) are more interested in an entity’s ability to repay them than
in its profitability. Whereas ‘profits’ might indicate that cash is likely to be available, cash flow
accounting is more direct with its message.
(d) Cash flow reporting provides a better means of comparing the results of different companies
than traditional profit reporting.
(e) Cash flow reporting satisfies the needs of all users better:
(i) For management, it provides the sort of information on which decisions should be taken
(in management accounting, ‘relevant costs’ to a decision are future cash flows);
traditional profit accounting does not help with decision-making.
(ii) For shareholders and auditors, cash flow accounting can provide a satisfactory basis for
stewardship accounting.
(iii) As described previously, the information needs of creditors and employees will be better
served by cash flow accounting.
(f) Cash flow forecasts are easier to prepare, as well as more useful, than profit forecasts.
(g) They can in some respects be audited more easily than accounts based on accrual
accounting.
(h) Cash flows are more easily understood than performance measures based on profit.
(i) Cash flow accounting should be both retrospective, and also include a forecast for the future.
This is of great information value to all users of accounting information.
(j) Forecasts can subsequently be monitored by the publication of variance statements which
compare actual cash flows against the forecast.
6.2 The disadvantages of cash flow accounting

The main disadvantages of cash accounting are essentially the advantages of accrual
accounting.
There is also the practical problem that few businesses keep historical cash flow information in the
form needed to prepare a historical statement of cash flows and so extra record keeping is likely to
be necessary.
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Chapter summary
IAS 7 Formats Interpretation of Cash flow

Statement statement of ratio
of Cash Flows cash flows
Key terms • Indirect method Analysis points Provides a useful

• Cash (examinable) • Overall increase/ indicator of a company's
• Cash equivalents • Direct method decrease in cash cash position
• Operating activities (awareness only – not • What are the Calculated as:
• Investing activities examinable in FR) significant Net operating
• Financing activities components in the cash inflow
× 100
cash flows? Total debt
Key sections of the • Cash flows from
statement of cash flows operating activities
• Cash flows from • Cash flows from
operating activities investing activities
• Cash flows from • Cash flows from
investing activities financing activities
• Cash flows from
financing activities
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1. IAS 7 Statement of Cash Flows

The purpose of the statement of cash flows is to show the effect of a company’s commercial
transactions on its cash balance.
Cash flows are used in investment appraisal methods such as net present value and hence a
statement of cash flows gives potential investors the chance to evaluate a business.
2. Formats
There are two methods of presenting statements of cash flows, the indirect method (which
reconciles profit to operating cash flows) and the direct method (which shows actual operating
cash flows). Only the indirect method is examined in your Financial Reporting studies.
3. Interpretation of statement of cash flows

The statement of cash flows provides users with useful information about the business’s ability to
generate cash and the source/use of cash.
It is important to analyse the reasons behind the cash flows in detail. Generally, you should seek
to explain each main component of the statement of cash flows:
• Cash flows from operating activities
• Cash flows from investing activities
• Cash flows from financing activities
Identify and explain the significant cash flows within each category and the information they give
users of this information regarding the financial stability and expected future prospects of the
business.
4. Cash flow ratio
Net cash inflow

× 100
Total debt
5. Advantages and disadvantages of the statement of cash flows

A key advantage of preparing a statement of cash flow is that for users, cash flow is more
comprehensive than ‘profit’ which is dependent on accounting conventions and concepts.
HB2022

Question practice
the Workbook):
Section A, Q18
Section C, Q52 Dundee Co
Section C, Q53 Elmgrove Co
Further reading
ACCA has prepared a useful technical article on analysing a statement of cash flows, which is
available on its website:
Analysing cash flows
www.accaglobal.com
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Activity answers
1
Property, plant & equipment

$’000
b/d 638
Depreciation/amortisation (54)
SPLOCI – OCI 60
Non-cash additions –
Disposals (58 – 7) (51)
Cash paid/(rec’d) β 205
c/d 798
Cash flows from financing activities $’000 $’000

Proceeds from share issue (W1) 80
Proceeds from issue of loan notes (W2) 150
Dividends paid (W1) (41)
Net cash used in financing activities 189
Workings
1 Equity

$’000 $’000
b/d (200 + 80) 280 570
Profit or loss 70
Non-cash – –
Cash (paid)/rec’d β 80 (41)
c/d (220 + 140) 360 599
2 Loan notes
$’000
b/d (54 + 24 = 78) 100
SPLOCI – P/L
– OCI
Non-cash –
Cash (paid)/rec’d β 150
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$’000
c/d (76 + 26 = 102) 250
Activity 2: Interpretation of a cash flow for Emma Co

Overall, the cash position has improved during the year as Emma Co has seen a cash inflow of
$64,000. However, the company is still in a cumulative overall negative cash position of $33,000.
This is not uncommon for a growing business which must invest in assets and materials in order to
further the business. Emma Co must ensure it manages its cash flow in such a way to ensure it
does not overtrade.
The company is making a positive cash flow from operations which is a positive sign and indicates
that Emma Co’s generates positive cash flows from its core operations. The working capital cycle
(cash from receivables, cash paid to payables and cash held in inventory) has decreased the cash
inflow by $115,000 ($48,000 + $75,000 – $8,000). The trade payables payment period is 26 days
(127/1,814 × 365) which is significantly less than the 60-day credit terms offered. Emma Co could
increase its payables payment period whilst still maintaining a good relationship with its suppliers
which would free up cash flow. Its receivables collection period is 56 days (390/2,553 × 365) which
is 11 days longer than the credit period offered. Better credit control would help to free up cash
flow. The additional cash flow released by better management of receivables and payables could
then be used to invest in the branded materials which are popular and selling at a good mark-up.
The inventories has also increased, however this may be due to Emma Co holding inventory to
satisfy the significant order that is due to be dispatched shortly after year end. Some caution
should be attached to holding inventories as there is an associated holding cost and a risk that
the goods may become slow moving if the order is withdrawn or the popularity of items declines.
There were significant cash outflows to purchase new property, plant and equipment ($161,000)
which shows is consistent with the fact that Emma Co is a growing company and investment is
being made in its future prospects. These purchases of property, plant and equipment have been
partly financed by the issue of share capital (raising $60,000). The issue of share capital is a
cheap way to finance the purchase of property, plant and equipment as there is no commitment
to repay dividends, but it may not be viable to make further share issues to friends and family
going forward. Emma Co is considering using lease arrangements to fund assets in the future
which would have a positive impact on cash flow in the year of purchase as it would not require a
large initial cash outflow, but would result in cash outflows in the future in the form of interest paid
(operating activities) and capital repayments (financing activities) made.
Interestingly, dividends equal to the amount long-term loan were paid during the year. It is
reasonable that a company funds the acquisition of property, plant and equipment using
finance, however it could be questioned why a dividend has been paid when the funds would have
been better utilised within the business. Had the cash allocated to the dividend payment been
used to repay the long-term loan, this would have the additional bonus of reducing Emma Co’s
interest payments.
Activity 3: Financial adaptability

The correct answer is: The failure of Quebec Co to raise long-term finance to fund its investing
activities has resulted in a deterioration of Quebec Co’s financial adaptability and liquidity.
It is good financial management to finance long-term assets (investing activities) with long-term
finance (financing activities). However, whilst Quebec Co has managed to finance some of its
investing activities from its operating activities, it has failed to raise long-term finance to cover the
remainder. Instead, it has relied on an overdraft which is both expensive and risky.
The other statements are incorrect for the following reasons:
A negative cash flow in investing activities is indicative of expansion rather than decline. Quebec
Co has not shown competent stewardship by financing long-term assets with an overdraft. As no
prior year figures are given, it is not possible to conclude on whether Quebec Co’s working capital
management has improved or deteriorated.
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Specialised, not-for-
23 profit and public sector
entities
23
Learning objectives
Explain how the interpretation of the financial statement of a C4(a)

specialised, not-for-profit or public sector organisations might
differ from that of a profit making entity by reference to the
different aims, objectives and reporting requirements.
23
Exam context
In the Financial Reporting exam, you are likely to get an OT Question on the types of performance
indicator used by not-for-profit companies. You may also get asked to analyse a set of not-for-
profit company financial statements, commenting on any differences between the profit and
not-for-profit ratios and performance indicators used in each case.
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23
Chapter overview
Specialised, not-for-profit and public sector entities
Primary aims of Regulatory Performance

not-for profit and framework measurement
public sector entities
Non-profit focused IFRS Standards form the basis Three Es: Economy, efficiency,
for accounting standards effectiveness
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1 Primary aims of not-for-profit and public sector entities
Not-for-profit or public sector organisations are focussed on meeting the needs of various,
specialised groups, such as hospital users and local communities. You have already seen how
many profit-making companies use ratios to analyse performance, such as return on capital. In
this chapter, the focus is on analysing the performance of companies where the main driver is not
meeting shareholder expectations for dividends, instead the question is how the company
resources have been used or whether performance targets have been met (such as bed
occupancy in hospitals or staff training).
Examples:
• Government departments and agencies, both at national and regional levels
• Local councils
• Public-funded bodies providing health/social services (eg NHS in the UK)
• Education institutions (schools, universities, colleges)
• Charities
• Sporting bodies such as national teams or associations
Aims:
• Quality of service provision is often more important than profit
• Efficiency of use of resources is key
• Focus is often on breakeven rather than profit-making
• Need to satisfy a wide group of stakeholders
2 Regulatory framework
IFRS Standards are designed ‘to help participants in the various capital markets of the world and
other users of the information to make economic decisions’ (IASB, IASB Objectives).
The world’s capital markets tend to focus on profit and fair value (buy; hold; sell decisions) which
are concepts that are not so relevant to not-for-profit and public sector entities.
However, accountability is still very important for these entities as they often handle public funds.
The use of IFRS Standards, which are designed for ‘general purpose financial statements’, would
make the performance of not-for-profit and public sector entities more accountable and
comparable.
Accounting regimes that apply IFRS Standards do not normally require the use of IFRS Standards
for these entities.
Other international or national bodies publish specific standards for these entities which are
applicable in some national regimes, eg:
(a) The International Federation of Accountants (IFAC) publishes International Public Sector
Accounting Standards (IPSAS), based on IFRS Standards, but adapted to the public sector.
National governments can choose to apply them.
(b) The UK publishes a Statement of Recommended Practice (SORP) for charities which, while
not compulsory, is seen as best practice.
3 Performance measurement
Profit is clearly not the key objective of a ‘not-for-profit’ organisation.
However, such organisations produce budgets, which their performance can be assessed against
and many of the performance indicators relating to efficiency (eg inventory management) will be
relevant to a not-for-profit organisation.
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23: Specialised, not-for-profit and public sector entities 557

3.1 The Three Es
The ‘Three Es’ (or value for money) are often a useful way of assessing performance for not-for-
profit and public sector entities:
Economy Efficiency Effectiveness
Cost of resources used How is the work What is

and the output obtained completed? achieved?
Inputs Outputs Results
Cost of used trainee Proportion of donations Percentage of rubbish

teachers instead of spent on administration collections made on time
qualified teachers: Is the and overheads
quality of grades
obtained by students
achieved by using a less
expensive resource?
3.2 Key Performance Indicators (KPIs)

Examples of Key Performance Indicators (KPIs) relevant to not-for-profit organisations. These will
depend on the type of entity and the sector in which they operate.
Public sector (hospital):
• Length of waiting lists
• Percentage of patients treated successfully
• Level of skilled staff in the departments
Public sector (local council):
• Potholes reported and corrected
• Children using school transport
• Percentage of domestic waste recycled
Private sector (charity):
• Proportion of donations spent on administration
• Humanitarian aid provided
• Cancer patients homed in the hospice
• Animals rehomed from the shelter
Exam focus point

In the exam, it is important to read the requirement carefully to ensure that you understand
the main objectives for the not-for-profit entity. You may be asked to select the most
appropriate KPIs for that entity.
HB2022

Activity 1: Council KPIs
Public sector entities have performance measures laid down by government, based on KPIs.
Which FOUR of the following are likely to be financial KPIs for a local council?
 Rent receipts outstanding
 Interest paid
 P/E ratio
 Interest cover
 Dividend cover
 Financial actuals against budget
 Return on capital employed
3.3 Financial reporting issues

Problems of reporting for specialised, not-for-profit and public sector entities include:
• Multiple objectives within the entity, eg a local council will be required to report in the most
efficient way on KPIs relating to education, social, environmental, political (because of local
elections) and administrative support.
• Difficulty of measurement of non-financial indicators, eg it may not be easy to decide whether
all children in the region are attending school as not all children may be registered with the
local authority (travelling families, new families moving into the area, children educated
privately, home-schooled children).
• Problems with comparison with similar entities, eg smaller charities may lack the skill and
resources to produce multiple results for KPIs, so they may focus purely on their one objective.
Charities of a similar size are likely to have differing objectives, so comparing a medical
research charity with an educational one is difficult due to their different aims.
• Financial constraints, how best to prioritise if resources are limited? Most charities rely on
donations or legacies, and are wholly reliant on those revenue streams. Poor publicity may
affect the flow of these donations, or a significant disaster may increase both the donations
and change the priorities of the charity. Governments will be dependent on income from
taxation affecting how they can use their resources.
• Pressures of external factors, which may be social, political or legal. Charities, especially those
operating on an international basis, may be affected by political changes including the
outbreak of conflict affecting their ability to carry out their activities.
Essential reading
There are additional activities and information available in Chapter 23 of the Essential reading.
HB2022

Chapter summary
Specialised, not-for-profit and public sector entities
Primary aims of Regulatory Performance

not-for profit and framework measurement
public sector entities
Non-profit focused IFRS Standards form the basis Three Es: Economy, efficiency,
• Government departments for accounting standards effectiveness
• Local councils • IPSAS 42 standards in issue • KPIs will be dependent on the
• Public funded bodies • SORP in the UK (non type of entity and the sector in
• Educational institutions compulsory) which they operate
• Charities • Problems with reporting can be
• Sporting bodies caused by:
– Multiple objectives
– Difficult of non-financial
indicators
– Comparison may be difficult
– Financial constraints
– Social, political and legal
barriers
HB2022

1. Primary aims of not-for-profit and public sector entities

Entities will have different KPIs dependent on their main objectives rather than a reliance on profit
as a measure of performance.
There are different types of entities, including public sector (national and local government, local
councils) and charities (such as health, raising awareness of environmental measures or animal or
human welfare).
2. Regulatory framework
IFAC produces a framework, based upon IFRS Standards, but which has additional guidance on
topics which are covered only in the not-for-profit and public sector (such as guidance on
governmental reporting).
3. Performance measurement
• The Three Es (economy, efficiency and effectiveness)
• Wide range of KPIs available which will be reported on dependent on the main objectives of the
entity
• Problems in reporting the performance include external issues such as political and legal
barriers, problems with comparison between different charities and the often limited resources
of the entity restricting the achievement of the objectives
HB2022

Question practice
the Workbook):
Section C Q25 Standard setters
Section C Q54 Measurement
Section C Q55 Not for profit
Further reading
ACCA has useful articles online, including two which are Performance Management articles, but
relevant to the FR qualification:
Not for profit organisations (part 1)
Not for profit organisations (part 2)
Performance appraisal (Financial Reporting article)
www.accaglobal.com
HB2022

Activity answers
Activity 1: Council KPIs

• Rent receipts outstanding
• Interest paid
• Interest cover
• Financial actuals against budget
The council will need to ensure that they can service any debts or loans, therefore the interest KPIs
are useful. The local council will need to compare actuals against budget, as they will need to
explain where the resources have been used and explain any overruns. Councils often have social
housing and will need to ensure that the rents are paid and any in arrears are managed.
HB2022

HB2022

3
Tangible non-current
assets
Essential reading
HB2022

1 IAS 16 Property, Plant and Equipment
1.1 Scope
IAS 16 should be followed when accounting for property, plant and equipment unless another
international accounting standard requires a different treatment.
IAS 16 does not apply to the following.
(a) Biological assets related to agricultural activity, apart from bearer biological assets (see
below)
(b) Mineral rights and mineral reserves, such as oil, gas and other non-regenerative resources
(c) Property, plant and equipment classified as held for sale (IFRS 5 Non-Current Assets Held for
Sale and Discontinued Operations)
However, the standard applies to property, plant and equipment used to develop these assets (IAS
16: paras. 2–3).
1.1.1 Bearer biological assets

Bearer biological assets such as grape vines, rubber trees and oil palms, are within the scope of
IAS 16. Bearer plants are living plants which are solely used to grow produce over several periods
and are not themselves consumed, being usually scrapped when no longer productive. They are
measured at accumulated cost until maturity and then become subject to depreciation and
impairment charges (IASB, Agriculture: Bearer Plants (Amendments to IAS 16 and IAS 41)).
1.2 Definitions
Entity specific value: The present value of the cash flows an entity expects to arise from the
KEY
TERM continuing use of an asset and from its disposal at the end of its useful life or expects to incur
when settling a liability.
Impairment loss: The amount by which the carrying amount of an asset exceeds its
recoverable amount.
Bearer plant: A living plant that:
• Is used in the production or supply of agricultural produce;
• Is expected to bear produce for more than one period; and
• Has a remote likelihood of being sold as agricultural produce, except for incidental scrap
sales
(IAS 16: para. 6)
1.3 Separate items

Most of the time assets will be identified individually, but this will not be the case for smaller
items, such as tools, dies and moulds, which are written off as an expense.
Major components or spare parts, however, should be recognised as property, plant and
equipment (IAS 16: para. 8).
For very large and specialised items, an apparently single asset should be broken down into its
significant parts. This occurs where the different parts have different useful lives and different
depreciation rates are applied to each part, eg an aircraft, where the body and engines are
separated as they have different useful lives (IAS 16: para. 13).
1.4 Safety and environmental equipment

These items may be necessary for the entity to obtain future economic benefits from its other
assets. For this reason, they are recognised as assets. However the original assets plus the safety
equipment should be reviewed for impairment (IAS 16: para. 11).
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1.5.1 Cost of self-constructed assets
In the case of self-constructed assets, the same principles are applied as for acquired assets. If
the entity’s normal course of business is to make these assets and sell them externally, then the
cost of the asset will be the cost of its production. This also means that abnormal costs (wasted
material, labour or downtime costs) are excluded from the cost of the asset. An example of a self-
constructed asset is when a building company builds its own head office (IAS 16: para. 22).
1.5.2 Subsequent expenditure

Parts of some items of property, plant and equipment may require replacement at regular
intervals. IAS 16 gives examples of a furnace which may require relining after a specified number
of hours or aircraft interiors which may require replacement several times during the life of the
aircraft.
This cost is recognised in full when it is incurred and added to the carrying amount of the asset. It
will be depreciated over its useful life, which may be different from the useful life of the other
components of the asset. For example, the passenger seats of an aircraft may have a useful life of
five years, whereas the engines may last for 10 years. Therefore, there may be different
depreciation rates for the different parts of the asset.
Expenditure incurred in replacing or renewing a component of an item of property, plant and
equipment must be recognised in the carrying amount of the item. The carrying amount of the
replaced or renewed component must be derecognised. This also applies when a separate
component of an item of property, plant and equipment is identified during a major inspection to
allow the continued use of the item (IAS 16: para. 13).
1.5.3 Exchanges of assets

If items of property, plant and equipment are exchanged, IAS 16 requires them to be measured at
fair value, unless:
The exchange transaction

lacks commercial substance
Cost is measured at the carrying
or amount of the asset given up
The fair value of neither of the assets
exchanged can be measured reliably
(IAS 16: para. 24)
1.6 Depreciation and impairment

The standard states:
• The depreciable amount of an item of property, plant and equipment should be allocated on a
systematic basis over its useful life.
• The depreciation method used should reflect the pattern in which the asset’s economic
benefits are consumed by the entity.
• The depreciation charge for each period should be recognised as an expense unless it is
included in the carrying amount of another asset.
(IAS 16: para. 48)
Land and buildings are dealt with separately even when they are acquired together because land
normally has an unlimited life and is therefore not depreciated. By contrast buildings do have a
limited life and must be depreciated. Any increase in the value of land on which a building is
standing will have no impact on the determination of the building’s useful life (IAS 16: para. 58).
Depreciation is covered in more detail in Section 2 below.
1.6.1 Impairment of carrying amounts of non-current assets

Impairment of assets is covered in detail in Chapter 5.
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An impairment loss should be treated in the same way as a revaluation decrease ie the decrease
should be recognised as an expense. However, a revaluation decrease (or impairment loss) should
be charged directly against any related revaluation surplus to the extent that the decrease does
not exceed the amount recognised in other comprehensive income and presented in the
revaluation surplus in respect of that same asset (IAS 38: para. 60).
A reversal of an impairment loss should be treated in the same way as a revaluation increase, ie a
revaluation increase should be recognised as income to the extent that it reverses a revaluation
decrease or an impairment loss of the same asset previously recognised as an expense (IAS 38:
para 119).
1.7 Retirements and disposals

When an asset is permanently withdrawn from use, or sold or scrapped, and no future economic
benefits are expected from its disposal, it should be derecognised from the statement of financial
position (IAS 16: para. 67).
Gains or losses are the difference between the estimated net disposal proceeds and the carrying
amount of the asset. They should be recognised as income or expense in profit or loss (IAS 16:
para. 71).
1.7.1 Disposal of a revalued asset

When a revalued asset is disposed of, the entity can choose whether to leave the amount in the
revaluation surplus in equity or to transfer it directly to retained earnings. Any revaluation surplus
may be transferred directly to retained earnings. Alternatively, it may be left in equity under the
heading revaluation surplus.
The transfer to retained earnings should not be made through the profit or loss for the year.
1.8 Derecognition
An entity is required to derecognise the carrying amount of an item of property, plant or
equipment that it disposes of on the date the criteria for the sale in IFRS 15 Revenue from
Contracts with Customers would be met. This also applies to parts of an asset (IAS 16: para. 68A).
An entity cannot classify as revenue a gain it realises on the disposal of an item of property,
plant and equipment (IAS 16: para. 68).
1.9 Disclosure
The standard has a long list of disclosure requirements, for each class of property, plant and
equipment.
(a) Measurement bases for determining the gross carrying amount (if more than one, the gross
carrying amount for that basis in each category)
(b) Depreciation methods used
(c) Useful lives or depreciation rates used
(d) Gross carrying amount and accumulated depreciation (aggregated with accumulated
impairment losses) at the beginning and end of the period
(e) Reconciliation of the carrying amount at the beginning and end of the period showing:
(i) Additions
(ii) Disposals
(iii) Acquisitions through business combinations
(iv) Increases/decreases during the period from revaluations and from impairment losses
(v) Impairment losses recognised in profit or loss
(vi) Impairment losses reversed in profit or loss
(vii) Depreciation
(viii) Net exchange differences (from translation of statements of a foreign entity)
(ix) Any other movements
The financial statements should also disclose the following:
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(a) Any recoverable amounts of property, plant and equipment
(b) Existence and amounts of restrictions on title, and items pledged as security for liabilities
(c) Accounting policy for the estimated costs of restoring the site
(d) Amount of expenditures on account of items in the course of construction
(e) Amount of commitments to acquisitions
Revalued assets require further disclosures.
(a) Basis used to revalue the assets
(b) Effective date of the revaluation
(c) Whether an independent valuer was involved
(d) Nature of any indices used to determine replacement cost
(e) Carrying amount of each class of property, plant and equipment that would have been
included in the financial statements, had the assets been carried at cost less accumulated
depreciation and accumulated impairment losses
(f) Revaluation surplus, indicating the movement for the period and any restrictions on the
distribution of the balance to shareholders
The standard also encourages disclosure of additional information, which the users of financial
statements may find useful.
(a) The carrying amount of temporarily idle property, plant and equipment
(b) The gross carrying amount of any fully depreciated property, plant and equipment that is
still in use
(c) The carrying amount of property, plant and equipment retired from active use and held for
disposal
(d) The fair value of property, plant and equipment when this is materially different from the
carrying amount
(IAS 16: paras. 73–77)
The following format (with notional figures) is commonly used to disclose non-current assets
movements.
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Land and Plant and
Total buildings equipment
$ $ $
Cost or valuation
At 1 January 20X4 50,000 40,000 10,000
Revaluation 12,000 12,000 –
Additions in year 4,000 – 4,000
Disposals in year (1,000) – (1,000)
At 31 December 20X4 65,000 52,000 13,000
Depreciation
At 1 January 20X4 16,000 10,000 6,000
Charge for year 4,000 1,000 3,000
Eliminated on disposals (500) – (500)
At 31 December 20X4 19,500 11,000 8,500
Carrying amount
At 31 December 20X4 45,500 41,000 4,500
At 1 January 20X4 34,000 30,000 4,000
2 Depreciation
2.1 Property, plant and equipment
If an asset’s life extends over more than one accounting period, it earns profits over more than one
period. It is a non-current asset.
With the exception of land, every non-current asset eventually wears out over time. Machines,
cars and other vehicles, fixtures and fittings, and even buildings do not last forever. When a
business acquires a non-current asset, it will have some idea about how long its useful life will be,
and it might decide what to do with it.
(a) Keep on using the non-current asset until it becomes completely worn out, useless, and
worthless.
(b) Sell off the non-current asset at the end of its useful life, either by selling it as a second‑hand
item or as scrap.
Since a non-current asset has a cost, and a limited useful life, and its value eventually declines, it
follows that a charge should be made in profit or loss to reflect the use that is made of the asset
by the business. This charge is called depreciation.
2.2 Depreciation
IAS 16 requires the depreciable amount of a depreciable asset to be allocated on a systematic
basis to each accounting period during the useful life of the asset. Every part of an item of
property, plant and equipment with a cost that is significant in relation to the total cost of the
item must be depreciated separately (IAS 16: para. 44).
One way of defining depreciation is to describe it as a means of spreading the cost of a non-
current asset over its useful life, and so matching the cost against the full period during which it
earns profits for the business. Depreciation charges are an example of the application of the
accrual assumption to calculate profits.
The need for depreciation of non-current assets arises from the accruals assumption. If money is
expended in purchasing an asset, then the amount expended must at some time be charged
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against profits. If the asset is one which contributes to an entity’s revenue over a number of
accounting periods, it would be inappropriate to charge any single period with the whole of the
expenditure. Thus, this is a method where the cost is spread over the useful life of the asset.
There are situations where, over a period, an asset has increased in value, ie its current value is
greater than the carrying amount in the financial statements. You might think that in such
situations it would not be necessary to depreciate the asset. The standard states, however, that
this is irrelevant, and that depreciation should still be charged to each accounting period, based
on the depreciable amount, irrespective of a rise in value (IAS 16: para. 52).
An entity is required to begin depreciating an item of property, plant and equipment when it is
available for use and to continue depreciating it until it is derecognised, even if it is idle during the
period (IAS 16: para. 55).
2.3 Useful life

The following factors should be considered when estimating the useful life of a depreciable asset.
• Expected physical wear and tear
• Obsolescence
• Legal or other limits on the use of the assets
Once decided, the useful life should be reviewed at least every financial year end and
depreciation rates adjusted for the current and future periods if expectations vary significantly
from the original estimates. The effect of the change should be disclosed in the accounting period
in which the change takes place.
The assessment of useful life requires judgement based on previous experience with similar assets
or classes of asset. When a completely new type of asset is acquired (ie through technological
advancement or through use in producing a brand-new product or service) it is still necessary to
estimate useful life, even though the exercise will be much more difficult.
The standard also points out that the physical life of the asset might be longer than its useful life
to the entity in question. One of the main factors to be taken into consideration is the physical
wear and tear the asset is likely to endure. This will depend on various circumstances, including
the number of shifts for which the asset will be used, the entity’s repair and maintenance
programme and so on. Other factors to be considered include obsolescence (due to technological
advances/improvements in production/reduction in demand for the product/service produced by
the asset) and legal restrictions, eg length of a related lease (IAS 16: para. 57).
2.3.1 Review of useful life

A review of the useful life of property, plant and equipment should be carried out at least at each
financial year end and the depreciation charge for the current and future periods should be
adjusted if expectations have changed significantly from previous estimates. Changes are
changes in accounting estimates and are accounted for prospectively as adjustments to future
depreciation (IAS 16: para. 51).
Illustration 6: Review of useful life
Bashful Co acquired a non-current asset on 1 January 20X2 for $80,000. It had no residual value
and a useful life of ten years.
On 1 January 20X5, the remaining useful life was reviewed and revised to four years.
Required
What will be the depreciation charge for 20X5?
Solution
$
Depreciation 20X2 – 20X4 (80,000 × 3/10) (24,000)
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$
Carrying amount at 31 December 20X4 56,000
Remaining life 4 years
Depreciation charge years 20X5 – 20X8 (56,000/4) 14,000
2.4 Residual value

In most cases the residual value of an asset is likely to be immaterial. If it is likely to be of any
significant value, that value must be estimated at the date of purchase or any subsequent
revaluation. The amount of residual value should be estimated based on the current situation with
other similar assets, used in the same way, which are now at the end of their useful lives. Any
expected costs of disposal should be offset against the gross residual value.
2.5 Depreciation methods

Consistency is important. The depreciation method selected should be applied consistently from
period to period, unless altered circumstances justify a change. When the method is changed, the
effect should be quantified and disclosed and the reason for the change should be stated.
Various methods of allocating depreciation to accounting periods are available, but whichever is
chosen must be applied consistently to ensure comparability from period to period. Change of
policy is not allowed simply because of the profitability situation of the entity.
You should be familiar with the various accepted methods of allocating depreciation and the
relevant calculations and accounting treatments, which are revised in questions at the end of this
section.
2.5.1 Review of depreciation method

The depreciation method should also be reviewed at least at each financial year end and, if there
has been a significant change in the expected pattern of economic benefits from those assets, the
method should be changed to suit this changed pattern. When such a change in depreciation
method takes place, the change should be accounted for as a change in accounting estimate
and the depreciation charge for the current and future periods should be adjusted (IAS 16: para.
61).
2.6 Disclosure
An accounting policy note should disclose the valuation bases used for determining the amounts
at which depreciable assets are stated, along with the other accounting policies.
IAS 16 also requires the following to be disclosed for each major class of depreciable asset.
• Depreciation methods used
• Useful lives or the depreciation rates used
• Total depreciation allocated for the period
• Gross amount of depreciable assets and the related accumulated depreciation
(IAS 16: paras. 73–78)
3 Investment property (IAS 40)

3.1 Fair value model
Fair value model: After initial recognition, an entity that chooses the fair value model should
KEY
TERM measure all of its investment property at fair value, except in the extremely rare cases where
this cannot be measured reliably. In such cases, it should apply the IAS 16 cost model.
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A gain or loss arising from a change in the fair value of an investment property should be
recognised in net profit or loss for the period in which it arises.
The fair value of investment property should reflect market conditions at the end of the
reporting period (IAS 40: paras. 33, 35, 40).
The fair value model for investment property is not the same as a revaluation, where increases in
carrying amount above a cost-based measure are recognised as revaluation surplus. Under the
fair-value model, all changes in fair value are recognised in profit or loss.
The standard elaborates on issues relating to fair value.
(a) Fair value is not the same as ‘value in use’ as defined in IAS 36 Impairment of Assets. Value in
use reflects factors and knowledge specific to the entity, while fair value reflects factors and
knowledge relevant to the market.
(b) In determining fair value, an entity should not double count assets. For example, elevators or
air conditioning are often an integral part of a building and should be included in the
investment property, rather than recognised separately.
(c) When a lessee uses the fair value model to measure an investment property that is held as a
right-of-use asset, it shall measure the right-of-use asset, and not the underlying property,
at fair value.
(d) In those rare cases where the entity cannot determine the fair value of an investment
property reliably, the cost model in IAS 16 must be applied until the investment property is
disposed of. The residual value must be assumed to be zero.
(e) When lease payments are at market rates, the fair value of an investment property held by a
lessee as a right-of-use asset, net of all expected lease payments, should be zero (IAS 40:
paras. 50–55).
3.2 Cost model

The cost model is the cost model in IAS 16 for owned assets. Assets held by lessees as right-of-use
assets are measured at cost in accordance with IFRS 16. Investment property should be measured
at depreciated cost, less any accumulated impairment losses. An entity that chooses the cost
model should disclose the fair value of its investment property (IAS 40: paras. 56,79).
3.3 Changing models

Once the entity has chosen the fair value or cost model, it should apply it to all its investment
property. It should not change from one model to the other, unless the change will result in a
more appropriate presentation. IAS 40 states that it is highly unlikely that a change from the fair
value model to the cost model will result in a more appropriate presentation (IAS 40: para. 31).
4 Borrowing costs
4.1 Commencement of capitalisation
Three events or transactions must be taking place for capitalisation of borrowing costs to be
started.
(a) Expenditure on the asset is being incurred
(b) Borrowing costs are being incurred
(c) Activities are in progress that are necessary to prepare the asset for its intended use or sale
Expenditure must result in the payment of cash, transfer of other assets or assumption of interest-
bearing liabilities. Deductions from expenditure will be made for any progress payments or grants
received in connection with the asset. IAS 23 allows the average carrying amount of the asset
during a period (including borrowing costs previously capitalised) to be used as a reasonable
approximation of the expenditure to which the capitalisation rate is applied in the period.
Presumably, more exact calculations can be used.
Activities necessary to prepare the asset for its intended sale or use extend further than physical
construction work. They encompass technical and administrative work prior to construction, eg
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obtaining permits. They do not include holding an asset when no production or development that
changes the asset’s condition is taking place, eg where land is held without any associated
development activity (IAS 23: paras. 17–19).
4.2 Suspension of capitalisation

If active development is interrupted for any extended periods, capitalisation of borrowing costs
should be suspended for those periods.
Suspension of capitalisation of borrowing costs is not necessary for temporary delays or for
periods when substantial technical or administrative work is taking place (IAS 23: paras. 20–21).
4.3 Cessation of capitalisation

Once substantially all the activities necessary to prepare the qualifying asset for its intended use
or sale are complete, then capitalisation of borrowing costs should cease. This will normally be
when physical construction of the asset is completed, although minor modifications may still be
outstanding.
The asset may be completed in parts or stages, where each part can be used while construction
is still taking place on the other parts. Capitalisation of borrowing costs should cease for each
part as it is completed. The example given by the standard is a business park consisting of several
buildings (IAS 23: paras. 22–25).
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4
Intangible assets
Essential reading
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1 Recognition of an intangible asset
1.1 Identifiability
An intangible asset must be identifiable in order to distinguish it from goodwill. With non-physical
items, there may be a problem with ‘identifiability’.
(a) If an intangible asset is acquired separately through purchase, there may be a transfer of a
legal right that would help to make an asset identifiable, eg patent.
(b) An intangible asset may be identifiable if it is separable, ie if it could be rented or sold
separately. However, ‘separability’ is not an essential feature of an intangible asset. (IAS 38:
para. 11)
1.2 Control by the entity

An intangible asset must be under the control of the entity as a result of a past event. The entity
must be able to enjoy the future economic benefits from the asset, and prevent others from also
benefiting. A legally enforceable right is evidence of such control, but is not always a necessary
condition.
(a) Control over technical knowledge or know-how only exists if it is protected by a legal right.
(b) The skill of employees, arising out of the benefits of training costs, are unlikely to be
recognised as an intangible asset, because the entity does not control the future actions of
its staff.
(c) Similarly, market share and customer loyalty cannot normally be intangible assets, since an
entity cannot control the actions of its customers. (IAS 38: paras. 13–16)
1.3 Expected future economic benefits

An item can only be recognised as an intangible asset if economic benefits are expected to flow in
the future from ownership of the asset. Economic benefits may come from the sale of products or
services, or from a reduction in expenditures (cost savings). (IAS 38: para. 17)
An intangible asset, when recognised initially, must be measured at cost. It should be recognised
if, and only if, both of the following occur:
(a) It is probable that the future economic benefits that are attributable to the asset will flow to
the entity, eg a licence to provide services for a fee (a franchise, broadcasting licence).
(b) The cost can be measured reliably eg the cost of the licence or franchise.
Management has to exercise its judgement in assessing the degree of certainty attached to the
flow of economic benefits to the entity. External evidence is best.
(a) If an intangible asset is acquired separately, its cost can usually be measured reliably as its
purchase price (including incidental costs of purchase such as legal fees, and any costs
incurred in getting the asset ready for use).
(b) When an intangible asset is acquired as part of a business combination (ie an acquisition or
takeover), the cost of the intangible asset is its fair value at the date of the acquisition.
(IAS 38: para. 33)
IFRS 3 explains that the fair value of intangible assets acquired in business combinations can
normally be measured with sufficient reliability to be recognised separately from goodwill. (IFRS
3: para. B31)
2 Research and development costs

You should be familiar with the research and development phase of a project from your previous
studies. This section should remind you of the key concepts.
2.1 Research
Research activities by definition do not meet the criteria for recognition under IAS 38. This is
because, at the research stage of a project, it cannot be certain that future economic benefits will
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probably flow to the entity from the project. There is too much uncertainty about the likely
success or otherwise of the project.
Research costs should therefore be written off as an expense as they are incurred
Examples of research costs from IAS 38:
(a) Activities aimed at obtaining new knowledge
(b) The search for, evaluation and final selection of, applications of research findings or other
knowledge
(c) The search for alternatives for materials, devices, products, processes, systems or services
(d) The formulation, design evaluation and final selection of possible alternatives for new or
improved materials, devices, products, systems or services
(IAS 38: paras. 54–56)
2.2 Development
Development costs may qualify for recognition as intangible assets provided that the following
strict ‘PIRATE’ criteria can be demonstrated.
Probable future economic benefits for the entity. The entity should demonstrate the existence of a
market for the output of the intangible asset or the intangible asset itself or the usefulness of the
intangible asset to the business.
Intention to complete the intangible asset and use or sell it.
Resources (technical, financial and other) are available to complete the development and to use
or sell the intangible asset.
Ability to use or sell the intangible asset.
Technical feasibility of the project and the ability to complete the project to generate an asset for
use or sale.
Expenditure attributable to the intangible asset during its development can be measured reliably.
In contrast with research costs, development costs are incurred at a later stage in a project, and
the probability of success should be more apparent. Examples of development costs include:
(a) The design, construction and testing of pre-production or pre-use prototypes and models
(b) The design of tools, jigs, moulds and dies involving new technology
(c) The design, construction and operation of a pilot plant that is not of a scale economically
feasible for commercial production
(d) The design, construction and testing of a chosen alternative for new or improved materials,
devices, products, processes, systems or services
(IAS 38: paras. 57–62)
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5
Essential reading
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1 Measuring recoverable amount
The recoverable amount of an asset is the higher of its:
• Fair value less costs of disposal; or
• Value in use
We will now consider these terms in more detail.
1.1 Fair value less costs of disposal

An asset’s fair value less costs of disposal is the price that would be received to sell the asset in an
orderly transaction between market participants at the measurement date, less direct disposal
costs, such as legal expenses. (IFRS 13: para. 15)
(a) If there is an active market in the asset, the fair value should be based on the market price, or
on the price of the recent transactions in similar assets.
(b) If there is no active market in the asset, it might be possible to estimate fair value using best
estimates of what market participants might pay in an orderly transaction.
Fair value less costs of disposal cannot be reduced by including restructuring or reorganisation
expenses within costs of disposal, or any costs that have already been recognised in the accounts
as liabilities.
1.2 Value in use

The concept of ‘value in use’ involves estimating the future cash flows that will arise from using an
asset or cash generating unit and selecting an appropriate discount rate to calculate the present
value.
You do not need to calculate value in use in the Financial Reporting exam.
2 Further activities
Activity 5: Impairment loss individual asset
Grohl Co, a company that extracts natural gas and oil, has a drilling platform in the Caspian
Sea. It is required by legislation of the country concerned to remove and dismantle the platform at
the end of its useful life. Accordingly, Grohl Co has included an amount in its accounts for
removal and dismantling costs and is depreciating this amount over the platform’s useful life.
Grohl Co is carrying out an exercise to establish whether there has been an impairment of the
platform.
(1) Its carrying amount in the statement of financial position is $3 million.
(2) The company has received an offer of $2.8 million for the platform from another oil company.
The bidder would take over the responsibility (and costs) for dismantling and removing the
platform at the end of its life.
(3) The value in use of the estimated cash flows from the platform’s continued use is $3.3 million
(before adjusting for dismantling costs of $0.6 million).
Required
What should be the carrying amount of the drilling platform in the statement of financial position,
and what, if anything, is the impairment loss?
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Solution
Activity 6: Impairment loss CGU
Biscuit Co has acquired another business for $4.5 million: non-current assets are valued at $4.0
million and goodwill at $0.5 million.
An asset with a carrying amount of $1 million is destroyed in a terrorist attack. The asset was not
insured. The loss of the asset, without insurance, has prompted the company to assess whether
there has been an impairment of assets in the acquired business and what the amount of any
such loss is.
The recoverable amount of the business (a single cash-generating unit) is measured as $3.1
million.
Required
Calculate the impairment loss and revised carrying amounts of the tangible assets and goodwill
in the revised financial statements.
Note. Extracts are not required.
Solution
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Activity answers
Activity 5: Impairment loss individual asset
Fair value less costs of disposal = $2.8m

Value in use = $3.3m – $0.6m = $2.7m
Recoverable amount = Higher of these two amounts, ie $2.8m
Carrying amount = $3m
Impairment loss = $0.2m
The carrying amount should be reduced to $2.8 million.
Activity 6: Impairment loss CGU

There has been an impairment loss of $1.4 million ($4.5m – $3.1m).
The impairment loss will be recognised in profit or loss. The loss will be allocated between the
assets in the cash-generating unit as follows.
(1) A loss of $0.5 million should be allocated to goodwill in the first instance.
(2) The remaining loss of $0.9 million will then be attributed directly to the uninsured asset that
has been destroyed.
The carrying amount of the assets will now be $3.1 million for tangible assets and goodwill will be
fully impaired.
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6
Revenue and
government grants
Essential reading
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1 Introduction
1.1 Background to IFRS 15 Revenue from Contracts with Customers
Revenue is usually the largest amount in a statement of profit or loss so it is important that it is
correctly stated. US studies have shown that over half of all financial statement frauds and
requirements for restatements of previously published financial information involved revenue
manipulation.
The most blatant recent example was the Satyam Computer Servises fraud in 2010, in which false
invoices were used to record fictitious revenue amounting to $1.5 billion.
Revenue recognition fraud also featured in the Enron and Worldcom cases.
In the UK, Tesco admitted that profits for the first half of 2014 were overstated by £250 million
partly due to ‘accelerated’ revenue recognition.
So it is not surprising that it was decided that a ‘comprehensive and robust framework’ for
accounting for revenue was needed.
2 IAS 20 Government Grants and Disclosure of

Government Assistance
Activity 10: Depreciation periods and government grants
Arturo Co receives a government grant representing 50% of the cost of a depreciating asset which
costs $40,000. How will the grant be recognised if Arturo Co depreciates the asset:
1 Over four years straight line; or
2 At 40% reducing balance?
Note. The residual value is nil. The useful life is four years.
Solution
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Activity 11: Accounting for grants related to assets
StarStruck Co receives a 20% grant towards the cost of a new item of machinery, which cost
$100,000. The machinery has a useful life of four years and a nil residual value. The expected
profits of Starstruck Co, before accounting for depreciation on the new machine or the grant,
amount to $50,000 per annum in each year of the machinery’s life.
Required
Show the effect on profit and the accounting treatment if the grant is accounted for by
1 Offsetting the grant income against the cost of the asset
2 Treating the grant as deferred income
Solution
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Activity answers
Activity 10: Depreciation periods and government grants

The grant should be recognised in the same proportion as the depreciation.
1
Straight line
Depreciation Grant income

$ $
Year 1 10,000 5,000
Year 2 10,000 5,000
Year 3 10,000 5,000
Year 4 10,000 5,000
Reducing balance
Depreciation Grant income

$ $
Year 1 16,000 8,000
Year 2 9,600 4,800
Year 3 5,760 2,880
Year 4 (remainder) 8,640 4,320
Activity 11: Accounting for grants related to assets

The results of Starstruck Co for the four years of the machine’s life would be as follows.
1
Reducing the cost of the asset
Year 1 Year 2 Year 3 Year 4 Total

$ $ $ $ $
Profit before depreciation 50,000 50,000 50,000 50,000 200,000
Depreciation* 20,000 20,000 20,000 20,000 80,000
Profit 30,000 30,000 30,000 30,000 120,000
*The depreciation charge on a straight line basis, for each year, is ¼ of $(100,000 - 20,000) =
$20,000.
Statement of financial position at year end (extract)
$ $ $ $
Non-current asset 80,000 80,000 80,000 80,000
Depreciation 25% 20,000 40,000 60,000 80,000
Carrying amount 60,000 40,000 20,000 –
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2
Treating the grant as deferred income
Year 1 Year 2 Year 3 Year 4 Total

$ $ $ $ $
Profit as above 50,000 50,000 50,000 50,000 200,000
Depreciation (25,000) (25,000) (25,000) (25,000) (100,000)
Grant 5,000 5,000 5,000 5,000 20,000
Profit 30,000 30,000 30,000 30,000 120,000
Statement of financial position at year end (extract)
Year 1 Year 2 Year 3 Year 4

$ $ $ $
Non-current asset at cost 100,000 100,000 100,000 100,000
Depreciation 25% (25,000) (50,000) (75,000) (100,000)
Carrying amount 75,000 50,000 25,000 –
Government grant deferred
income 15,000 10,000 5,000
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7
Essential reading
HB2022

1 Exemptions and exclusions
1.1 Exemption from preparing consolidated financial statements
A parent need not prepare consolidated financial statements providing:
(a) It is itself a wholly-owned subsidiary, or is partially owned with the consent of the non-
controlling interests;
(b) Its debt or equity instruments are not publicly traded;
(c) It did not or is not in the process of filing its financial statements with a regulatory
organisation for the purpose of publicly issuing financial instruments; and
(d) The ultimate or any intermediate parent produces consolidated financial statements
available for public use that comply with IFRS Standards.
(IFRS 10: para. 4)
1.2 Exclusion of a subsidiary from the consolidated financial statements

IFRS 10 does not permit subsidiaries to be excluded from the consolidated financial statements for
the following reasons:
Dissimilar activities Adequate information is provided by segment

disclosures (IFRS 8: outside syllabus)
Control is temporary as Such subsidiaries are consolidated, but accounted for

subsidiary was purchased for under the principles of IFRS 5 Non-Current Assets
resale Held for Sale and Discontinued Operations (see
Chapter 17 Reporting Financial Performance).
2 Goodwill
2.1 What is goodwill?
Goodwill is created by good relationships between a business and its customers.
(a) By building up a reputation (by word of mouth perhaps) for high quality products or high
standards of service
(b) By responding promptly and helpfully to queries and complaints from customers
(c) Through the personality of the staff and their attitudes to customers
The value of goodwill to a business might be considerable. However, goodwill is not usually valued
in the accounts of a business at all, and we should not normally expect to find an amount for
goodwill in its statement of financial position. For example, the welcoming smile of the bar staff
may contribute more to a bar’s profits than the fact that a new electronic cash register has
recently been acquired. Even so, whereas the cash register will be recorded in the accounts as a
non-current asset, the value of staff would be ignored for accounting purposes.
On reflection, we might agree with this omission of goodwill from the accounts of a business.
(a) The goodwill is inherent in the business but it has not been paid for, and it does not have an
‘objective’ value. We can guess at what such goodwill is worth, but such guesswork would be
a matter of individual opinion, and not based on hard facts.
(b) Goodwill changes from day to day. One act of bad customer relations might damage
goodwill and one act of good relations might improve it. Staff with a favourable personality
might retire or leave to find another job, to be replaced by staff who need time to find their
feet in the job, etc. Since goodwill is continually changing in value, it cannot realistically be
recorded in the accounts of the business.
2.2 Purchased goodwill

There is one exception to the general rule that goodwill has no objective valuation. This is when a
business is sold. People wishing to set up in business have a choice of how to do it – they can
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either buy their own long-term assets and inventory and set up their business from scratch, or
they can buy up an existing business from a proprietor willing to sell it. When a buyer purchases
an existing business, he will have to purchase not only its long-term assets and inventory (and
perhaps take over its accounts payable and receivable too) but also the goodwill of the business.
2.2.1 How is the value of purchased goodwill decided?

When a business is sold, there is likely to be some purchased goodwill in the selling price. But how
is the amount of this purchased goodwill decided?
This is not really a problem for accountants, who must simply record the goodwill in the accounts
of the new business. The value of the goodwill is a matter for the purchaser and seller to agree
upon in fixing the purchase/sale price. However, two methods of valuation are worth mentioning
here:
(a) The seller and buyer agree on a price for the business without specifically quantifying the
goodwill. The purchased goodwill will then be the difference between the price agreed and
the value of the identifiable net assets in the books of the new business.
(b) However, the calculation of goodwill often precedes the fixing of the purchase price and
becomes a central element of negotiation. There are many ways of arriving at a value for
goodwill and most of them are related to the profit record of the business in question.
No matter how goodwill is calculated within the total agreed purchase price, the goodwill shown
by the purchaser in his accounts will be the difference between the purchase consideration and
his own valuation of the net assets acquired. If A values his net assets at $40,000, goodwill is
agreed at $21,000 and B agrees to pay $61,000 for the business but values the net assets at only
$38,000, then the goodwill in B’s books will be $61,000 – $38,000 = $23,000.
2.3 IFRS 3 Business Combinations

IFRS 3 covers the accounting treatment of goodwill acquired in a business combination.
Goodwill acquired in a business combination is recognised as an asset and is initially measured
at cost. Cost is the excess of the cost of the combination over the acquirer’s interest in the net fair
value of the acquiree’s identifiable assets, liabilities and contingent liabilities. (IFRS 3: para. 32)
After initial recognition, goodwill acquired in a business combination is measured at cost less any
accumulated impairment losses. It is not amortised. Instead, it is tested for impairment at least
annually, in accordance with IAS 36 Impairment of Assets.
A gain on a bargain purchase (‘negative goodwill’) arises when the acquirer’s interest in the net
fair value of the acquiree’s identifiable assets, liabilities and contingent liabilities exceeds the cost
of the business combination. IFRS 3 defines a gain on a bargain purchase as the ‘excess of
acquirer’s interest in the net fair value of acquiree’s identifiable assets, liabilities and contingent
liabilities over cost’. (IFRS 3: para. 34)
A gain on a bargain purchase can arise because the entity has genuinely obtained a bargain (for
example, the seller has been forced to accept a lower price). It can also be the result of errors in
measuring the fair value of either the cost of the combination or the acquiree’s identifiable net
assets. Actions should be taken to review any bargain purchases prior to recognition in the
financial statements:
(a) An entity should first reassess the amounts at which it has measured both the cost of the
combination and the purchased and identifiable net assets. This exercise should identify any
errors.
(b) Any excess remaining should be recognised immediately in profit or loss.
(IFRS 3: para. 36)
It could be argued that, because goodwill is so different from other intangible non-current assets,
it does not make sense to account for it in the same way. Thus, the capitalisation and
amortisation treatment would not be acceptable. Furthermore, because goodwill is so difficult to
value, any valuation may be misleading, and it is best eliminated from the statement of financial
position altogether. However, there are strong arguments for treating it like any other intangible
non-current asset. This issue remains controversial.
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3 Consistent accounting policies and year ends
3.1 Accounting policies
As the group reports a single economic entity, uniform accounting policies must be used in the
consolidated financial statements (IFRS 10: para. 19).
If a member of the group does not use the same accounting policies as used in the consolidated
financial statements, consolidation adjustments must be made to align them.
3.2 Reporting dates

Where possible, the financial statements of the parent and its subsidiaries should be prepared to
the same reporting date to facilitate the consolidation process.
Where this is impracticable, the most recent financial statements of the subsidiary can be used,
providing:
(a) The difference between the year ends is no more than three months;
(b) Adjustments are made for the effects of significant transactions or events that occur in the
intervening period; and
(c) The length of the reporting periods and any difference between the dates of the financial
statements is the same from period to period.
(IFRS 10: paras. B92 & B93)
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8
The consolidated
statement of financial
position
Essential reading
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1 Forms of consideration
The consideration paid by the parent for the shares in the subsidiary can take different forms and
this will affect the calculation of goodwill. Here are some examples:
1.1 Contingent consideration

Contingent consideration is ‘an obligation of the acquirer to transfer additional assets or equity
interests to the former owners of an acquiree as part of the exchange for control of the acquiree if
specified future events occur or conditions are met. However, contingent consideration also may
give the acquirer the right to the return of previously transferred consideration if specified
conditions are met.’ (IFRS 3: Appendix A).
IFRS 3 requires that all contingent consideration, measured at fair value, is recognised at the
acquisition date (para. 39).
The acquirer may be required to pay contingent consideration in the form of equity or cash. The
journal entry to record contingent consideration is:
DR Investment in subsidiary
CR Equity (if in the form of equity) / liability (if in cash)
1.1.1 Refunds of original consideration

If part of the original consideration transferred might be refunded, the contingent consideration
can also be an asset.
IFRS 3 sets out the treatment according to the circumstances
(a) If the change in fair value is due to additional information obtained that affects the position
at the acquisition date, goodwill should be re-measured.
(b) If the change is due to events which took place after the acquisition date then:
(i) Account under IFRS 9 Financial Instruments if the consideration is in the form of a
financial instrument (such as loan notes).
(ii) Account under IAS 37 Provisions, Contingent Liabilities and Contingent Assets if the
consideration is in the form of cash.
(iii) Equity instruments are not re-measured.
1.2 Deferred consideration

An agreement may be made that part of the consideration for the combination will be paid at a
future date. This is different from a contingent consideration as it is not conditional upon future
conditions or events. Deferred consideration should be discounted to its present value using the
acquiring entity’s cost of capital.
Example
The parent acquired 75% of the subsidiary’s 80 million $1 shares on 1 January 20X6. It paid $3.50
per share and agreed to pay a further $108 million on 1 January 20X7.
The parent company’s cost of capital is 8%.
In the financial statements for the year to 31 December 20X6, the cost of the combination will be:
$m
80m shares × 75% × $3.50 210
Deferred consideration: $108m × 1/1.08 100
Total consideration 310
At 31 December 20X6, $8 million will be charged to finance costs, being the unwinding of the
discount on the deferred consideration. The deferred consideration was discounted by $8 million
to allow for the time value of money. At 1 January 20X7, the full amount becomes payable.
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1.3 Share exchange
Example
Assume the parent has acquired 12,000 $1 shares in the subsidiary by issuing five of its own $1
shares for every four shares in the subsidiary. The market value of the parent company’s shares is
$6.
Consideration:
$
12,000 × 5/4 × $6 90,000
Note that this is credited to the share capital and share premium of the parent company as
follows:
$ $
DEBIT Investment in subsidiary 90,000

CREDIT Share capital ($12,000 × 5/4) 15,000
CREDIT Share premium ($12,000 × 5/4 × 5) 75,000
1.4 Expenses and issue costs

Expenses of the combination, such as lawyers’ and accountants’ fees, are written off as incurred.
However, IFRS 3 requires that the costs of issuing equity are treated as a deduction from the
proceeds of the equity issue (para. 53). Share issue costs will therefore be debited to share
premium. Issue costs of financial instruments are deducted from the proceeds of the financial
instrument.
2 IFRS 3 and IFRS 13: Fair values

The general rule under IFRS 3 is that the subsidiary’s assets and liabilities must be measured at
fair value except in limited, stated cases. The assets and liabilities must:
(a) Meet the definitions of assets and liabilities in the Conceptual Framework
(b) Be part of what the acquiree (or its former owners) exchanged in the business combination
rather than the result of separate transactions
IFRS 13 provides extensive guidance on how the fair value of assets and liabilities should be
established.
This standard requires that the following are considered in determining fair value:
(a) The asset or liability being measured (IFRS 13: para. 11)
(b) The principal market (ie that where the most activity takes place) or where there is no
principal market, the most advantageous market (ie that in which the best price could be
achieved) in which an orderly transaction would take place for the asset or liability (IFRS 13:
para. 16)
(c) The highest and best use of the asset or liability and whether it is used on a standalone basis
or in conjunction with other assets or liabilities (IFRS 13: para. 27)
(d) Assumptions that market participants would use when pricing the asset or liability
Having considered these factors, IFRS 13 provides a hierarchy of inputs for arriving at fair value. It
requires that Level 1 inputs are used where possible:
Level 1 Quoted prices in active markets for identical assets that the entity can access
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at the measurement date (IFRS 13: para. 76)
Level 2 Inputs other than quoted prices that are directly or indirectly observable for the
asset (IFRS 13: para. 81)
Level 3 Unobservable inputs for the asset (IFRS 13: para. 86)
We will look at the requirements of IFRS 3 regarding fair value in more detail below. First, let us
look at a practical example.
Illustration 6: Land
Anscome Co has acquired land in a business combination. The land is currently developed for
industrial use as a site for a factory. The current use of land is presumed to be its highest and best
use unless market or other factors suggest a different use. Nearby sites have recently been
developed for residential use as sites for high-rise apartment buildings. On the basis of that
development and recent zoning and other changes to facilitate that development, Anscome
determines that the land currently used as a site for a factory could be developed as a site for
residential use (ie for high-rise apartment buildings) because market participants would take into
account the potential to develop the site for residential use when pricing the land.
Required
How would the highest and best use of the land be determined?
Solution
The highest and best use of the land would be determined by comparing both of the following:
(1) The value of the land as currently developed for industrial use (ie the land would be used in
combination with other assets, such as the factory, or with other assets and liabilities).
(2) The value of the land as a vacant site for residential use, taking into account the costs of
demolishing the factory and other costs (including the uncertainty about whether the entity
would be able to convert the asset to the alternative use) necessary to convert the land to a
vacant site (ie the land is to be used by market participants on a stand-alone basis).
The highest and best use of the land would be determined on the basis of the higher of those
values.
2.1 IFRS 3
IFRS 3 sets out general principles for arriving at the fair values of a subsidiary’s assets and
liabilities (IFRS 3: para. 18). The acquirer should recognise the acquiree’s identifiable assets,
liabilities and contingent liabilities at the acquisition date only if they satisfy the following criteria.
(a) In the case of an asset other than an intangible asset, it is probable that any associated
future economic benefits will flow to the acquirer, and its fair value can be measured
reliably.
(b) In the case of a liability other than a contingent liability, it is probable that an outflow of
resources embodying economic benefits will be required to settle the obligation, and its fair
value can be measured reliably.
(c) In the case of an intangible asset or a contingent liability, its fair value can be measured
reliably.
The acquiree’s identifiable assets and liabilities might include assets and liabilities not previously
recognised in the acquiree’s financial statements. For example, a tax benefit arising from the
acquiree’s tax losses that was not recognised by the acquiree may be recognised by the group if
the acquirer has future taxable profits against which the unrecognised tax benefit can be applied.
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2.2 Restructuring and future operating losses
An acquirer should not recognise liabilities for future losses or other costs expected to be
incurred as a result of the business combination.
IFRS 3 explains that a plan to restructure a subsidiary following an acquisition is not a present
obligation of the acquiree at the acquisition date. Neither does it meet the definition of a
contingent liability. Therefore, an acquirer should not recognise a liability for such a
restructuring plan as part of allocating the cost of the combination unless the subsidiary was
already committed to the plan before the acquisition.
This prevents creative accounting. An acquirer cannot set up a provision for restructuring or
future losses of a subsidiary and then release this provision to the profit or loss in subsequent
periods in order to reduce losses or smooth profits.
2.3 Intangible assets

The acquiree may have intangible assets, such as development expenditure. These can be
recognised separately from goodwill only if they are identifiable. An intangible asset is
identifiable only if it:
(a) Is separable, ie capable of being separated or divided from the entity and sold, transferred,
or exchanged, either individually or together with a related contract, asset or liability; or
(b) Arises from contractual or other legal rights.
(IAS 38: IN6)
The acquiree may also have internally generated assets such as brand names which have not
been recognised as intangible assets. As the acquiring company is giving valuable consideration
for these assets, they are now recognised as assets in the consolidated financial statements.
2.4 Contingent liabilities

Contingent liabilities of the acquiree are recognised if their fair value can be measured reliably.
This is a departure from the normal rules in IAS 37; contingent liabilities are not normally
recognised, but only disclosed.
After their initial recognition, the acquirer should measure contingent liabilities that are
recognised separately at the higher of:
(a) The amount that would be recognised in accordance with IAS 37
(b) The amount initially recognised
(IFRS 3: para. 56)
Activity 8: Contingent liabilities at acquisition
On 1 January 20X5, Sutherland Co acquired 100% of the 80,000 $1 shares in Underhill Co at

$4.50 per share. Consideration was paid in cash and in full on the acquisition date.
The financial statements prepared by Underhill Co as at 31 December 20X4 showed retained
earnings of $220,000 with total ordinary share capital of $100,000.
On 22 November 20X4, legal proceedings commenced against Underhill Co, which the legal team
have estimated to be a potential liability against the company of $80,000. A contingent liability in
respect of the legal proceedings was disclosed in the Notes to the financial statements of Underhill
Co as at 31 December 20X4. The fair value of the contingent liability has been assessed as
$80,000 at the date of acquisition.
Required
Calculate the goodwill on the acquisition of Underhill Co that will be included in the consolidated
financial statements of the Sutherland Co group for the year ended 31 December 20X5.
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Solution
2.5 Other exceptions to the recognition or measurement principles

(a) Deferred tax: use IAS 12 values.
(b) Assets held for sale: use IFRS 5 values.
3 Additional activity – Subsidiary acquired mid-way

through the year
Activity 9: Consolidated statement of financial position 1
The draft statements of financial position of Ping Co and Pong Co on 30 June 20X8 were as
follows:
STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE 20X8
Ping Co Pong Co
$ $
Assets
Non-current assets
20,000 ordinary shares in Pong Co at cost 30,000
80,000
Current assets
Owed by Ping Co 10,000
Cash and cash equivalents 2,000 –
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Ping Co Pong Co
$ $
21,000 25,000
Equity
Ordinary shares of $1 each 45,000 25,000
83,000 58,000
Current liabilities
Owed to Pong Co 8,000 –
18,000 7,000
Ping Co acquired its investment in Pong Co on 1 July 20X7 when the retained earnings of Pong Co
stood at $6,000. The agreed consideration was $30,000 cash and a further $10,000 on 1 July
20X9. Ping Co’s cost of capital is 7%. Pong Co has an internally-developed brand name – ‘Pongo’
– which was valued at $5,000 at the date of acquisition. There have been no changes in the share
capital or revaluation surplus of Pong Co since that date. At 30 June 20X8, Pong Co had invoiced
Ping Co for goods to the value of $2,000 and Ping Co had sent payment in full but this had not
been received by Pong Co.
There is no impairment of goodwill. It is group policy to value NCI at full fair value. At the
acquisition date the NCI was valued at $9,000.
Required
Prepare the consolidated statement of financial position of Ping Co as at 30 June 20X8.
Solution
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Activity 10: Consolidated statement of financial position II
On 1 September 20X7, Tyzo Co acquired six million $1 shares in Kono Co at $2.00 per share. At
that date Kono Co produced the following interim financial statements:
$m $m
Property, plant and equipment Trade payables 3.2
(note (i)) 16.0 Taxation 0.6
Inventories (note (ii)) 4.0 Bank overdraft 3.9
Receivables 2.9 Long-term loans 4.0
Cash in hand 1.2 Share capital ($1 shares) 8.0
–––––– Retained earnings 4.4
24.1 24.1
Notes.
1 The following information relates to the property, plant and equipment of Kono Co at 1
September 20X7 (see table below).
2 The inventories of Kono Co which were shown in the interim financial statements are raw
materials at cost to Kono Co of $4 million. They would have cost $4.2 million to replace at 1
September 20X7.
3 On 1 September 20X7, Tyzo Co took a decision to rationalise the group to integrate Kono Co.
The costs of the rationalisation were estimated to total $3 million and the process was due to
start on 1 March 20X8. No provision for these costs has been made in the financial statements
given above.
4 It is group policy to recognise NCI at full (fair) value.
$m
Gross replacement cost 28.4
Net replacement cost (gross replacement cost less depreciation) 16.6
Economic value 18.0
Net realisable value 8.0
Required
Compute the goodwill on consolidation of Kono Co that will be included in the consolidated
financial statements of the Tyzo Co group for the year ended 31 December 20X7, explaining your
treatment of the items mentioned above. You should refer to the provisions of relevant accounting
standards.
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Solution
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Activity answers
Activity 8: Contingent liabilities at acquisition

The contingent liability should be recognised at the higher of the amount recognised under IAS 37
($nil) and the fair value at the acquisition date ($80,000). Even though the statement of financial
position of Underhill Co does not recognise the contingent liability (it is only disclosed in the Notes
to the financial statements), the liability existed at the acquisition date of 1 January 20X5
(proceedings commenced on 22 November 20X4), and therefore the fair value of the net assets at
acquisition should be adjusted.
$000 $000
Consideration ($4.50 × 80,000) 360,000
Fair value of net assets acquired:
Share capital 100,000
Pre-acquisition reserves 220,000
Less contingent liability (80,000)
(240,000)
Goodwill 120,000
Activity 9: Consolidated statement of financial position 1

(1) Calculate goodwill
Group
$
Consideration transferred (W2) 38,734
Fair value of NCI 9,000
Net assets acquired as represented by:
Ordinary share capital 25,000
Revaluation surplus on acquisition 5,000
Retained earnings on acquisition 6,000
Intangible asset – brand name 5,000
(41,000)
Goodwill 6,734
This goodwill must be capitalised in the consolidated statement of financial position.

(2) Consideration transferred
$
Cash paid 30,000
Fair value of deferred consideration (10,000 × 1/(1.072*)) 8,734
38,734
*Note that the deferred consideration has been discounted at 7% for two years (1 July 20X7 to 1
July 20X9).
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However, at the date of the current financial statements, 30 June 20X8, the discount for one year
has unwound. The amount of the discount unwound is:
$
(10,000 × 1/1.07) – 8,734 612
This amount will be charged to finance costs in the consolidated financial statements and the
deferred consideration under liabilities will be shown as $9,346 ($8,734 + $612).
(3) Calculate consolidated reserves
Consolidated revaluation surplus
$
Ping Co 12,000
Share of Pong Co’s post acquisition revaluation surplus –
12,000
Consolidated retained earnings
Ping Pong
$ $
Retained earnings per question 26,000 28,000
Less pre-acquisition (6,000)
22,000
Discount unwound – finance costs (612)
Share of Pong: 80% × $22,000 17,600
42,988
(4) Calculate non-controlling interest at year-end
$
Fair value of NCI 9,000
Share of post-acquisition retained earnings (22,000 × 20%) 4,400
13,400
(5) Agree current accounts

Pong Co has cash in transit of $2,000 which should be added to cash and deducted from the
amount owed by Ping Co.
Cancel common items: these are the current accounts between the two companies of $8,000
each.
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(6) Prepare the consolidated statement of financial position.
PING CO
CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE 20X8
$ $
Assets
Non-current assets
Intangible assets: Goodwill (W1) 6,734
Brand name (W1) 5,000
Current assets
Inventories (3,000 + 8,000) 11,000
Cash and cash equivalents (2,000 + 2,000) 4,000
38,000
Equity
Ordinary shares of $1 each 45,000
Revaluation surplus (W3) 12,000
99,988
NCI (W4) 13,400
113,388
Current liabilities
Trade and other payables (10,000 + 7,000) 17,000
Deferred consideration (W2) 9,346
Activity 10: Consolidated statement of financial position II

Goodwill on consolidation of Kono Co
$m $m
Consideration transferred ($2.00 × 6m) 12.0
NCI ($2.00 × 2m) 4.0
Fair value of net assets acquired
Share capital 8.0
Pre-acquisition reserves 4.4
Fair value adjustments
Property, plant and equipment (16.6 – 16.0) 0.6
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$m $m
Inventories (4.2 – 4.0) 0.2
(13.2)
Goodwill 2.8
Notes.
1 Share capital and pre-acquisition profits represent the carrying amount of the net assets of
Kono Co at the date of acquisition. Adjustments are then required to this book value in order to
give the fair value of the net assets at the date of acquisition. For short-term monetary items,
fair value is their carrying value on acquisition.
2 IFRS 3 states that the fair value of property, plant and equipment should be determined by
market value or, if information on a market price is not available (as is the case here), then by
reference to depreciated replacement cost, reflecting normal business practice. The net
replacement cost (ie $16.6 million) represents the gross replacement cost less depreciation
based on that amount, and so further adjustment for extra depreciation is unnecessary.
3 IFRS 3 also states that raw materials should be valued at replacement cost. In this case, that
amount is $4.2 million.
4 The rationalisation costs cannot be reported in pre-acquisition results under IFRS 3 as they are
not a liability of Kono Co at the acquisition date.
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9
The consolidated
statement of profit or
loss and other
Essential reading
HB2022

1 Mid-year acquisitions
1.1 Profit for the year
The group retained earnings in the statement of financial position should reflect the group’s share
of post‑acquisition retained earnings in the subsidiary. The same applies to the consolidated
statement of profit or loss, as recall that the profit or loss for the year is transferred to retained
earnings in the consolidated statement of financial position. Previous examples have shown how
the non-controlling interest share of profits is treated in the statement of profit or loss. Its share of
profits is deducted from profit for the year, while the figure for profits brought forward in the
consolidation schedule includes only the group share of the subsidiary’s profits.
In the same way, when considering examples which include pre‑acquisition profits in a subsidiary,
the figure for profits brought forward should include only the group share of the post‑acquisition
retained profits. If the subsidiary is acquired during the accounting year, it is therefore necessary
to apportion its profit for the year between pre‑acquisition and post‑acquisition elements. This
can be done by simple time apportionment (ie assuming that profits arose evenly throughout the
year) but there may be seasonal trading or other effects which imply a different split than by time
apportionment.
With a mid‑year acquisition, the entire statement of profit or loss of the subsidiary is split between
pre‑acquisition and post‑acquisition amounts. Only the post‑acquisition figures are included in
the consolidated statement of profit or loss.
Activity 3: Mid-year acquisition
Dougal Co acquired 60% of the $100,000 equity of Ted Co on 1 April 20X5. The statements of
profit or loss of the two companies for the year ended 31 December 20X5 are set out below:
Dougal Co Ted Co Ted Co (9/12)

$ $ $
Revenue 170,000 80,000 60,000
Cost of sales (65,000) (36,000) (27,000)
Gross profit 105,000 44,000 33,000
Other income – dividend received Ted Co 3,600
Administrative expenses (43,000) (12,000) (9,000)
Profit before tax 65,600 32,000 24,000
Income tax expense (23,000) (8,000) (6,000)
Profit for the year 42,600 24,000 18,000
The retained earnings of Dougal Co and Ted Co are as follows:
$ $
Dividends (paid 31 December) 12,000 6,000
Profit retained 30,600 18,000
Retained earnings brought forward 81,000 40,000
Retained earnings carried forward 111,600 58,000
Required
Prepare the consolidated statement of profit or loss and the retained earnings and non-controlling
interest extracts from the statement of changes in equity.
HB2022

Solution
HB2022

Activity answers
Activity 3: Mid-year acquisition

The shares in Ted Co were acquired three months into the year. Only the post‑acquisition
proportion (9/12ths) of Ted Co’s statement of profit or loss is included in the consolidated
statement of profit or loss. This is shown above for convenience.
DOUGAL CO CONSOLIDATED STATEMENT OF PROFIT OR LOSS
$
Revenue (170 + 60) 230,000
Cost of sales (65 + 27) (92,000)
Administrative expenses (43 + 9) (52,000)
Income tax expense (23 + 6) (29,000)
Profit for the year 57,000
Owners of the parent (balancing figure) 49,800
Non-controlling interest (18 × 40%) 7,200
57,000
STATEMENT OF CHANGES IN EQUITY
Non-controlling
Retained earnings interest
$ $
Balance at 1 January 20X5 81,000 –
Dividends paid (NCI: 6,000 × 40%) (12,000) (2,400)
Total comprehensive income for the year 49,800 7,200
Added on acquisition of subsidiary (W) – 58,400
Balance at 31 December 20X5 118,800 63,200
Note that all of Ted Co’s profits brought forward are pre‑acquisition.
Working
NCI on acquisition of subsidiary
$
Added on acquisition of subsidiary:
Retained earnings brought forward 40,000
Profits Jan-March 20X5 (24,000 – 18,000) 6,000
146,000
HB2022

$
Non-controlling share 40% 58,400
HB2022

11
Accounting for
associates
Essential reading
HB2022

1 Requirement to apply the equity method
IAS 28 (para. 20) requires all investments in associates to be accounted for in the consolidated
accounts using the equity method, unless the investment is classified as ‘held for sale’ in
accordance with IFRS 5, in which case it should be accounted for under IFRS 5 (see Chapter 18),
or the exemption in the paragraph below applies.
An investor is exempt from applying the equity method if:
(a) It is a parent exempt from preparing consolidated financial statements under IFRS 10, or
(b) All of the following apply:
(i) The investor is a wholly-owned subsidiary or it is a partially owned subsidiary of another
entity and its other owners, including those not otherwise entitled to vote, have been
informed about, and do not object to, the investor not applying the equity method.
(ii) The investor’s securities are not publicly traded
(iii) It is not in the process of issuing securities in public securities markets
(iv) The ultimate or intermediate parent publishes consolidated financial statements that
comply with IFRS Standards.
(IAS 28: para. 17)
IAS 28 does not allow an investment in an associate to be excluded from equity accounting when
an investee operates under severe long-term restrictions that significantly impair its ability to
transfer funds to the investor. Significant influence must be lost before the equity method ceases
to be applicable.
The use of the equity method should be discontinued from the date that the investor ceases to
have significant influence.
From that date, the investor shall account for the investment in accordance with IFRS 9 Financial
Instruments. The carrying amount of the investment at the date that it ceases to be an associate
shall be regarded as its cost on initial measurement as a financial asset under IFRS 9.
(IAS 28: para. 22)
2 Consolidated financial statements including an

associate
Activity 6: Consolidated statement of financial position with an associate
The statements of financial position of John Co and its investee companies, Paul Co and George
Co, at 31 December 20X5 are shown below.
STATEMENTS OF FINANCIAL POSITION AS AT 31 DECEMBER 20X5
John Co Paul Co George Co

$’000 $’000 $’000
Non-current assets
Freehold property 1,950 1,250 500
Plant and machinery 795 375 285
Investments 1,500 – –
4,245 1,625 785
Current assets
Inventories 575 300 265
Trade receivables 330 290 370
HB2022

$’000 $’000 $’000
Cash and cash equivalents 50 120 20
955 710 655
Total assets 5,200 2,335 1,440
Equity
Share capital – $1 shares 2,000 1,000 750
Retained earnings 1,460 885 390
3,460 1,885 1,140
12% loan stock 500 100 –
Current liabilities
Trade and other payables 680 350 300
Bank overdraft 560 – –
1,240 350 300
Total equity and liabilities 5,200 2,335 1,440
Additional information
(1) John Co acquired 600,000 ordinary shares in Paul Co on 1 January 20X0 for $1,000,000
when the retained earnings of Paul Co were $200,000.
(2) At the date of acquisition of Paul Co, the fair value of its freehold property was considered to
be $400,000 greater than its value in Paul Co’s statement of financial position. Paul Co had
acquired the property in January 20W0 and the buildings element (comprising 50% of the
total value) is depreciated on cost over 50 years.
(3) John Co acquired 225,000 ordinary shares in George Co on 1 January 20X4 for $500,000
when the retained earnings of George Co were $150,000.
(4) Paul Co manufactures a component, the Ringo, used by both John Co and George Co.
Transfers are made by Paul Co at cost plus 25%. John Co held $100,000 inventory of the
Ringo at 31 December 20X5. In the same period, John Co sold goods to George Co, of which
George Co had $80,000 in inventory at 31 December 20X5. John Co had marked these
goods up by 25%.
(5) The goodwill in Paul Co is impaired and should be fully written off. An impairment loss of
$92,000 is to be recognised on the investment in George Co.
(6) Non-controlling interest is valued at full fair value. Paul Co shares were trading at $1.60 just
prior to the acquisition by John Co.
Required
Prepare, using the proformas below, in a format suitable for inclusion in the annual report of the
John Group, the consolidated statement of financial position at 31 December 20X5.
HB2022

Solution
JOHN GROUP CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20X5
$’000
Non-current assets
Freehold property (W2)
Plant and machinery
Investment in associate (W7) 475.20
Current assets
Inventories (W3)
Receivables
Total assets
Equity
Share capital
Retained earnings (W8)
Non-controlling interest (W9)
12% loan stock
Current liabilities
Total equity and liabilities
HB2022

Workings
1 Group structure
John Co
1.1.X0 1.1.X4
60% 30%
(6 years ago) (2 years ago)
Paul Co George Co
2 Freehold property
$’000
John Co
Paul Co
Fair value adjustment
Additional depreciation
3 Inventory
$’000
John Co
Paul Co
PUP
(
) (W4)
4 Unrealised profit (PUP)
$’000
On sales by Paul Co to John Co (parent co)
On sales by John Co to George Co (associate - downstream transaction)
HB2022

Difference at acquisition Difference now
$’000 $’000
Property
Additional depreciation:

6 Goodwill
$’000 $’000
Paul Co
Non-controlling interest
Net assets acquired:
Share capital
Retained earnings
Goodwill at acquisition
Impairment loss
$’000
Cost of investment
Share of post-acquisition profit
HB2022

$’000
Less PUP
Less impairment loss
8 Retained earnings
$’000 $’000 $’000
Retained earnings per question
Adjustments
Unrealised profit (W4)
Impairment loss (Paul Co)
Less pre-acquisition reserves -
Paul Co:
George Co:
Impairment loss George Co
9 Non-controlling interest at reporting date
$’000
Share of post-acquisition retained earnings
HB2022

Activity answers
Activity 6: Consolidated statement of financial position with an associate

JOHN GROUP CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20X5
$’000
Non-current assets
Freehold property (W2) 3,570.00
Plant and machinery (795 + 375) 1,170.00
Investment in associate (W7) 475.20
5,215.20
Current assets
Inventories (W3) 855.00
Receivables (330 + 290) 620.00
Cash and cash equivalents (50 + 120) 170.00
1,645.00
Total assets 6,860.20
Equity
Share capital 2,000.00
Retained earnings (W8) 1,792.20
3,792.20
Non-controlling interest (W9) 878.00
4,670.20
12% loan stock (500 + 100) 600.00
Current liabilities (680 + 560 + 350) 1,590.00
Total equity and liabilities 6,860.20
Workings
1 Group structure
John Co
1.1.X0 1.1.X4
60% 30%
(6 years ago) (2 years ago)
Paul Co George Co
HB2022

2 Freehold property
$’000
John Co 1,950
Paul Co 1,250
Additional depreciation (400 × 50% / 40) × 6 years (20X0–20X5) (30)
3,570
3 Inventory
$’000
John Co 575
Paul Co 300
PUP
(100 × 25/125) (W4) (20)
855
4 Unrealised profit (PUP)
$’000
On sales by Paul Co to John Co (parent co) 100 × 25/125 20.0
On sales by John Co to George Co (associate - downstream transaction)

80 × 25/125 × 30% 4.8
Difference at acquisition Difference now
$’000 $’000
Property 400 400
Additional depreciation: 200 × 6/40 – (30)
400 370
 Charge $30,000 to retained earnings

6 Goodwill
HB2022

$’000 $’000
Paul Co
Non-controlling interest (400 × $1.60) 640
1,640
Net assets acquired:
Share capital 1,000
(1,600)
Goodwill at acquisition 40
Impairment loss (40)
$’000
Cost of investment 500.00
Share of post-acquisition profit (390 – 150) × 30% 72.00
Less PUP
Less impairment loss (92.00)
475.20
8 Retained earnings
$’000 $’000 $’000
Retained earnings per question 1,460.0 885.0 390.0
Adjustments
Unrealised profit (W4) (4.8) (20.0)
Fair value adjustments (W5) (30.0)
Impairment loss (Paul Co) (40.0)
795.0 390.0
Less pre-acquisition reserves -
HB2022

$’000 $’000 $’000
(200.0) (150.0)
1,455.20 595.0 240.0
Paul Co: 60% × 595 357.00
George Co: 30% × 240 72.00
Impairment loss George Co (92.00)
1,792.20
9 Non-controlling interest at reporting date
$’000
NCI at acquisition (W6) 640.00
Share of post-acquisition retained earnings (595 × 40%) 238.00
878.00
HB2022

12
Essential reading
HB2022

1 Compound financial instruments
Some financial instruments contain both a liability and an equity element. In such cases, IAS 32
requires the component parts of the instrument to be classified separately, according to the
substance of the contractual arrangement and the definitions of a financial liability and an equity
instrument.
(IAS 32: para. 28)
One of the most common types of compound instrument is convertible debt. This creates a
primary financial liability of the issuer and grants an option to the holder of the instrument to
convert it into an equity instrument (usually ordinary shares) of the issuer. This is the economic
equivalent of the issue of conventional debt plus a warrant to acquire shares in the future.
Although in theory there are several possible ways of calculating the split, IAS 32 requires the
following method:
(a) Calculate the value for the liability component.
(b) Deduct this from the instrument as a whole to leave a residual value for the equity
component.
(IAS 32: para. 32)
The reasoning behind this approach is that an entity’s equity is its residual interest in its assets
amount after deducting all its liabilities.
The sum of the carrying amounts assigned to liability and equity will always be equal to the
carrying amount that would be ascribed to the instrument as a whole.
Ishmail Co issues $20 million of 4% convertible loan notes at par on 1 January 20X7. The loan
notes are redeemable for cash or convertible into equity shares on the basis of 20 shares per $100
of debt at the option of the loan note holder on 31 December 20X9. Similar but non-convertible
loan notes carry an interest rate of 9%.
The present value of $1 receivable at the end of the year, based on discount rates of 4% and 9%,
can be taken as:
4% 9%
$ $
End of year:
1 0.96 0.92
2 0.93 0.84
3 0.89 0.77
Cumulative 2.78 2.53
Required
Show how these loan notes should be accounted for in the financial statements at 31 December
20X7.
HB2022

Solution
2 Business model test in more detail

IFRS 9 introduces a business model test that requires an entity to assess whether its business
objective for a debt instrument is to collect the contractual cash flows of the instrument, as
opposed to realising any change in its fair value by selling it prior to its contractual maturity. Note
the following key points:
(a) The assessment of a ‘business model’ is not made at an individual financial instrument level.
(b) The assessment is based on how key management personnel actually manage the business,
rather than management’s intentions for specific financial assets.
(c) An entity may have more than one business model for managing its financial assets and the
classification need not be determined at the reporting entity level. For example, it may have
one portfolio of investments that it manages with the objective of collecting contractual cash
flows, and another portfolio of investments held with the objective of trading to realise
changes in fair value. It would be appropriate for entities like these to carry out the
assessment for classification purposes at portfolio level, rather than at entity level.
(d) Although the objective of an entity’s business model may be to hold financial assets in order
to collect contractual cash flows, the entity need not hold all of those assets until maturity.
Thus, an entity’s business model can be to hold financial assets to collect contractual cash
flows, even when sales of financial assets occur.
(IFRS 9: para. B4.1)
3 Contractual cash flow test in more detail

The requirement in IFRS 9 to assess the contractual cash flow characteristics of a financial asset is
based on the concept that only instruments with contractual cash flows of principal and interest
on principal may qualify for amortised cost measurement. By interest, IFRS 9 means
consideration for the time value of money and the credit risk associated with the principal
outstanding during a particular period of time. (IFRS 9: para. B4.1)
HB2022

4 Financial assets further activities
Activity 7: Financial assets at FVTPL and FVTOCI
In February 20X8, Bonce Co purchased 20,000 $1 listed equity shares at a price of $4 per share.
Transaction costs were $2,000. At the year end of 31 December 20X8, these shares were trading
at $5.50. A dividend of 20c per share was received on 30 September 20X8.
Required
Show the financial statement extracts of Bonce Co at 31 December 20X8 relating to this
investment on the basis that:
1 The shares were bought for trading (conditions for FVTOCI have not been met)
2 Conditions for FVTOCI have been met
Solution
Activity 8: Financial assets at amortised cost
On 1 January 20X1, Abacus Co purchases a debt instrument for its fair value of $1,000. The debt
instrument is due to mature on 31 December 20X5. The instrument has a principal amount of
$1,250 and the instrument carries fixed interest at 4.72% that is paid annually. The effective rate
of interest is 10%.
Required
How should Abacus Co account for the debt instrument over its five-year term?
HB2022

Solution
5 Disclosure of financial instruments

5.1 IFRS 7 Financial Instruments: Disclosures
As well as specific monetary disclosures, narrative commentary by issuers is encouraged by the
Standard (IFRS 7: para. 33). This will enable users to understand management’s attitude to risk,
whatever the current transactions involving financial instruments are at the period end.
The standard does not prescribe the format or location for disclosure of information. A
combination of narrative descriptions and specific quantified data should be given, as
appropriate.
The level of detail required is a matter of judgement. Where a large number of very similar
financial instrument transactions are undertaken, these may be grouped together. Conversely, a
single significant transaction may require full disclosure.
Classes of instruments will be grouped together by management in a manner appropriate to the
information to be disclosed. (IAS 32: para. 6)
HB2022

Activity answers

$’000
Finance costs (W2) 1,568
Equity – option to convert (W1) 2,576
4% convertible loan notes (W2) 18,192
Workings
1 Equity and liability elements
$’000
3 years interest (20,000 × 4% × 2.53) 2,024
Redemption (20,000 × 0.77) 15,400
Liability element 17,424
Equity element (β) 2,576
Proceeds of loan notes 20,000
2 Loan note balance
$’000
Liability element (W1) 17,424
Interest for the year at 9% 1,568
Less interest paid (20,000 × 4%) (800)
Carrying amount at 31 December 20X7 18,192
Activity 7: Financial assets at FVTPL and FVTOCI

1
$
Investment income (20,000 × (5.5 – 4.0)) 30,000
Dividend income (20,000 × 20c) 4,000
Transaction costs (2,000)
Investments in equity instruments (20,000 × 5.5) 110,000
HB2022

2
$
Dividend income 4,000
Gain on investment in equity instruments
(20,000 × 5.5) – ((20,000 × 4) + 2,000) 28,000
Investments in equity instruments (20,000 × 5.5) 110,000
Activity 8: Financial assets at amortised cost

Abacus Co will receive interest of $59 (1,250 × 4.72%) each year and $1,250 when the instrument
matures.
Abacus Co must allocate the discount of $250 and the interest receivable over the five-year term
at a constant rate on the carrying amount of the debt. To do this, it must apply the effective
interest rate of 10%.
The following table shows the allocation over the years.
Profit or loss: Interest received

Amortised cost at Interest income for during year (cash Amortised cost at
Year beginning of year year (@10%) inflow) end of year
$ $ $ $
20X1 1,000 100 (59) 1,041
20X2 1,041 104 (59) 1,086
20X3 1,086 109 (59) 1,136
20X4 1,136 113 (59) 1,190
20X5 1,190 119 (1,250 + 59) –
Each year, the carrying amount of the financial asset is increased by the interest income for the
year, and reduced by the interest actually received during the year.
This is a financial asset that has passed the cash flow test for measurement at amortised cost. If
Abacus Co was also holding this instrument for trading, the IFRS 9 business model would allow it
to be carried at fair value through other comprehensive income.
In this case, fair value changes will go through other comprehensive income; interest charges will
be measured at amortised cost and go through profit or loss.
For instance, if at 1 January 20X2 the fair value of the debt instrument was $1,080, the difference
of $39 (1,080 – 1,041) would go to OCI and the asset would be shown in the statement of financial
position at $1,080.
HB2022

13
Leasing
Essential reading
HB2022

1 Lease
1.1 Objective
IFRS 16 sets out the principles for the recognition, measurement, presentation and disclosure of
leases. The objective is to ensure that lessees and lessors provide relevant information in a manner
that faithfully represents those transactions (IFRS 16: para. IN1).
It replaces IAS 17, which required lessees and lessors to classify their leases as either finance
leases or operating leases and account for these two types of lease differently. IAS 17 did not
require lessees to recognise assets and liabilities arising from operating leases (IFRS 16: para. IN5).
IFRS 16 was introduced to remedy this.
The lessee recognises a right-of-use asset, representing its right to use the underlying asset and a
lease liability, representing its obligation to make lease payments (IFRS 16: para. IN10).
The following flowchart may assist you in determining whether a lease may be identified in the
examples that follow.
Is there an identified asset? NO
YES
Does the customer have the right to obtain

substantially all of the economic benefits from NO
use of the asset throughout the period of use?
YES
Does the customer, the supplier or neither party

CUSTOMER have the right to direct how and for what purpose SUPPLIER
the asset is used throughout the period of use?
NEITHER; HOW AND FOR WHAT PURPOSE

THE ASSET WILL BE USED IS PREDETERMINED
Does the customer have the right to operate the asset

YES throughout the period of use, without the supplier
having the right to change those operating instructions?
NO
Did the customer design the asset in a way that

predetermines how and for what purpose the NO
asset will be used throughout the period of use?
YES
The contract contains a lease The contract does

not contain a lease
Illustration 2: Is this a lease?
Broketown Council has recently made substantial cuts to its community transport service. It will
now provide such services only in cases of great need, assessed on a case-by-case basis. It has
entered into a two-year contract with Fleetcar Co for the use of one of its minibuses for this
purpose. The minibus must seat ten people, but Fleetcar Co can use any of its ten-seater
minibuses when required.
HB2022

Required
Is this a lease?
Solution
This is not a lease. There is no identifiable asset. Fleetcar can exchange one minibus for another.
Therefore, Broketown Council should account for the rental payments as an expense in profit or
loss.

IFRS 16 sets out the principles for the recognition, measurement, presentation and disclosure of
leases. The objective is to ensure that lessees and lessors provide relevant information in a manner
that faithfully represents those transactions (IFRS 16: para. IN1).
1.3 Allocation of costs

This example is based on IFRS 16 Illustrative example 13.
Illustration 3: Lion Co
Lion Co enters into a five-year lease of a building, which has a remaining useful life of ten years.
Lease payments are $50,000 per annum, payable at the beginning of each year.
Lion Co incurs initial direct costs of $20,000 and receives lease incentives of $5,000. There is no
transfer of the asset at the end of the lease and no purchase option.
The interest rate implicit in the lease is not immediately determinable but the lessee’s incremental
borrowing rate is 5%, with the value of $1 having a cumulative present value in four years’ time of
$3.546. The value of $1 has a cumulative present value in five years’ time of $4.329.
At the commencement date, Lion Co pays the initial $50,000, incurs the direct costs and receives
the lease incentives.
Required
Calculate and show the transactions to be reflected in the financial statements.
Solution
Step 1: Calculate the lease liability
The lease liability is measured at the present value of the remaining four payments:
$50,000 × $3.546 = $177,300
Step 2: Calculate the initial carrying amount of the right-of-use asset
$
Initial payment 50,000
PV of future lease payments 177,300
Initial direct costs 20,000
Incentives received (5,000)
242,300
Record the transaction in the financial statements

Assets and liabilities would initially be recognised as follows:
HB2022

Debit Credit
$ $
Right-to-use asset 242,300
Cash (50,000 + 20,000 – 5,000) - 65,000
242,300 242,300
At the end of year 1, the liability will be measured as:
$
Opening balance 177,300
Interest 5% 8,865
186,165
Current liability 50,000

Non-current liability 136,165
186,165
The right-of-use asset will be depreciated over five years, being the shorter of the lease term and
the useful life of the underlying asset.
Now we will see how this would work out if the lease payments were made in arrears.
At the commencement date, the lessee would incur the direct costs and receive the lease
incentives.
Step 1: Calculate the lease liability
The lease would be measured at the present value in five years:
$50,000 × $4.329 = $216,450
Step 2: Calculate the value of the right-of-use asset
$
PVFLP 216,450
Direct costs 20,000
Lease incentives (5,000)
231,450
Record the transaction in the financial statements

Assets and liabilities would initially be recognised as follows:
Debit Credit
$ $
Right-of-use asset 231,450
Cash (20,000 – 5,000) - 15,000
231,450 231,450
HB2022

At the end of year 1, the liability will be measured as:
$
Interest 5% 10,823
Lease payment year 1 (50,000)
Year-end balance 177,273
In order to ascertain the split between non-current and current liabilities, we work out the balance
at the end of year 2:
$
Interest 5% 8,864
Lease payment year 2 (50,000)
Year-end balance 136,137
The statement of financial position will show:
$
Non-current liability 136,137
Current liability (177,273 – 136,137) 41,136
177,273
Note that when payments are made in arrears, the next instalment due will contain interest, so
this is effectively deducted to arrive at the capital repayment.
Activity 7: Sidcup Co
On 1 January 20X6, Sidcup Co sold its head office building to Eltham Co for $3 million and
immediately leased it back on a 10-year lease. On that date, the carrying amount of the building
was $2.6 million and its fair value was $3 million. The present value of the lease payments was
calculated as $2.1 million. The remaining useful life of the building at 1 January 20X6 was 15
years. The transaction constituted a sale in accordance with IFRS 15.
Required
A right-of-use asset must be recognised in respect of the leased building. At what amount should
this right-of-use asset be recognised on 1 January 20X6 in the financial statements of Sidcup Co?
 $2,100,000
 $1,820,000
 $3,000,000
 $280,000
 $400,000
 Nil
 $280,000
 $120,000
HB2022

Activity answers
Activity 7: Sidcup Co
IFRS 16 requires that, at the start of the lease, Sidcup should measure the right-of-use asset
arising from the leaseback of the building at the proportion of the previous carrying amount of
the building that relates to the right of use retained. This is calculated as carrying amount ×
discounted lease payments/fair value. The discounted lease payments were given in the question
as $2.1 million.
Sidcup only recognises the amount of gain that relates to the rights transferred.
Stage 1: Gain is $3,000,000 – $2,600,000 = $400,000
Stage 2: Gain relating to rights retained $(400,000 × 2,100,000/3,000,000) = $280,000
Stage 3: Gain relating to rights transferred $(400,000 – 280,000) = $120,000
HB2022

14
Provisions and events
after the reporting
period
Essential reading
HB2022

1 Provisions
1.1 Revision of the detail of the recognition and measurement of provisions
You have covered the detail of IAS 37 Provisions, Contingent Liabilities and Contingent Assets in
your earlier studies in Foundations in Accounting: Financial Accounting (FA/FFA). The basics that
were learnt at the FFA level will still be examinable in the Financial Reporting (FR) examination so
you should make sure you revise it. You will also be introduced to the more complex provisions,
such as restructuring provisions, which are covered in the main part of the workbook. Attempting
the activities below will help you to consolidate your knowledge.
1.2 Issue
Prior to the introduction of IAS 37 Provisions, Contingent Liabilities and Contingent Assets in 1998,
there was little meaningful guidance on when a provision must (and must not) be made.
This caused problems with companies choosing to make then release provisions in order to smooth
profits.
Activity 9: Provision according to IAS 37
Which of the following best describes a provision according to IAS 37 Provisions, Contingent
Liabilities and Contingent Assets?
 A provision is a liability of uncertain timing or amount.
 A provision is a possible obligation of uncertain timing or amount.
 A provision is a credit balance set up to offset a contingent asset so that the effect on the
statement of financial position is nil.
 A provision is a possible asset that arises from past events.
Activity 10: Obligation
Explain whether an obligation exists in each of the following circumstances:

1 On 13 December 20X9, the board of an entity decided to close down a division. The reporting
date of the company is 31 December. Before 31 December 20X9, the decision was not
communicated to any of those affected and no other steps were taken to implement the
decision.
2 The details are as above; however, the board agreed a detailed closure plan on 20 December
20X9 and details were given to customers and employees immediately.
3 At its reporting date a company is obliged to incur clean-up costs for environmental damage
that has already been caused.
4 At its reporting date, a company intends to carry out future expenditure to operate in a
particular way in the future.
Solution
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1.3 Probable transfer of economic benefits
A transfer of economic benefits is regarded as ‘probable’ if the event is more likely than not to
occur (IAS 37: paras. 23–24). This appears to indicate a probability of more than 50%. However,
where there is a number of similar obligations the probability should be based on a consideration
of the population as a whole, rather than one single item.
Example – Transfer of economic benefits

If a company has entered into a warranty obligation then the probability of an outflow of
resources embodying economic benefits (transfer of economic benefits) may well be extremely
small in respect of one specific item. However, when considering the population as a whole the
probability of some transfer of economic benefits is quite likely to be much higher. If there is a
greater than 50% probability of some transfer of economic benefits then a provision should be
made for the expected amount.
1.4 IAS 37 decision tree

The decision tree below summarises the main recognition requirements of IAS 37 for provisions and
contingent liabilities.
Start
Present obligation as a result of Possible

NO NO
an ongoing obligating event? obligation?
YES
Probable outflow? NO Remote? YES
YES
NO
Reliable estimate? NO (RARE)
YES
Provide Disclose Do nothing

contingent liability
(IAS 37: Implementation guidance B)
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Activity 11: Case OTQ Provisions
(1) Proviso Co issued a one-year guarantee for faulty workmanship on an item of specialist
equipment that it delivered to its customer. At the company’s year-end, the company is being
sued by the customer for refusing to replace or repair the item of equipment within the
guarantee period, as Proviso Co believes the fault is not covered by the guarantee, but
instead has arisen because of the customer not following the operating instructions.
The company’s lawyer has advised Proviso Co that it is more likely than not that they will be
found liable. This would result in the company being forced to replace or repair the
equipment plus pay court costs and a fine amounting to approximately $10,000.
Based on past experience with similar items of equipment, the company estimates that there
is a 70% chance that the central core would need to be replaced which would cost $40,000
and a 30% chance that the repair would only cost about $15,000.
(2) The company also manufactures small items of equipment which it sells via a retail network.
The company sold 12,000 items of this type this year, which also have a one-year guarantee
if the equipment fails. Based on past experience, 5% of items sold are returned for repair or
replacement. In each case, one-third of the items returned are able to be repaired at a cost of
$50, while the remaining two-thirds are scrapped and replaced. The manufacturing cost of a
replacement item is $150.
Required
1 What is a constructive obligation?
 An obligation whereby past practice has created a valid expectation that the entity will
discharge its responsibilities
 An obligation whereby the entity is legally required to discharge its responsibilities
 An obligation whereby the entity commits to construct an asset
 An obligation whereby past policies commit the entity to continue to discharge its
responsibilities
2 How much should be provided for the equipment guarantee?
$
3 State whether the following statements regarding the legal claim are true or false.
TRUE OR FALSE
A present obligation exists
The obligation is not probable
No provision is required
The provision will be $32,500
1.5 Measurement
In the core Chapter of the Workbook, Activity 1 discounts the provision. This can be a trickier
concept to understand, but this more detailed explanation will take you through the main steps,
including the double entry and reviewing the overall impact on the financial statements.
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Example – Discounting the provision
Cambridge Co is preparing the financial statements for the year ended 31 December 20X5.
Cambridge Co knows that when it ceases a certain operation in five years’ time it will have to pay
environmental clean-up costs of $5 million. These clean up costs are in relation to a fracking drill.
The relevant discount rate in this case is 10%.
The discounted values of $1 are as follows:
$1 in five years = $0.621
$1 in four years = $0.683
Initial recognition: The company will need to pay $5 million in five-years’ time. Because of the time
value of money, the value of the provision on Day 1 is less than $5 million. IAS 37 requires the
present value of the provision to be calculated using a discount rate, in this case 10%.
The present value of $5 million payable in five years is: $5m × 0.621 = $3,105,000
The clean-up costs are in relation to a drill, which will have been capitalised as part of property,
plant and equipment. IAS 37 permits the provision to be capitalised as part of the cost of the
factory,
The provision is initially recognised by:
$ $
DR PPE cost of the asset 3,105,000
CR Provision 3,105,000
Note. If the provision was not related to the cost of an asset, it would have been debited to the
statement of profit or loss as an expense.
Subsequent recognition: As time passes, and it gets closer to making the payment of the
environmental clean-up costs, the present value of the provision will go up. This is referred to as
‘unwinding the discount’ which is calculated as:
Carrying amount of the provision × Discount rate
The unwinding of the discount is accounted for as a finance cost in the statement of profit or loss.
At 31 December 20X6, the provision to be recognised is calculated as:
Bfwd provision Finance cost 10% Cfwd provision

$ $ $
3,105,000 310,500 3,415,500*
*The c/fwd provision could also have been calculated using the four-year discount factor: $5m ×
0.683 = $3,415,000
The change in the provision for the year ended 31 December 20X6 is recorded by:
$ $
DR Finance cost 310,500
CR Provision 310,500
The resulting provision of $3,415,500 is carried as a liability in the books of Cambridge Co.
This is repeated throughout the five-year period, so the entries for the whole period will look like
this:

$ $ $
Y1 3,105,000 310,500 3,415,500
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$ $ $
Y2 3,415,500 341,550 3,757,050
Y3 3,757,050 375,705 4,132,755
Y4 4,132,755 413,275 4,546,031
Y5 4,546,031 453,969 5,000,000
At the end of Year 5, there will be a provision held on the statement of financial of $5 million.
Treatment of capitalised provision: Usually a provision is debited to the statement of profit or loss
on initial recognition. However, if the provision relates to an asset, as in this case, it is capitalised
as part of the cost of the asset. Subsequently it is debited to the statement of profit or loss, as
part of the depreciation charge, over the life of the asset.
$ $
DR Amortisation/Depreciation expense (3.105m/5 years) 621,000
CR Accumulated depreciation/amortisation 621,000
Over the five-year period, there will be a finance charge and a depreciation charge in the
statement of profit or loss each year relating to the provision. The cost of the provision is spread
across the five years rather than incurring the cost just in year five. This supports the accrual
concept whereby income and the expenses are matched across the period of the economic
benefit.
Year Interest + Dep’n expense Amount expensed in the SOPL

$ $
1 310,500 + 621,000 931,500
2 341,550 + 621,000 962,550
3 375,705 + 621,000 996,705
4 412,375 + 621,000 1,033,375
5 454,130 + 621,000 1,075,130
Total 4,999,260*
*Rounding due to the discount factor used

The final double entry will be to pay the $5 million, thereby debiting the provision and crediting
cash.
$ $
DR Provision 5,000,000
CR Cash 5,000,000
Activity 12: Discounted provision
Extraction Co prepares its financial statements to 31 December each year. During the years
ended 31 December 20X0 and 31 December 20X1, the following event occurred:
Extraction Co is involved in extracting minerals in a number of different countries. The process
typically involves some contamination of the site from which the minerals are extracted.
Extraction Co makes good this contamination only where legally required to do so by legislation
passed in the relevant country.
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The company has been extracting minerals in Copperland since January 20W8 and expects its
site to produce output until 31 December 20X5. On 31 December 20X0, it came to the attention of
the directors of Extraction Co that the government of Copperland was virtually certain to pass
legislation requiring the making good of mineral extraction sites. The legislation was duly passed
on 15 March 20X1. The directors of Extraction Co estimate that the cost of making good the site in
Copperland will be $2 million. This estimate is of the actual cash expenditure that will be incurred
on 31 December 20X5.
Note. The annual discount rate to be used in any relevant calculations is 10%. The relevant
discount factors at 10% are:
• Year 4 at 10% – 0.683
• Year 5 at 10% – 0.621
Required
Calculate the effect of the estimated cost of making good the site on the financial statements of
Extraction Co for BOTH of the years ended 31 December 20X0 and 20X1. Give full explanations of
the figures you compute.
Solution
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2 Contingent liabilities (IAS 37)
2.1 Definition
‘A contingent liability is either:
(a) A possible obligation arising from past events whose existence will be confirmed only by the
occurrence of one or more uncertain future events not wholly within the control of the entity;
oder
(b) A present obligation that arises from past events but is not recognised because:
(i) It is not probable that an outflow of economic benefits will be required to settle the
obligation; or
(ii) The amount of the obligation cannot be measured with sufficient reliability’ (IAS 37: para.
10).
2.2 Recognition
A contingent liability is not recognised. A contingent liability is disclosed unless the possibility of
an outflow of economic benefits is remote.
Activity 13: Recognition and measurement of provisions
After a wedding in 20X8, ten people died possibly as a result of food poisoning from products sold
by Callow Co. Legal proceedings are started seeking damages from Callow but it disputes
liability. Up to the date of approval of the financial statements for the year to 31 December 20X8,
Callow’s lawyers advise that it is probable that it will not be found liable. However, when Callow
prepares the financial statements for the year to 31 December 20X9, its lawyers advise that,
owing to developments in the case, it is probable that it will be found liable.
Required
What is the required accounting treatment?
Solution
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3 Contingent assets (IAS 37)
3.1 Definition
A contingent asset is a possible asset arising from past events whose existence will only be
confirmed by the occurrence of one or more uncertain future events not wholly within the control
of the entity.
3.2 Recognition
• A contingent asset is not recognised because it could result in the recognition of profits that
may never be realised. However, where the realisation of profit is virtually certain, then the
related asset is not a contingent asset and recognition is appropriate.
• A contingent asset is disclosed where an inflow of economic benefits is probable.
4 IAS 10 Events After the Reporting Period

IAS 10 sets out the criteria for recognising events occurring after the reporting date.
4.1 Definition
Events occurring after the reporting period are those events, both favourable and unfavourable,
that occur between the end of the reporting period and the date on which the financial
statements are authorised for issue. Two types of events can be identified:
• Those that provide evidence of conditions that existed at the end of the reporting period –
adjusting
• Those that are indicative of conditions that arose after the reporting period – non-adjusting
(IAS 10: para. 3)
4.2 Reason for the standard

The financial statements are significant indicators of a company’s success or failure. It is
important, therefore, that they include all the information necessary for an understanding of the
company’s position.
Between the end of the reporting period and the date the financial statements are authorised (ie
for issue outside the organisation), events may occur which show that assets and liabilities at the
end of the reporting period should be adjusted, or that disclosure of such events should be given.
4.3 Events requiring adjustment

The standard requires adjustment of assets and liabilities in certain circumstances.
An entity shall adjust the amounts recognised in its financial statements to reflect adjusting events
after the reporting period. An entity shall not adjust the amounts recognised in its financial
statements to reflect non-adjusting events after the reporting period (IAS 10: paras. 8 & 10).
An example of additional evidence which becomes available after the reporting period is where a
customer goes into liquidation, thus confirming that the trade account receivable balance at
the year-end is uncollectable (IAS 10: para. 9).
In relation to going concern, the standard states that, where operating results and the financial
position have deteriorated after the reporting period, it may be necessary to reconsider whether
the going concern assumption is appropriate in the preparation of the financial statements (IAS
10: para. 14).
Examples of adjusting events would be:
• Evidence of a permanent diminution in property value prior to the year-end
• Sale of inventory after the reporting period for less than its carrying value at the yea- end
• Insolvency of a customer with a balance owing at the year-end
• Amounts received or paid in respect of legal or insurance claims which were in negotiation at
the year-end
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• Determination after the year end of the sale or purchase price of assets sold or purchased
before the year-end
• Evidence of a permanent diminution in the value of a long-term investment prior to the year-
end
• Discovery of error or fraud which shows that the financial statements were incorrect
(IAS 10: para. 9)
4.4 Events not requiring adjustment

4.4.1 Examples of non-adjusting events
The standard then looks at events which do not require adjustment.
The standard gives the following examples of events which do not require adjustments:
• Acquisition of, or disposal of, a subsidiary after the year end
• Announcement of a plan to discontinue an operation
• Major purchases and disposals of assets
• Destruction of a production plant by fire after the reporting period
• Announcement or commencing implementation of a major restructuring
• Share transactions after the reporting period
• Litigation commenced after the reporting period
But note that, while they may be non-adjusting, some events after the reporting period will require
disclosure.
(IAS 10: para. 22)
4.4.2 Material non-adjusting events after the reporting period

If non-adjusting events after the reporting period are material, non-disclosure could influence the
economic decisions of users taken on the basis of the financial statements. Accordingly, an entity
shall disclose the following for each material category of non-adjusting event after the reporting
period:
(a) The nature of the event
(b) An estimate of its financial effect, or a statement that such an estimate cannot be made
(IAS 10: para. 21)
The example given by the standard of such an event is where the value of an investment falls
between the end of the reporting period and the date the financial statements are authorised
for issue. The fall in value represents circumstances during the current period, not conditions
existing at the end of the previous reporting period, so it is not appropriate to adjust the value of
the investment in the financial statements. Disclosure is an aid to users, however, indicating
‘unusual changes’ in the state of assets and liabilities after the reporting period.
(IAS 10: para. 11)
4.5 Examples of events after the reporting period

The table below provides examples of adjusting and non-adjusting events. Look out for these
events in your FR exam.
Adjusting events Non-adjusting events

• The settlement of a court case that was • Acquisitions or disposals of subsidiaries
ongoing at the reporting date • Announcement of a plan to discontinue an
• The receipt of information indicating that operation or restructure operations
an asset was impaired at the reporting • The purchase or disposal of assets
date
• The destruction of an asset through
• The determination of the proceeds of accident
assets sold or cost of assets bought before
•
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Adjusting events Non-adjusting events
the reporting date • Ordinary share transactions including the
• The determination of a bonus payment if issue of shares
there was a constructive obligation to pay • Changes in asset prices, foreign exchange
it at the reporting date rates or tax rates
• The discovery of fraud or errors resulting in • The commencement of litigation arising
incorrect financial statements from an event after the reporting period
• Declaration of dividends after the end of
the reporting period
5 Additional activities
You are likely to be asked a question on IAS 37 or IAS 10 as part of an objective test question in
either Section A or section B. You may also be asked to adjust a set of financial statements for
errors, post year-end information, or be able to explain the impact of a provision or event after the
end of the reporting period as part of the interpretation question in Section C.
Activity 14: Narrative question on provisions
Ergonomic Co prepares its financial statements to 31 December each year. During the years
ended 31 December 20X0 and 31 December 20X1, the following event occurred:
Ergonomic Co is involved in extracting minerals in a number of different countries. The process
typically involves some contamination of the site from which the minerals are extracted.
Ergonomic Co makes good this contamination only where legally required to do so by legislation
passed in the relevant country.
The company has been extracting minerals in Golden Sands since January 20W8 and expects its
site to produce output until 31 December 20X5. On 23 December 20X0, it came to the attention of
the directors of Ergonomic Co that the government of Golden Sands was virtually certain to pass
legislation requiring the making good of mineral extraction sites. The legislation was duly passed
on 15 March 20X1. The directors of Ergonomic Co estimate that the cost of making good the site in
Golden Sands will be $2 million. This estimate is of the actual cash expenditure that will be
incurred on 31 December 20X5.
Required
Summarise the criteria that Ergonomic Co need to satisfy before a provision in respect of the
environmental clean-up costs is recognised.
Solution
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Activity 15: OTQ
Toad Co’s year-end is 30 December 20X4 and the following potential liabilities have been
identified.
Which TWO of the following should Toad Co recognise as liabilities as at 30 December 20X4?
 The signing of a non-cancellable contract in December 20X4 to supply goods in the following
year on which, due to a pricing error, a loss will be made.
 The cost of a reorganisation which was communicated to interested parties or announced
publicly, and approved by the board in November 20X4. However, it has not yet been
implemented.
 An amount of deferred tax relating to the gain on the revaluation of a property during the
current year. Toad Co has no intention of selling the property in the foreseeable future.
 The balance on the warranty provision which related to products for which there are no
outstanding claims and whose warranties had expired by 30 December 20X4.
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Activity answers
Activity 9: Provision according to IAS 37

The correct answer is: A provision is a liability of uncertain timing or amount.
Activity 10: Obligation

1 There is no obligation at the reporting date as the decision has not been communicated.
2 A constructive obligation exists at the reporting date and therefore a provision is made in the
20X9 financial statements assuming that the other recognition criteria are met.
3 A legal obligation exists and therefore a provision for clean-up costs is made providing that the
other recognition criteria are met.
4 No present obligation exists and under IAS 37 no provision can therefore be made. This is
because the entity could avoid the future expenditure by its future actions, maybe by
changing its method of operation.
Activity 11: Case OTQ Provisions

1
1 The correct answer is: An obligation whereby past practice has created a valid expectation
that the entity will discharge its responsibilities
2 $ 70,000
A present obligation exists at the end of the reporting period based on historical evidence of
items being repaired under the guarantee agreement.
Here, a large population of items is involved. A provision is therefore made for the expected
value of the outflow:
12,000 × 5% × 1/3 × $50 = $10,000
12,000 × 5% × 2/3 × $150 = $60,000
$70,000
TRUE OR FALSE
A present obligation exists TRUE
The obligation is not probable FALSE
No provision is required FALSE
The provision will be $32,500 FALSE
At the end of the reporting period, Proviso Co disputes the liability (and therefore whether a
present obligation exists).
However, given that it is more likely than not that Proviso will be found guilty, a present
obligation is assumed to exist (IAS 37: paras. 15–16).
Given that a single obligation is being measured, a provision is made for the outflow of the
most likely outcome (IAS 37: para. 40).
Consequently, a provision is recognised for $10,000 + $40,000 = $50,000.
Activity 12: Discounted provision

For the year ended 31 December 20X0:
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• A provision of $1,242,000 (2,000,000 × 0.621) is reported as a liability.
• A non-current asset of $1,242,000 is also recognised. The provision results in a corresponding
asset because the expenditure gives the company access to an inflow of resources embodying
future economic benefits; there is no effect on profit or loss for the year.
For the year ended 31 December 20X1:
• Depreciation of $248,400 (1,242,000 × 20%) is charged to profit or loss. The non-current asset
is depreciated over its remaining useful life of five years from 31 December 20X0 (the site will
cease to produce output on 31 December 20X5).
• Therefore, at 31 December 20X1 the carrying amount of the non-current asset will be $993,600
(1,242,000 – 248,400).
• At 31 December 20X1, the provision will be $1,366,000 (2,000,000 × 0.683).
• The increase in the provision of $124,000 (1,366,000 – 1,242,000) is recognised in profit or loss
as a finance cost. This arises due to the unwinding of the discount.
Activity 13: Recognition and measurement of provisions

1 On the basis of the evidence available when the financial statements were approved, there is
no obligation as a result of past events. No provision is recognised. The matter is disclosed as a
contingent liability unless the probability of any transfer is regarded as remote.
2 On the basis of the evidence available, there is a present obligation. A transfer of economic
benefits in settlement is probable.
A provision is recognised for the best estimate of the amount needed to settle the present
obligation.
Activity 14: Narrative question on provisions

The criteria that need to be satisfied before a provision is recognised
IAS 37 states that a provision should not be recognised unless:
(1) An entity has a present obligation (legal or constructive) as a result of a past event.
(2) It is probable that an outflow of resources embodying economic benefits will be required to
settle the obligation.
(3) A reliable estimate can be made of the amount of the obligation.
An obligation can be legal or constructive. An entity has a constructive obligation if:
(1) It has indicated to other parties that it will accept certain responsibilities (by an established
pattern of past practice or published policies).
(2) As a result, it has created a valid expectation on the part of those other parties that it will
discharge those responsibilities.
Ergonomic Co should recognise a provision for the estimated costs of making good the site
because:
(1) It has a present obligation to incur the expenditure as a result of a past event. In this case the
obligating event occurred when it became virtually certain that the legislation would be
passed. Therefore, the obligation existed at 31 December 20X0.
(2) An outflow of resources embodying economic benefits is probable.
(3) It is possible to make a reliable estimate of the amount.
Activity 15: OTQ

• The signing of a non-cancellable contract in December 20X4 to supply goods in the
following year on which, due to a pricing error, a loss will be made.
• An amount of deferred tax relating to the gain on the revaluation of a property during the
current year. Toad Co has no intention of selling the property in the foreseeable future.
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The signing of a non-cancellable contract in December 20X4 to supply goods in the following
year on which, due to a pricing error, a loss will be made.
An amount of deferred tax relating to the gain on revaluation of a property during the current
year. Toad Co has no intention of selling the property in the foreseeable future.
The reorganisation does not meet the criteria for a provision and a provision is no longer needed
for the warranties.
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15
Inventories and
biological assets
Essential reading
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1 Consistency – different cost formulas for inventories
IAS 2 allows two cost formulas (FIFO or weighted average cost) for inventories that are ordinarily
interchangeable or are not produced and segregated for specific projects. The issue is whether an
entity may use different cost formulas for different types of inventories.
IAS 2 provides that an entity should use the same cost formula for all inventories having similar
nature and use to the entity. For inventories with different nature or use (for example, certain
commodities used in one business segment and the same type of commodities used in another
business segment), different cost formulas may be justified. A difference in geographical location
of inventories (and in the respective tax rules), by itself, is not sufficient to justify the use of
different cost formulas (IAS 2: para. 25).
2 Net realisable value (NRV)

As a general rule, assets should not be carried at amounts greater than those expected to be
realised from their sale or use. In the case of inventories this amount could fall below cost when
items are damaged or become obsolete, or where the costs to completion have increased in
order to make the sale (IAS 2: para. 28).
In fact, we can identify the principal situations in which NRV is likely to be less than cost, ie where
there has been:
(a) An increase in costs or a fall in selling price
(b) A physical deterioration in the condition of inventory
(c) Obsolescence of products
(d) A decision as part of the company’s marketing strategy to manufacture and sell products at
a loss
(e) Errors in production or purchasing
A write down of inventories would normally take place on an item by item basis, but similar or
related items may be grouped together. This grouping together is acceptable for, say, items in
the same product line, but it is not acceptable to write down inventories based on a whole
classification (eg finished goods) or a whole business (IAS 2: para. 29).
The assessment of NRV should take place at the same time as estimates are made of selling price,
using the most reliable information available. Fluctuations of price or cost should be taken into
account if they relate directly to events after the reporting period, which confirm conditions
existing at the end of the period (IAS 2: para. 30).
The reasons why inventory is held must also be taken into account. Some inventory, for example,
may be held to satisfy a firm contract and its NRV will therefore be the contract price. Any
additional inventory of the same type held at the period end will, in contrast, be assessed
according to general sales prices when NRV is estimated (IAS 2: para. 31).
Net realisable value must be reassessed at the end of each period and compared again with cost.
If the NRV has risen for inventories held over the end of more than one period, then the previous
write down must be reversed to the extent that the inventory is then valued at the lower of cost
and the new NRV. This may be possible when selling prices have fallen in the past and then risen
again (IAS 2: para. 33).
3 Biological assets
Biological assets are the core income-producing assets of agricultural activities, held for their
transformative capabilities. Biological transformation leads to various different outcomes (IAS 41:
para. 7):
• Asset changes:
- Growth: increase in quantity and or quality
- Degeneration: decrease in quantity and/or quality
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• Creation of new assets:
- Production: producing separable non-living products
- Procreation: producing separable living animals
We can distinguish between the importance of these by saying that asset changes are critical to
the flow of future economic benefits both in and beyond the current period, but the relative
importance of new asset creation will depend on the purpose of the agricultural activity.
IAS 41 distinguishes between two broad categories of agricultural production system (para. 44).
(a) Consumable: animals/plants themselves are harvested eg wheat, pigs for meat.
(b) Bearer: animals/plants bear produce for harvest eg dairy cattle, grapevines.
A few further points are made (para. 25):
(a) Biological assets are usually managed in groups of animal or plant classes, with
characteristics (eg male/female ratio) which allow sustainability in perpetuity.
(b) Land often forms an integral part of the activity itself in pastoral and other land-based
agricultural activities.
3.1 Bearer biological assets

These assets should be accounted for under IAS 16 Property, Plant and Equipment.
Agricultural produce from these plants continues to be recognised under IAS 41/IAS 2.
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16
Taxation
Essential reading
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1 Deferred tax
The key to understanding deferred tax is plenty of question practice. The following activities
enable you to practice the information from the workbook and apply your knowledge.
Activity 9: Cyclon Co
Cyclon Co purchased land on 1 January 20X7 for $400,000. On 31 December 20X8, the land was
revalued to $500,000. In the tax regime in which the company operates, revaluations do not
affect either the tax base of the asset or taxable profits.
The income tax rate is 30%.
Required
Prepare the accounting entry to record the deferred tax in relation to this revaluation for the year
Solution
Activity 10: Zebra Co
Zebra Co owns a property which has a carrying amount at the beginning of 20X9 of $1.5 million.
At the year-end, it has entered into a contract to sell the property for $1,800,000. The tax rate is
30%.
Required
How will this gain on the property revaluation be shown in the financial statements?
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Solution
Activity 11: Ginger Co
Ginger Co has an asset with a carrying amount of $80,000 and a tax base of $50,000. The
current tax rate is 30% and the rate is being reduced to 25% in the next tax year. Ginger Co plans
to dispose of the asset for its carrying amount and will do so after the tax rate falls.
Required
What is the deferred tax arising in relation to this asset?
Solution
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Activity 12: Norman Kronkest Co
For the year ended 31 July 20X4, Norman Kronkest Co made taxable trading profits of $1.2 million
on which income tax is payable at 30%.
(1) A transfer of $20,000 will be made to the deferred taxation account. The balance on this
account was $100,000 before making any adjustments for items listed in this paragraph.
(2) The estimated tax on profits for the year ended 31 July 20X3 was $80,000, however tax has
now been agreed at $84,000 and fully paid.
(3) Tax on profits for the year to 31 July 20X4 is payable on 1 May 20X5.
(4) In the year to 31 July 20X4 the company made a capital gain of $60,000 on the sale of some
property. This gain is taxable at a rate of 30%.
Required
1 Calculate the tax charge for the year to 31 July 20X4.
2 Prepare extracts from the statement of profit or loss of Norman Kronkest for the year ended 31
July 20X4.
3 Calculate the tax liabilities in the statement of financial position of Norman Kronkest as at 31
July 20X4.
Solution
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Activity answers
Activity 9: Cyclon Co
DEBIT Other comprehensive income (and revaluation surplus) $30,000

CREDIT Deferred tax liability $30,000
Working
Deferred tax
$
Carrying amount of asset 500,000
Less tax base (400,000)
Temporary difference 100,000
Deferred tax (liability) (30% × 100,000) (30,000)
Activity 10: Zebra Co

STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME (EXTRACT)
$’000
Profit for the year X
Gains on property revaluation 300
Income tax relating to components of other comprehensive income (300 × 30%) (90)
Other comprehensive income for the year net of tax 210
The amounts will be posted as follows:
Debit Credit
$’000 $’000
Property, plant and equipment 300
Deferred tax 90
210
Revaluation surplus
In this case, the deferred tax has been deducted from the revaluation surplus rather than being
charged to profit or loss.
Activity 11: Ginger Co

The deferred tax on the temporary difference is therefore $30,000 × 25% = $7,500.
In addition, deferred tax assets/liabilities should not be classified as current assets/liabilities,
where an entity makes such a distinction (IAS 12: paras. 71–74).
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Activity 12: Norman Kronkest Co
1 Tax charge:
$
Tax on trading profits (30% of 1,200,000) 360,000
Tax on capital gain (30% of 60,000) 18,000
398,000
Underprovision of taxation in previous years $(84,000 – 80,000) 4,000
Tax charge on profit for the period 402,000
2 The statement of profit or loss will show the following:
$
Profit before tax (1,200,000 + 60,000) 1,260,000
Income tax expense (402,000)
3 Deferred taxation
$
Balance brought forward 100,000
Transferred from profit or loss 20,000
Deferred taxation in the statement of financial position 120,000
The tax liability is as follows:
$
Payable on 1 May 20X5
Tax on profits (30% of $1,200,000) 360,000
Tax on capital gain (30% of $60,000) 18,000
Due on 1 May 20X5 378,000
Summary
$
Current liabilities
Tax, payable on 1 May 20X5 378,000
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It may be helpful to show the journal entries for these items.
$ $
DEBIT Tax charge (statement of profit or loss) 402,000
CREDIT Tax payable *382,000
Deferred tax liability 20,000
*This account will show a debit balance of $4,000 until the under provision is recorded, since
payment has already been made: (360,000 + 18,000 + 4,000). The closing balance will
therefore be $378,000.
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17
Presentation of
published financial
statements
Essential reading
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1 IAS 1 Presentation of Financial Statements
1.1 Profit or loss for the year
The statement of profit or loss and other comprehensive income is the most significant indicator of
a company’s financial performance. It is therefore important to ensure that it is not misleading.
IAS 1 stipulates that all items of income and expense recognised in a period shall be included in
profit or loss unless a standard requires otherwise. (IAS 1: para. 88)
Circumstances where items may be excluded from profit or loss for the current year include the
correction of errors and the effect of changes in accounting policies. These are covered in IAS 8.
(IAS 1: para. 89)
1.2 How items are disclosed

IAS 1 specifies disclosures of certain items in certain ways:
• Some items must appear on the face of the statement of financial position or statement of
profit or loss and other comprehensive income.
• Other items can appear in a note to the financial statements instead.
• Recommended formats are given, which entities may or may not follow, depending on their
circumstances. (IAS 1: paras. 79, 97)
Of course, disclosures specified by other standards must also be made, and the necessary
disclosures are mentioned in the Workbook when each standard is explained. Disclosures in both
IAS 1 and other standards must be made, either on the face of the statement or in the notes,
unless otherwise stated, ie disclosures cannot be made in an accompanying commentary or
report.
1.2.1 Materiality
If items are material, the entity must disclose their nature and amount separately. Such items
may include:
• Write downs of inventories to net realisable value
• Disposals of property, plant and equipment or investments
• Discontinued operations
• Legal claims
Materiality and disclosure in the financial statements has been a focus of the Board for a number
of years under the heading of the Disclosure Initiative. The Disclosure Initiative commenced in
2013 to address a number of perceived problems with disclosure in the financial statements.
Too much irrelevant

information
Not enough Ineffective communication
relevant information of information
The
disclosure problem
Materiality was addressed as part of the Disclosure Initiative by:

(a) Amending the definition of material to make it clear that obscuring information has the same
effect as omitting or misstating it (covered in Chapter 1)
(b) Issuing IFRS Practice Statement 2: Making Materiality Judgements (which will be considered
further in Strategic Business Reporting)
1.3 Identification of financial statements

As a result of the above point, it is most important that entities distinguish the financial statements
very clearly from any other information published with them. This is because all IASs/IFRSs apply
only to the financial statements (ie the main statements and related notes), so readers of the
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annual report must be able to differentiate between the parts of the report which are prepared
under IFRSs, and other parts which are not. (IAS 1: para. 50)
The entity should identify each financial statement and the notes very clearly. IAS 1 also requires
disclosure of the following information in a prominent position. If necessary, it should be repeated
wherever it is felt to be of use to the reader in their understanding of the information presented.
• Name of the reporting entity (or other means of identification)
• Whether the accounts cover the single entity only or a group of entities
• The date of the end of the reporting period or the period covered by the financial statements
(as appropriate)
• The presentation currency
• The level of rounding used in presenting amounts in the financial statements (IAS 1: para. 51)
Judgement must be used to determine the best method of presenting this information. In
particular, the standard suggests that the approach to this will be very different when the
financial statements are communicated electronically. (IAS 1: para. 52)
The level of rounding is important, as presenting figures in thousands or millions of units makes
the figures more understandable. The level of rounding must be disclosed, however, and it should
not obscure necessary details or make the information less relevant. (IAS 1: para. 53)
1.4 Reporting period

It is normal for entities to present financial statements annually and IAS 1 states that they should
be prepared at least as often as this. If (unusually) the end of an entity’s reporting period is
changed, for whatever reason, the period for which the statements are presented will be less or
more than one year. In such cases, the entity should also disclose:
(a) The reason(s) why a period other than one year is used
(b) The fact that the comparative figures given are not in fact comparable (IAS 1: para. 36)
For practical purposes, some entities prefer to use a period which approximates to a year, eg 52
weeks, and the IAS allows this approach, as it will produce statements not materially different
from those produced on an annual basis. (IAS 1: para. 37)
1.5 Timeliness
If the publication of financial statements is delayed too long after the reporting period, their
usefulness will be severely diminished. An entity with consistently complex operations cannot use
this as a reason for its failure to report on a timely basis. Local legislation and market regulation
imposes specific deadlines on certain entities.
IAS 1 looks at the statement of financial position and statement of profit or loss and other
comprehensive income. We will not give all the detailed disclosures, as some are outside the scope
of the Financial Reporting syllabus. Instead, we will look at a proforma set of accounts based on
the Standard.
2 Financial statement presentation

2.1 Information presented in the statement of profit or loss
The standard lists the following as the minimum to be disclosed on the face of the statement of
profit or loss.
(a) Revenue
(b) Finance costs
(c) Share of profits and losses of associates and joint ventures accounted for using the equity
method
(d) A single amount for the total of discontinued operations
(e) Tax expense
(IAS 1: para. 82)
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The following items must be disclosed as allocations of profit or loss for the period.
• Profit or loss attributable to non-controlling interest
• Profit or loss attributable to owners of the parent
(IAS 1: para. 81)
The allocated amounts must not be presented as items of income or expense. (These relate to
group accounts, covered separately in this Workbook.)
2.2 Information presented either in the statement or in the notes

An analysis of expenses must be shown, either in the profit or loss section (as above, which is
encouraged by the standard) or by note, using a classification based on either the nature of the
expenses or their function. This sub-classification of expenses indicates a range of components of
financial performance; these may differ in terms of stability, potential for gain or loss and
predictability.
(IAS 1: paras. 99–106)
2.2.1 Nature of expense method

Expenses are not reallocated amongst various functions within the entity, but are aggregated in
the statement of profit or loss according to their nature (eg purchase of materials, depreciation,
wages and salaries, transport costs). This is by far the easiest method, especially for smaller
entities.
(IAS 1: para. 102)
2.2.2 Function of expense/cost of sales method

You are likely to be more familiar with this method. Expenses are classified according to their
function as part of cost of sales, distribution or administrative activities. This method often gives
more relevant information for users, but the allocation of expenses by function requires the use of
judgement and can be arbitrary. Consequently, perhaps, when this method is used, entities
should disclose additional information on the nature of expenses, including staff costs, and
depreciation and amortisation expense.
(IAS 1: para. 103)
Which of the above methods is chosen by an entity will depend on historical and industry factors,
and also the nature of the organisation. Under each method, there should be given an indication
of costs, which are likely to vary (directly or indirectly) with the level of sales or production. The
choice of method should fairly reflect the main elements of the entity’s performance (IAS 1: para.
105). This is the method you should expect to see in your exam.
Exam focus point

Note that you are not awarded marks for typing out the format for a financial statement.
However, you must input the format so that you can then fill in the numbers and earn the
marks.
2.3 Dividends
IAS 1 also requires disclosure of the amount of dividends paid during the period covered by the
financial statements. This is shown either in the statement of changes in equity or in the notes.
(IAS 1: para. 107)
2.4 Further points

(a) All requirements previously set out in other standards for the presentation of particular line
items in the statement of financial position and statement of profit or loss and other
comprehensive income are now dealt with in IAS 1. These line items are: biological assets;
liabilities and assets for current tax and deferred tax; and pre-tax gain or loss recognised on
the disposal of assets or settlement of liabilities attributable to discontinued operations.
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(b) An entity must disclose, in the summary of significant accounting policies and/or other notes,
the judgements made by management in applying the accounting policies that have the
most significant effect on the amounts of items recognised in the financial statements. (IAS 1:
para. 122)
(c) An entity must disclose in the notes information regarding key assumptions about the future,
and other sources of measurement uncertainty, that have a significant risk of causing a
material adjustment to the carrying amounts of assets and liabilities within the next financial
year. (IAS 1: para. 125)
Exam focus point

You will have to produce financial statements suitable for publication in your exam, so this
chapter is important and you should refer back to it.
3 Notes to the financial statements

Some items need to be disclosed by way of a note.
3.1 Contents of notes

The notes to the financial statements will amplify the information given in the statement of
financial position, statement of profit or loss and other comprehensive income and statement of
changes in equity. To some extent, the contents of the notes will be determined by the level of
detail shown on the face of the statements.
3.2 Structure
The notes to the financial statements should perform the following functions:
(a) Present information about the basis on which the financial statements were prepared and
which specific accounting policies were chosen and applied to significant transactions/events
(b) Disclose any information, not shown elsewhere in the financial statements, which is required
by IFRSs
(c) Show any additional information that is relevant to understanding which is not shown
elsewhere in the financial statements
(IAS 1: para. 112)
The way the notes are presented is important. They should be given in a systematic manner and
cross-referenced back to the related figure(s) in the statement of financial position, statement of
comprehensive income or statement of cash flows. (IAS 1: para. 113)
Notes to the financial statements will amplify the information shown therein by giving the
following:
(a) More detailed analysis or breakdowns of figures in the statements
(b) Narrative information explaining figures in the statements
(c) Additional information, eg contingent liabilities and commitments
IAS 1 suggests a certain order for notes to the financial statements. This will assist users when
comparing the statements of different entities.
(a) Statement of compliance with IFRSs
(b) Statement of the measurement basis (bases) and accounting policies applied
(c) Supporting information for items presented in each financial statement in the same order as
each line item and each financial statement is presented
(d) Other disclosures, eg:
(i) Contingent liabilities, commitments and other financial disclosures
(ii) Non-financial disclosures
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The order of specific items may have to be varied occasionally, but a systematic structure is still
required. (IAS 1: para. 114)
3.3 Disclosure of accounting policies

The accounting policies section should describe the following:
(a) The measurement basis (or bases) used in preparing the financial statements
(b) The other accounting policies used, as required for a proper understanding of the financial
statements (IAS 1: para. 117)
This information may be shown in the notes or sometimes as a separate component of the
The information on measurement bases used is obviously fundamental to an understanding of the
financial statements. Where more than one basis is used, it should be stated to which assets or
liabilities each basis has been applied. (IAS 1: para. 118)
Note. Accounting policies are covered in Chapter 17.
3.4 Other disclosures

An entity must disclose in the notes:
(a) The amount of dividends proposed or declared before the financial statements were
authorised for issue but not recognised as a distribution to owners during the period, and the
amount per share
(b) The amount of any cumulative preference dividends not recognised
(IAS 1: para. 137)
IAS 1 ends by listing some specific disclosures which will always be required if they are not shown
elsewhere in the financial statements.
(a) The domicile and legal form of the entity, its country of incorporation and the address of the
registered office (or, if different, principal place of business)
(b) A description of the nature of the entity’s operations and its principal activities
(c) The name of the parent entity and the ultimate parent entity of the group
(IAS 1: para. 138)
Illustration 1: Preparation of financial statements – Wislon Co
The accountant of Wislon Co has prepared the following list of account balances as at 31
December 20X7.
$’000
50c ordinary shares (fully paid) 450
10% loan notes (secured) 200
Retained earnings 1.1.X7 242
Other components of equity 1.1.X7 171
Land and buildings 1.1.X7 (cost) 430
Plant and machinery 1.1.X7 (cost) 830
Buildings 1.1.X7 20
Plant and machinery 1.1.X7 222
Inventory 1.1.X7 190
Sales 2,695
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$’000
Purchases 2,152
Ordinary dividend 15
Loan note interest 10
Wages and salaries 254
Light and heat 31
Sundry expenses 113
Suspense account 135
Trade accounts receivable 179
Trade accounts payable 195
Cash 126
(1) Sundry expenses include $9,000 paid in respect of insurance for the year ending 1 September
20X8. Light and heat does not include an invoice of $3,000 for electricity for the three
months ending 2 January 20X8, which was paid in February 20X8. Light and heat also
includes $20,000 relating to sales commission.
(2) The suspense account is in respect of the items shown in table ‘Suspense account’
(3) The net assets of Mary & Co were purchased on 3 March 20X7. Assets were valued as shown
in table ‘Asset value’. All the inventory acquired was sold during 20X7. The equity investments
were still held by Wislon at 31.12.X7. Goodwill has not been impaired in value.
(4) The property was acquired some years ago. The buildings element of the cost was estimated
at $100,000 and the estimated useful life of the assets was 50 years at the time of purchase.
As at 31 December 20X7, the property is to be revalued at $800,000.
(5) The plant, which was sold, had cost $350,000 and had a carrying amount of $274,000 as on
1.1.X7. $36,000 depreciation is to be charged on plant and machinery for 20X7.
(6) The management wish to provide for:
(i) Loan note interest due
(ii) A transfer from other components of equity to retained earnings of $16,000 in respect of
a previous revaluation surplus
(iii) Audit fees of $4,000
(7) Inventory as at 31 December 20X7 was valued at $220,000 (cost).
(8) Taxation is to be ignored.
Suspense account
$’000
Proceeds from the issue of 100,000 ordinary shares 120
Proceeds from the sale of plant 300
420
Less consideration for the acquisition of Mary & Co 285
135
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Asset value
$’000
Equity investments 231
Inventory 34
265
Required
Prepare the financial statements of Wislon Co as at 31 December 20X7. You do not need to
produce notes to the statements.
Solution
For ease of reference, we will first address the adjustments and then prepare the financial
statements proformas. Both the adjustments and figures per the trial balance that do not require
adjustment are posted to the proformas.
(1) Normal adjustments are needed for accruals and prepayments (insurance, light and heat,
loan note interest and audit fees). The loan note interest accrued is calculated as follows:
$’000
Charge needed in profit or loss (10% × $200,000) 20
Amount paid so far, as shown in list of account balances 10
Accrual: presumably six months’ interest now payable 10
The accrued expenses shown in the statement of financial position comprise:
$’000
Loan note interest 10
Light and heat 3
Audit fee 4
17
The misposting of $20,000 to light and heat is also adjusted, by reducing the light and heat
expense, but charging $20,000 to sales commission.
(2) Depreciation on the building is calculated as $100,000/50 = $2,000.
The carrying amount of the building is then $430,000 – $20,000 – $2,000 = $408,000 at the
end of the year. When the property is revalued, a revaluation surplus of $800,000 –
$408,000 = $392,000 is then recognised within other components of equity.
(3) The profit on disposal of plant is calculated as proceeds $300,000 (per suspense account)
less carrying amount $274,000, ie $26,000. The cost of the remaining plant is calculated at
$830,000 – $350,000 = $480,000. The depreciation provision at the year end is:
$’000
Balance 1.1.X7 222
Charge for 20X7 36
Less depreciation on disposals (350 – 274) (76)
182
(4) Goodwill arising on the acquisition of Mary & Co is:
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$’000
Consideration (per suspense account) 285
Assets at valuation 265
Goodwill 20
This is shown as an asset in the statement of financial position. The equity investments, being
owned by Wislon Co at the year end, are also shown on the statement of financial position,
whereas Mary & Co’s inventory, acquired and then sold, is added to the purchases figure for the
year.
(5) The other item in the suspense account is dealt with as follows:
$’000
Proceeds of issue of 100,000 ordinary shares 120
Less nominal value 100,000 × 50c 50
Excess of consideration over par value (= share premium) 70
(6) The transfer from other components of equity results in an other components of equity
balance of $171,000 (b/f) + $392,000 (Note 3) – $16,000 = $547,000.
We are now ready to prepare the financial statements of Wislon Co

WISLON CO STATEMENT OF PROFOIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
$’000
Revenue 2,695
Gross profit 539
Other income (profit on disposal of plant) 26
Administrative expenses (W2) (437)
Finance costs (20)
Total comprehensive income for the year 500
Workings
1 Cost of sales
$’000
Opening inventory 190
Purchases (2,152 + 34) 2,186
Closing inventory (220)
2,156
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2 Administrative expenses
$’000
Wages, salaries and commission (254 + 20) 274
Sundry expenses (113 – 6) 107
Light and heat (31 – 20 + 3) 14
Depreciation: buildings 2
plant 36
Audit fees 4
437
WISLON CO STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20X7
$’000 $’000
Assets
Non-current assets
Property at valuation 800
Plant: cost 480
accumulated depreciation (182)
298
Goodwill 20
Equity investments 231
Current assets
Inventories 220
Trade accounts receivable 179
Prepayments 6
Cash and cash equivalents 126
531
Total assets 1,880
Equity
50c ordinary shares 500
Share premium 70
Other components of equity 547
1,468
10% loan stock (secured) 200
Current liabilities
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Trade and other payables 195
Accrued expenses 17
212
WISLON CO STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 20X7
Other
Share Share Retained components
capital premium earnings of equity Total
$’000 $’000 $’000 $’000 $’000
Balance at 1.1.X7 450 – 242 171 863
Issue of share capital 50 70 120
Dividends (15) (15)
Total comprehensive
income for the year 108 392 500
Transfer to other
components of equity – – 16 (16) –
Balance at 31.12.X7 500 70 351 547 1,468
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18
Reporting financial
performance
Essential reading
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1 IAS 8 Accounting Policies, Changes in Accounting
Estimates and Errors
1.1 Changes in accounting policies
Activity 6: Tabby Co
Tabby Co has always valued inventory on a first in, first out (FIFO) basis. In 20X9, it decides to
switch to the weighted average method of valuation. Gross profit in the 20X8 financial statements
was calculated as follows:
$’000 $’000
Revenue 869
Cost of sales:
Purchases 246
Closing inventory (174) (207)
Gross profit 662
Required
Restate the 20X8 comparative figures to show the effect of the change in accounting policy.
Solution
$’000 $’000
Revenue
Cost of sales:
Opening inventory
Purchases
Closing inventory
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2 Errors
Activity 7: Correction of errors
During 20X7, Global Co discovered that certain items had been included in inventory at 31
December 20X6, valued at $4.2 million, which had in fact been sold before the year-end. The
following figures for 20X6 (as reported) and 20X7 (draft) are as follows:
20X6 20X7 (draft)

$’000 $’000
Revenue 47,400 67,200
Cost of goods sold (34,570) (55,800)
Profit before taxation 12,830 11,400
Income taxes (3,880) (3,400)
Profit for the period 8,950 8,000
Retained earnings at 1 January 20X6 were $13 million. The cost of goods sold for 20X7 includes
the $4.2 million error in opening inventory. The income tax rate was 30% for 20X6 and 20X7. No
dividends have been declared or paid.
Required
Show the statement of profit or loss for 20X7, with the 20X6 comparative, and retained earnings.
Solution
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3 IFRS 5 Non-current Assets Held for Sale and
3.1 Classification of assets held for sale
Activity 8: Assets held for sale
On 1 December 20X3, ManiCo became committed to a plan to sell a manufacturing facility and
has already found a potential buyer. ManiCo does not intend to discontinue the operations
currently carried out in the facility. At 31 December 20X3, there is a backlog of uncompleted
customer orders. The company will not be able to transfer the facility to the buyer until after it
ceases to operate the facility and has eliminated the backlog of uncompleted orders. This is not
expected to occur until spring 20X4.
Required
Can the manufacturing facility be classified as ‘held for sale’ at 31 December 20X3?
Solution
3.2 Discontinued operations

3.2.1 Discontinued operations: Proforma disclosure – on the face and in notes
Minimum disclosure on the face of the statement of profit or loss and other comprehensive
income
XYZ GROUP – STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
20X3 20X2
$’000 $’000
Revenue X X
Cost of sales (X) (X)
Gross profit X X
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20X3 20X2
$’000 $’000
Other income X X
Distribution costs (X) (X)
Administrative expenses (X) (X)
Other expenses (X) (X)
Finance costs (X) (X)
Profit before tax X X
Income tax expense (X) (X)
Profit for the year from continuing operations X X
Loss for the year from discontinued operations (X) (X)
PROFIT FOR THE YEAR X X
Other comprehensive income for the year, net of tax X X
TOTAL COMPREHENSIVE INCOME FOR THE YEAR X X
3.2.2 In the notes

On 1 October 20X2, the company entered into an agreement to sell its toys manufacturing
operations. The sale was completed on 30 June 20X3 and the toy manufacturing business is
reported as a discontinued operation for 20X2 and 20X3.
The results of the discontinued operation were as follows:
20X3 20X2
$’000 $’000
Revenue X X
Cost of sales (X) (X)
Gross profit X X
Other income X X
Distribution costs (X) (X)
Administrative expenses (X) (X)
Other expenses (X) (X)
Finance costs (X) (X)
Loss before tax (X) (X)
Income tax expense X X
Loss after tax (X) (X)
Post-tax gain on remeasurement and disposal of assets X X
LOSS FOR THE YEAR (X) (X)
Other comprehensive income for the year, net of tax X X
TOTAL COMPREHENSIVE INCOME FOR THE YEAR X X
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3.2.3 Proforma disclosure – on the face
XYZ GROUP – STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE
Continuing Discontinued
operations operations Entity as a whole
20X3 20X2 20X3 20X2 20X3 20X2
$’000 $’000 $’000 $’000 $’000 $’000
Revenue X X X X X X
Cost of sales (X) (X) (X) (X) (X) (X)
Gross profit X X X X X X
Other income X X X X X X
Distribution costs (X) (X) (X) (X) (X) (X)
Administrative expenses (X) (X) (X) (X) (X) (X)
Other expenses (X) (X) (X) (X) (X) (X)
Finance costs (X) (X) (X) (X) (X) (X)
Profit/(loss) before tax X X (X) (X) X X
Income tax expense (X) (X) X X (X) (X)
Profit/(loss) after tax X X (X) (X) X X
Post-tax gain on
remeasurement and disposal
of assets and disposal
groups – – X – X –
PROFIT/(LOSS) FOR THE YEAR X X (X) (X) X X

for the year, net of tax X X X X X X
TOTAL COMPREHENSIVE
INCOME FOR THE YEAR X X X X X X
Activity 9: Discontinued operations
On 20 October 20X3, the directors of Largo Co made a public announcement of plans to close a
steel works. The closure means that the group will no longer carry out this type of operation,
which until recently has represented about 10% of its total revenue. The works will be gradually
shut down over a period of several months, with complete closure expected in July 20X4. At 31
December, output had been significantly reduced and some redundancies had already taken
place. The cash flows, revenues and expenses relating to the steel works can be clearly
distinguished from those of the subsidiary’s other operations.
Required
How should the closure be treated in the financial statements for the year ended 31 December
20X3?
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Solution
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Activity answers
Activity 6: Tabby Co
In order to prepare comparative figures for 20X8 showing the change of accounting policy, it is
necessary to recalculate the amounts for 20X7, so that the opening inventory for 20X8 is valued
on a weighted average basis.
It is established that opening inventory for 20X8 based on the weighted average method would be
$122,000 and closing inventory would be $143,000. So, the 20X8 gross profit now becomes:
$’000 $’000
Revenue 869
Cost of sales:
Purchases 246
644
This shows $18,000 lower gross profit for 20X8 which will reduce net profit and retained earnings
by the same amount. The opening inventory for 20X9 will be $143,000 rather than $174,000 and
the statement of changes in equity for 20X9 will show an $18,000 adjustment to opening retained
earnings.
Activity 7: Correction of errors

20X6 20X7
$’000 $’000
Revenue 47,400 67,200
Cost of sales (W1) (38,770) (51,600)
Income tax (W2) (2,620) (4,660)
RETAINED EARNINGS 20X6 20X7

Opening retained earnings $’000 $’000
As previously reported (13,000 + 8,950) 13,000 21,950
Correction of prior period error (4,200 – 1,260) – (2,940)
As restated 13,000 19,010
Closing retained earnings 19,010 29,950
HB2022

Workings
1 Cost of sales
20X6 20X7
$’000 $’000
As stated in question 34,570 55,800
Inventory adjustment 4,200 (4,200)
38,770 51,600
2 Income tax
20X6 20X7
$’000 $’000
As stated in question 3,880 3,400
Inventory adjustment (4,200 × 30%) (1,260) 1,260
2,620 4,660
Activity 8: Assets held for sale

The facility will not be transferred until the backlog of orders is completed; this means the facility
is not available for immediate sale in its present condition. The facility cannot be classified as
‘held for sale’ at 31 December 20X3. It must be treated in the same way as other items of
property, plant and equipment: it should continue to be depreciated and should not be
separately disclosed.
Activity 9: Discontinued operations

Because the steel works is being closed, rather than sold, it cannot be classified as ‘held for sale’.
In addition, the steel works is not a discontinued operation. Although at 31 December 20X3 Largo
Co was firmly committed to the closure, this has not yet taken place nor can its assets be
classified as held for sale, therefore the steel works must be included in continuing operations.
Information about the planned closure could be disclosed in the notes to the financial statements.
HB2022

19
Earnings per share
Essential reading
HB2022

1 Consideration
Shares are usually included in the weighted average number of shares from the date
consideration is receivable which is usually the date of issue. The treatment for the issue of
ordinary shares in different circumstances is as follows. (IAS 33: para. 21)
Ordinary shares issued as purchase consideration in an acquisition should be included as of the
date of acquisition because the acquired entity’s results will also be included from that date. (IAS
33: para. 22)
If ordinary shares are partly paid, they are treated as a fraction of an ordinary share to the
extent they are entitled to dividends relative to fully paid ordinary shares.
Contingently issuable shares (including those subject to recall) are included in the computation
when all necessary conditions for issue have been satisfied. (IAS 33: para. 24)
Flame Co is a company with a called up and paid up capital of 100,000 ordinary shares of $1
each and 20,000 10% redeemable preference shares of $1 each.
The gross profit was $200,000 and trading expenses were $50,000. Flame Co paid the required
preference share dividend and an ordinary dividend of 42c per share. The tax charge for the year
was estimated at $40,000.
Required
Calculate basic eps for the year.
Solution
2 Procedure for rights issue

The procedures for calculating the eps for the current year and a corresponding figure for the
previous year are:
(a) Calculate the ex-rights fair value
(b) Calculate the bonus fraction
HB2022

Fair value per share immediately before the exercise of rights
Theoretical ex - rights fair value per share
(c) To calculate the number of shares in the eps calculation, you should:
(i) Multiply the number of shares before the rights issue by the bonus fraction and pro-rate
based on the number of months in the year prior to the date of the rights issue and
(ii) Pro-rate the number of shares after the rights issue by the number of months in the year
after the date of the rights issue and add to the figure arrived at in (i).
(d) The total earnings should then be divided by the total number of shares calculated to give the
eps for the year.
Activity 7: Rights issue
Marcoli Co has produced the following net profit figures for the years ending 31 December:
$m
20X6 1.1
20X7 1.5
20X8 1.8
On 1 January 20X7, the number of shares outstanding was 500,000. During 20X7, the company
announced a rights issue with the following details.
Rights: 1 new share for each 5 outstanding (100,000 new shares in total)
Exercise price is $5.00.
Last date to exercise rights: 1 March 20X7.
The market (fair) value of one share in Marcoli Co immediately prior to exercise on 1 March 20X7 =
$11.00.
Required
Calculate the eps for 20X6, 20X7 and 20X8.
Solution
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3 Diluted eps
Activity 8: Diluted eps – Convertible debt
Ardent Co has five million ordinary shares of 25 cents each in issue, and also had in issue in 20X4:
(1) $1 million of 14% convertible loan stock, convertible in three years’ time at the rate of two
shares per $10 of loan stock
(2) $2 million of 10% convertible loan stock, convertible in one year’s time at the rate of three
shares per $5 of loan stock
The total earnings in 20X4 were $1.75 million.
The rate of income tax is 35%.
Required
Calculate the basic eps and diluted eps.
Solution
Activity 9: Diluted eps – Share options
Brand Co has the following results for the year ended 31 December 20X7:
Net profit for year $1,200,000

Weighted average number of ordinary shares outstanding during year 500,000 shares
Average fair value of one ordinary share during year $20.00
Weighted average number of shares under option during year 100,000 shares
Exercise price for shares under option during year $15.00
Required
Calculate both basic and diluted earnings per share.
HB2022

Solution
4 Disclosure
An entity should disclose the following:
(a) The amounts used as the numerators in calculating basic and diluted eps, and a
reconciliation of those amounts to the net profit or loss for the period
(b) The weighted average number of ordinary shares used as the denominator in calculating
basic and diluted eps, and a reconciliation of these denominators to each other
(IAS 33: para. 70)
5 Alternative eps figures

An entity may present alternative eps figures if it wishes. However, IAS 33 details certain rules
where this takes place.
(a) The weighted average number of shares as calculated under IAS 33 must be used.
(b) A reconciliation must be given if necessary between the component of profit used in the
alternative eps and the line item for profit reported in the statement of profit or loss and other
(c) Basic and diluted eps must be shown with equal prominence.
(IAS 33: para. 73)
HB2022

Activity answers

FLAME CO
TRADING RESULTS FOR YEAR TO 31 DECEMBER
$
Expense (50,000 + 2,000 preference dividend) (52,000)
Basic eps
= $108,000 / 100,000 = $1.08 per share
Activity 7: Rights issue

Computation of TERV:
This computation uses the total fair value and number of shares.
Fair value of all outstanding shares + total received from exercise of rights
No. shares outstanding prior to exercise + no. shares issued in exercise
($11.00 × 500,000) + ($5.00 × 100,000)

= = $10.00
500,000 + 100,000
Computation of eps
20X6 20X7 20X8

$ $ $
20X6 eps as originally reported
$1,100,000
500,000 2.20
20X6 eps restated for rights issue
$1,100,000 10 10
× (or 2.20 × )
500,000 11 11
2.00
20X7 eps including effects of rights issue
$1,500,000
(500,000 × 2/12 × 11/10) + (600,000 × 10/12)
2.54
$1,800,000
eps =
20X8 600,000 3.00
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Activity 8: Diluted eps – Convertible debt
(1) Basic eps = $1,750,000 / 5 million = $0.35
(2) We must decide which of the potential ordinary shares (ie the loan stocks) are dilutive (ie
would decrease the eps if converted).
For the 14% loan stock, incremental eps = 0.65 × 140,000 / 200,000 shares = $0.46
For the 10% loan stock, incremental eps = 0.65 × 200,000 /1,200,000 shares = $0.11
The effect of converting the 14% loan stock is therefore to increase the eps figure, since the
incremental eps of $0.46 is greater than the basic eps of $0.35. The 14% loan stock is not dilutive
and is therefore excluded from the diluted eps calculation.
The 10% loan stock is dilutive.
Diluted eps = ($1.75m + $0.13m) / 5m + 1.2m = $0.3
Note. The calculation of diluted eps (deps) should always be based on the maximum number of
shares that can be issued.
Activity 9: Diluted eps – Share options
Per share Earnings Shares

$ $
Net profit for year 1,200,000
Weighted average shares outstanding during 20X7 500,000
Basic earnings per share 2.40
Number of shares that would have been issued
At fair value: (100,000 × $15.00 / $20.00) (75,000)*
Diluted earnings per share 2.29 1,200,000 525,000
*The earnings have not been increased as the total number of shares has been increased only by
the number of shares (25,000) deemed for the purpose of the computation to have been issued
for no consideration.
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20
Interpretation of
Essential reading
HB2022

1 Liquidity
Liquidity: The amount of cash a company can put its hands on quickly to settle its debts (and
KEY
TERM possibly to meet other unforeseen demands for cash payments too) is the amount of cash a
company can put its hands on quickly to settle its debts (and possibly to meet other
unforeseen demands for cash payments too).
Liquid funds consist of:

(a) Cash
(b) Short-term investments for which there is a ready market
(c) Fixed term deposits with a bank or other financial institution, for example, a six-month high
interest deposit with a bank
(d) Trade receivables (because they will pay what they owe within a reasonably short period of
time)
(e) Bills of exchange receivable (because like ordinary trade receivables, these represent amounts
of cash due to be received within a relatively short period of time)
In summary, liquid assets are current asset items that will or could soon be converted into cash,
and cash itself. Two common definitions of liquid assets are:
• All current assets without exception
• All current assets with the exception of inventories
A company can obtain liquid assets from sources other than sales of goods and services, such as
the issue of shares for cash, a new loan or the sale of non-current assets. But a company cannot
rely on these at all times, and in general, obtaining liquid funds depends on making sales revenue
and profits. Even so, profits do not always lead to increases in liquidity. This is mainly because
funds generated from trading may be immediately invested in non-current assets or paid out as
dividends.
The reason why a company needs liquid assets is so that it can meet its debts when they fall due.
Payments are continually made for operating expenses and other costs, and so there is a cash
cycle from trading activities of cash coming in from sales and cash going out for expenses.
1.1 The cash cycle

To help you to understand liquidity ratios, it is useful to begin with a brief explanation of the cash
cycle. The cash cycle describes the flow of cash out of a business and back into it again as a
result of normal trading operations.
Cash goes out to pay for supplies, wages and salaries and other expenses, although payments
can be delayed by taking some credit. A business might hold inventory for a while and then sell it.
Cash will come back into the business from the sales, although customers might delay payment
by themselves taking some credit.
The main points about the cash cycle are:
(a) The timing of cash flows in and out of a business does not coincide with the time when sales
and costs of sales occur. Cash flows out can be postponed by taking credit. Cash flows in
can be delayed by having receivables.
(b) The time between making a purchase and making a sale also affects cash flows. If
inventories are held for a long time, the delay between the cash payment for inventory and
cash receipts from selling it will also be a long one.
(c) Holding inventories and having receivables can therefore be seen as two reasons why cash
receipts are delayed. Another way of saying this is that if a company invests in working
capital, its cash position will show a corresponding decrease.
(d) Similarly, taking credit from creditors can be seen as a reason why cash payments are
delayed. The company’s liquidity position will worsen when it has to pay the suppliers, unless
it can get more cash in from sales and receivables in the meantime.
HB2022

The liquidity ratios and working capital turnover ratios are used to test a company’s liquidity,
length of cash cycle, and investment in working capital. The cash cycle is also referred to as the
operating cycle.
2 The implications of high or low gearing/leverage

Gearing or leverage is, amongst other things, an attempt to quantify the degree of risk involved
in holding equity shares in a company, risk both in terms of the company’s ability to remain in
business and in terms of expected ordinary dividends from the company. The problem with a
highly-geared company is that by definition there is a lot of debt. Debt generally carries a fixed
rate of interest (or fixed rate of dividend if in the form of preference shares), hence there is a given
(and large) amount to be paid out from profits to holders of debt before arriving at a residue
available for distribution to the holders of equity. The riskiness will perhaps become clearer with
the aid of an illustration.
2.1 Example: Gearing

Alpha Co Brava Co Charlie Co
$’000 $’000 $’000
Ordinary shares 600 400 300
Retained earnings 200 200 200
Revaluation surplus 100 100 100
900 700 600
6% preference shares (redeemable) – – 100
10% loan stock 100 300 300
Capital employed 1,000 1,000 1,000
Gearing ratio 10% 30% 40%
Equity to assets ratio 90% 70% 60%
Now suppose that each company makes a profit before interest and tax of $50,000, and the rate
of tax on company profits is 30%. Amounts available for distribution to equity shareholders will be
as follows.

$’000 $’000 $’000
Profit before interest and tax 50 50 50
Interest/preference dividend 10 30 36
Taxable profit 40 20 14
Taxation at 30% 12 6 4
If in the subsequent year profit before interest and tax falls to $40,000, the amounts available to
ordinary shareholders will become as follows.

$’000 $’000 $’000
Profit before interest and tax 40 40 40
Interest/preference dividend 10 30 36
HB2022

$’000 $’000 $’000
Taxable profit 30 10 4
Taxation at 30% 9 3 1
Note the following:
Gearing ratio 10% 30% 40%

Equity to assets ratio 90% 70% 60%
Change in PBIT -20% -20% -20%
Change in profit available for ordinary
shareholders -25% -50% -70%
The more highly geared the company, the greater the risk that little (if anything) will be
available to distribute by way of dividend to the ordinary shareholders. The example clearly
displays this fact in so far as the more highly geared the company, the greater the percentage
change in profit available for ordinary shareholders for any given percentage change in profit
before interest and tax. The relationship similarly holds when profits increase, and if PBIT had risen
by 20% rather than fallen, you would find that once again the largest percentage change in profit
available for ordinary shareholders (this means an increase) will be for the highly geared
company. This means that there will be greater volatility of amounts available for ordinary
shareholders, and presumably therefore greater volatility in dividends paid to those shareholders,
where a company is highly geared. That is the risk: you may do extremely well or extremely badly
without a particularly large movement in the PBIT of the company.
The risk of a company’s ability to remain in business was referred to earlier. Gearing or leverage is
relevant to this. A highly geared company has a large amount of interest to pay annually
(assuming that the debt is external borrowing rather than preference shares). If those borrowings
are ‘secured’ in any way (and loan notes in particular are secured), then the holders of the debt
are perfectly entitled to force the company to realise assets to pay their interest if funds are not
available from other sources. Clearly the more highly geared a company the more likely this is to
occur when and if profits fall.
2.2 Debt ratio
Debt ratio: The ratio of a company’s total debts to its total assets.
KEY
TERM (a) Assets consist of non-current assets at their carrying amount, plus current assets
(b) Debts consist of all payables, whether they are due within one year or after more than
one year
You can ignore other non-current liabilities, such as deferred taxation.
There is no absolute guide to the maximum safe debt ratio, but as a very general guide, you might
regard 50% as a safe limit to debt. In practice, many companies operate successfully with a
higher debt ratio than this, but 50% is nonetheless a helpful benchmark. In addition, if the debt
ratio is over 50% and getting worse, the company’s debt position will be worth looking at more
carefully.
In the exam, it is important to look at the reasons for the changes which are specific to the
information given in the question and to consider the logic of whether an increase in one element
is justified by a reason in another.
HB2022

3 Further activities interpretation
Activity 8: Debt ratios
The following information has been extracted from the recently published accounts of Doolittle
Co.
EXTRACTS FROM THE STATEMENTS OF PROFIT OR LOSS TO 30 APRIL
20X9 20X8
$’000 $’000
Revenue 11,200 9,750
Cost of sales 8,460 6,825
Net profit before tax 465 320
This is after charging:
Depreciation 360 280
Loan note interest 80 60
Interest on bank overdraft 15 9
Audit fees 12 10
STATEMENTS OF FINANCIAL POSITION AS AT 30 APRIL
20X9 20X8
$’000 $’000 $’000 $’000
Assets
Non-current assets 1,850 1,430
Current assets
Inventories 640 490
1,950 1,690
Equity
Ordinary share capital 800 800
2,110 1,730
10% loan stock 800 600
Current liabilities
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20X9 20X8
$’000 $’000 $’000 $’000
Taxation 30 20
890 790
The following ratios are those calculated for Doolittle Co, based on its published accounts for the
previous year, and also the latest industry average ratios:
Industry
Doolittle Co average
30 April 20X8
ROCE (capital employed = equity and debentures) 16.30% 18.50%
Net profit margin 3.90% 4.73%
Asset turnover 4.18 times 3.91 times
Quick ratio 1.52 1.27
Accounts receivable collection period 40 days 52 days
Accounts payable payment period 37 days 49 days
Inventory turnover 13.90 times 18.30 times
Gearing 25.75% 32.71%
Required
1 Calculate comparable ratios (to two decimal places where appropriate) for Doolittle Co for the
year ended 30 April 20X9. All calculations must be clearly shown.
2 Write a report to your board of directors analysing the performance of Doolittle Co,
comparing the results against the previous year and against the industry average.
Solution
HB2022

Below are the summarised financial statements for the year to 31 March 20X5 and 20X6 of
Heywood Bottles Co, a company which manufactures bottles for many different drinks
companies.
The statements for the year to 31 March 20X6 have not been audited.
HEYWOOD BOTTLES CO – STATEMENTS OF PROFIT OR LOSS OR THE YEARS ENDED 31 MARCH
20X6 20X5
$m $m $m $m
Revenue 300 120
Manufacturing costs 261 83
Depreciation 9 7
Costs of sales (270) (90)
Gross profit 30 30
Other expenses (28) (10)
Profit before interest and tax 2 20
Profit/(loss) before tax (8) 18
Income tax expense (4) (6)
PROFIT/(LOSS) FOR THE
YEAR (12) 12
Dividends paid 8 8
HEYWOOD BOTTLES CO – STATEMENTS OF FINANCIAL POSITION AS AT 31 MARCH
20X6 20X5
$m $m
Non-current assets
Land and buildings 5 5
Plant and equipment 18 10
Right-of-use asset 40 28
63 43
Current assets
Inventories 18 12
Receivables 94 25
Other receivables 6 –
Bank – 8
HB2022

20X6 20X5
$m $m
118 45
181 88
Equity
Other reserves 10 11
Retained earnings (12) 8
23 44
Current liabilities
Other payables 12 10
Bank overdraft 34 –
126 25
181 88
The directors were disappointed in the profit for the year to 31 March 20X5 and held a board
meeting in April 20X5 to discuss future strategy. The Managing Director was insistent that the way
to improve the company’s results was to increase sales and market share. As a result, the
following actions were implemented.
(1) An aggressive marketing campaign costing $12 million was undertaken during the year. All
advertisements had been placed in the year to 31 March 20X5. Due to expected long-term
benefits $6 million of this has been included as a current asset in the statement of financial
position at 31 March 20X6.
(2) A ‘price promise’ to undercut any other supplier’s price was announced in the advertising
campaign.
(3) A major contract with Koola Drinks Co was signed that accounted for a substantial
proportion of the company’s output. This contract was obtained through very competitive
tendering.
(4) The credit period for receivables was extended from two to three months.
A preliminary review by the board of the accounts to 31 March 20X6 concluded that the
company’s performance had deteriorated rather than improved. There was particular concern
over the prospect of renewing the bank facility because the maximum agreed level of $30 million
had been exceeded. The board decided that it was time to seek independent professional advice
on the company’s situation.
Required
In the capacity of a business consultant, prepare a report for the board of Heywood Bottles Co
based on a review of the company’s performance for the year to 31 March 20X6 in comparison
with the previous year. Particular emphasis should be given to the effects of the implementation
of the actions referred to in points (1) to (4) above.
HB2022

Solution
Tutorial note. The above Activity is not representative of the style of question you may face in
the FR exam. It contains more calculations that you would be expected to produce. It is
however a useful learning tool and covers a good range of ratios that you should be
comfortable with calculating and analysing.
HB2022

Activity answers
Activity 8: Debt ratios

1
20X9 Industry average

ROCE 465 + 80 / 2,910 = 18.7% 18.50%
Net profit margin 465 + 80 / 11,200 = 4.87% 4.73%
Asset turnover 11,200/2,910 = 3.85 times 3.91 times
Current ratio 1,950 / 890 = 2.20 1.90
Quick ratio 1,230 + 80 / 890 = 1.47 1.27
Gross profit margin 11,200 - 8,460 / 11,200 = 24.46% 35.23%
Accounts receivable collection
period 1,230/11,200 × 365 = 40 days 52 days
Accounts payable payment period 750/8,460 × 365 = 32 days 49 days
Inventory turnover (times) 8,460/640 = 13.2 times 18.30 times
Gearing 800 / 2,910 = 27.5% 32.71%
2 REPORT
To: Board of Directors

From: Accountant
Date: xx/xx/xx
Subject: Analysis of performance of Doolittle Co
This report should be read in conjunction with the appendix attached which shows the
relevant ratios (from part (1)).
Trading and profitability

Return on capital employed has improved considerably between 20X8 and 20X9 and is now
higher than the industry average.
Net profit margin has also improved noticeably between the years and is also now marginally
ahead of the industry average. Gross margin, however, is considerably lower than in the
previous year and is only some 70% of the industry average. This suggests either that there
has been a change in the cost structure of Doolittle Co or that there has been a change in the
method of cost allocation between the periods. Either way, this is a marked change that
requires investigation. The company may be in a period of transition as sales have increased
by nearly 15% over the year and it would appear that new non-current assets have been
purchased.
Asset turnover has declined between the periods although the 20X9 figure is in line with the
industry average. This reduction might indicate that the efficiency with which assets are used
has deteriorated or it might indicate that the assets acquired in 20X9 have not yet fully
contributed to the business. A longer-term trend would clarify the picture.
Liquidity and working capital management
The current ratio has improved slightly over the year and is marginally higher than the
industry average. It is also in line with what is generally regarded as satisfactory (2:1).
The quick ratio has declined marginally but is still better than the industry average. This
suggests that Doolittle Co has no short-term liquidity problems and should have no difficulty
in paying its debts as they become due.
HB2022

Receivables collection period is unchanged from 20X8 and are considerably lower than the
industry average. Consequently, there is probably little opportunity to reduce this further and
there may be pressure in the future from customers to increase the period of credit given. The
period of credit taken from suppliers has fallen from 37 days’ purchases to 32 days’ and is
much lower than the industry average; thus, it may be possible to finance any additional
receivables by negotiating better credit terms from suppliers.
Inventory turnover has fallen slightly and is much slower than the industry average and this
may partly reflect stocking up ahead of a significant increase in sales. Alternatively, there is
some danger that the inventory could contain certain obsolete items that may require writing
off. The relative increase in the level of inventory has been financed by an increased overdraft
which may reduce if the inventory levels can be brought down.
The high levels of inventory, overdraft and receivables compared to that of payables suggests
a labour-intensive company or one where considerable value is added to bought‑in products.
Gearing
The level of gearing has increased only slightly over the year and is below the industry
average. Since the return on capital employed is nearly twice the rate of interest on the loan
stock, profitability is likely to be increased by a modest increase in the level of gearing.

REPORT
To: The directors of Heywood Bottles Co

From: Business Consultant
Date: May 20X6
Subject: Company performance year to 31 March 20X6
Introduction
This report was commissioned in order to assess the financial performance of Heywood Bottles Co
for the year to 31 March 20X6 in the light of the strategic actions taken in April 20X5.
Specific areas addressed include profitability, liquidity and solvency. An appendix sets out the
calculations of selected ratios used.
Financial performance
Growth
Heywood Bottles Co revenue has grown by approximately 150% in the year. This appears to be
due to increased sales volume as a result of:
• The marketing campaign undertaken during the year successfully attracting new customers
• The ‘price promise’ to undercut other suppliers winning customers from competitors
• The new contract won with Koola Drinks
• Extending the credit period from two to three months, so attracting new customers
Profitability
Return on capital employed has deteriorated from 31.7% to 3.6% implying a decline in efficiency in
the use of assets to generate profit. This is as a result of the decline in margins (explained below)
and also because Heywood Bottles has purchased and leased new assets during the current year.
Depending on the date on which the new assets were acquired, Heywood Bottles Co may not
have been able to take advantage of these assets to generate additional profit this year.
The improvement in asset turnover implies that Heywood Bottles is successfully using its assets to
generate revenue but has been unable to convert that into improved profitability.
The gross margin has deteriorated from 25% in 20X5 to 10% in 20X6. This is because increased
sales volume has been achieved at the cost of profit margins. The two main causes of this appear
to be:
• Lowering the sales price as a result of the ‘price promise’
HB2022

• Competitive tendering for the new large contract with Koola Drinks, which implies a lower than
usual sales price
The net profit margin has also deteriorated (from 16.7% to 0.7%). This is partly due to the fall in
gross margin (as explained above) but also due to the one-off marketing expenses of $12 million,
half of which ($6m) have been recognised in operating expenses. Half of the marketing expenses
($6m) were recorded as a current asset but this accounting treatment is not correct as marketing
expenses do not meet the definition of an asset. Therefore the $6 million asset should be written
off as additional operating expenses. Once this has been adjusted for, the decline in operating
margins is even more severe, resulting in an operating loss of $4 million.
Profitability has been further eroded by a fivefold increase in interest payable, due to Heywood
Bottles’ large overdraft and the new leases entered into during the year.
Financial position
Liquidity
Both the current and quick (acid test) ratios have deteriorated (from 1.8/1.3 to 0.9/0.8). The
expansion during the year has come at a cost of declining profitability and liquidity problems. The
liquidity problems are due to:
• Poor working capital management
• Reliance on the overdraft as a source of long-term finance
An overdraft is not a good source of long-term finance as it is both expensive and risky ie it could
be withdrawn by the bank at any time. Heywood Bottles Co is particularly at risk of having its
overdraft facility withdrawn because the current balance of $34 million is in excess of the $30
million agreed limit.
Working capital management
Working capital management has worsened in the year:
• The receivables collection period has increased from 76 days to 114 days. This is largely
because Heywood Bottles increased its credit terms from two to three months.
• The new contract with Koola Drinks Co was obtained through competitive tendering, which
may imply longer than usual credit terms for this new customer.
• As a result of customers taking longer to pay, a need for extra finance arose. This resulted in
Heywood Bottles Co taking longer to pay its suppliers (61 days in 20X5 and 108 days in 20X6)
and heavy reliance on the overdraft facility. If this continues, there is a risk that Heywood
Bottles Co’s suppliers might stop their credit or even stop supply.
• Even though Heywood Bottles Co appears to be struggling to pay suppliers, the suppliers are
being paid more quickly than debts are being collected from customers. This has exacerbated
the liquidity problems.
• The inventory holding period has gone down from 49 days to 24 days – this is probably due to
increased sales demand as a result of the marketing, price promise, new customer and
increased credit terms. It could also be due to suppliers restricting supplies due to slow
payment.
Solvency
Gearing has increased from 30% to 58%. This increase would have been even higher if the
overdraft were to be included as long-term debt in the 20X6 calculation.
This is due to the fact that new assets were leased during the year (increasing long-term debt)
and because the loss for the year has created negative retained earnings (decreasing equity).
This means that Heywood Bottles is unable to pay a dividend in the current year which will make
investors unhappy. This, combined with the risk associated with increased non-discretionary
interest payments each year, means that it might well be difficult to raise further finance from
investors in the future.
The decline in interest cover from 10 times to 0.2 times shows that whilst Heywood Bottles Co
could easily afford to pay its interest in 20X5, it is now struggling to do so. This could cause
serious problems in the future as interest is non-discretionary so non-payment could result in
withdrawal of the overdraft facility and/or seizure of non-current assets by the lessor.
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Fazit
The company is overtrading and will fail without an immediate injection of new capital and a
change in strategy.
The board actions in April 20X5 were, with hindsight, disastrous as, although they resulted in
expansion, it was at the cost of both profitability and liquidity. Increased turnover and market
share are only worthwhile while the company is trading profitably.
It will be very difficult to retain the loyalty of customers if prices are increased and relationships
with suppliers and other payables are severely strained.
APPENDIX
Selected ratios
Calculation 20X6 Calculation 20X5

ROCE 2/(23 + 32) × 100 3.6% 20/(44 + 19) × 100 31.7%
Asset turnover 300/(181 – 126) 5.5 120/(88 – 25) 1.9
Gross profit margin 30/300 × 100 10% 30/120 × 100 25%
Net profit margin 2/300 × 100 0.7% 20/120 × 100 16.7%
Current ratio 118/126 0.9 45/25 1.8
Acid-test ratio (118 – 18)/126 0.8 (45 – 12)/25 1.3
Inventory holding period 18/270 × 365 24 days 12/90 × 365 49 days
Receivables collection period 94/300 × 365 114 days 25/120 × 365 76 days
108
Payables payment period 80/270 × 365 days 15/90 × 365 61 days
Gearing (long-term debt/
long-term debt + equity) 32/(32 + 23) × 100 58% 19/(19 + 44) × 100 30%
0.2
Interest cover 2/10 times 20/2 10 times
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21
Limitations of financial
statements and
interpretation
techniques
Essential reading
HB2022

1 Limitations of financial statements
Chapter 20 and Chapter 21 have both noted that when analysing and interpreting the financial
performance and position of an entity, it is important to consider the basis on which the financial
statements are prepared and any transactions or events that might distort the key ratios.
It is common for entities to carry on activities with or through subsidiaries and associates, or
occasionally to engage in transactions with directors or their families. The point is that such
transactions cannot be assumed to have been engaged in ‘at arm’s length’ or in the best interests
of the entity itself, which is why investors and potential investors need to be made aware of them.
Transfer pricing can be used to transfer profit from one company to another and inter-company
loans and transfers of non-current assets can also be used in the same way.
1.1 Seasonal trading

This is another issue that can distort reported results. Many companies whose trade is seasonal,
position their year end after their busy period, to minimise time spent on the inventory count. At
this point in time, the statement of financial position will show a healthy level of cash and/or
receivables and a low level of trade payables, assuming most of them have been paid. Thus, the
position is reported at the moment when the company is at its most solvent. A statement of
financial position drawn up a few months earlier, or even perhaps a few months later, when trade
is still slack but fixed costs still have to be paid, may give a very different picture.
1.2 Asset acquisitions

Major asset acquisitions just before the end of an accounting period can also distort results. The
statement of financial position will show an increased level of assets and corresponding liabilities
(probably a loan or lease payable), but the income that will be earned from utilisation of the asset
will not yet have materialised. This will adversely affect the company’s return on capital
employed.
1.3 The effect of choice of accounting policies

Where accounting standards allow alternative treatment of items in the accounts, then the
accounting policy note should declare which policy has been chosen. It should then be applied
consistently.
You should be able to think of examples of how the choice of accounting policy can affect the
financial statements eg whether to revalue property in IAS 16, or how to account for government
grants in IAS 20.
1.4 Changes in accounting policy

The effect of a change of accounting policy is treated as a prior year adjustment according to IAS
8 para. 19 (see Chapter 18). This just means that the prior period figures are adjusted for the
change in accounting policy for comparative purposes and an adjustment is put through retained
earnings.
Directors may be able to manipulate the results through change(s) of accounting policies. This
would be done to avoid the effect of an old accounting policy or gain the effect of a new one. It is
likely to be done in a sensitive period, perhaps when the company’s profits are low or the
company is about to announce a rights issue. The management would have to convince the
auditors that the new policy was much better, but it is not difficult to produce reasons in such
cases.
The effect of such a change is very short-term. Most analysts and sophisticated users will
discount its effect immediately, except to the extent that it will affect any dividend (because of
the effect on distributable profits). It may help to avoid breaches of banking covenants because of
the effect on certain ratios.
Obviously, the accounting policy for any item in the accounts could only be changed once in
quite a long period of time. Auditors would not allow another change, even back to the old policy,
unless there was a wholly exceptional reason.
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The managers of a company can choose accounting policies initially to suit the company or the
type of results they want to get. Any changes in accounting policy must be justified, but some
managers might try to change accounting policies just to manipulate the results.
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22
Statement of cash
flows
Essential reading
HB2022

1 Reporting cash flows from operating activities
As has been seen earlier in the chapter, the standard offers a choice of method for this part of the
statement of cash flows:
(a) Indirect method. Net profit or loss is adjusted for the effects of transactions of a non-cash
nature, any deferrals or accruals of past or future operating cash receipts or payments, and
items of income or expense associated with investing or financing cash flows (IAS 7: para. 18).
(b) Direct method. Disclose major classes of gross cash receipts and gross cash payments.
Exam focus point

You will be familiar with the direct method from your Financial Accounting studies. The direct
method is not examinable in Financial Reporting and therefore the exam will focus on using
the indirect method for the preparation of a statement of cash flow.
1.1 Using the indirect method

This method is undoubtedly easier from the point of view of the preparer of the statement of cash
flows. The net profit or loss for the period is adjusted for:
(a) Changes during the period in inventories, operating receivables and payables
(b) Non-cash items, eg depreciation, provisions, profits/losses on the sales of non-current assets
(c) Other items, the cash flows from which should be classified under investing or financing
activities.
A proforma of such a calculation, taken from the IAS, is more common in the exam and is as
follows (IAS 7 IE: para. 18(b)):
$
Profit before taxation X
Adjustments for:
Depreciation X
Investment income (X)
Finance cost X
X
Increase in trade receivables (X)
Decrease in inventories X
Decrease in trade payables (X)
Cash generated from operations X
Interest paid (X)
Income taxes paid (X)
Net cash from operating activities X
It is important to understand why certain items are added and others subtracted. Note the
following.
(a) Depreciation is not a cash expense, but is deducted in arriving at profit. It makes sense,
therefore, to eliminate it by adding it back.
(b) By the same logic, a loss on a disposal of a non-current asset (arising through underprovision
of depreciation) needs to be added back and a profit deducted.
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(c) An increase in inventories means less cash – you have spent cash on buying inventory.
(d) An increase in receivables means the company’s debtors have not paid as much, and
therefore there is less cash.
(e) If we pay off payables, causing the figure to decrease, again we have less cash.
1.2 Interest and dividends paid

Cash flows from interest and dividends received and paid should each be disclosed separately.
Each should be classified in a consistent manner from period to period as either operating,
investing or financing activities (IAS 7: para. 31).
Dividends paid by the entity can be classified in one of two ways:
(a) As a financing cash flow, showing the cost of obtaining financial resources
(b) As a component of cash flows from operating activities so that users can assess the entity’s
ability to pay dividends out of operating cash flows.
(IAS 7: para. 34)
1.3 Income taxes paid

Cash flows arising from taxes on income should be separately disclosed and should be classified
as cash flows from operating activities unless they can be specifically identified with financing
and investing activities (IAS 7: para. 35).
Taxation cash flows are often difficult to match to the originating underlying transaction, so most
of the time all tax cash flows are classified as arising from operating activities (IAS 7: para. 36).
2 Approach to preparing a statement of cash flows

When completing Activity 1, it is advisable to follow this approach:
Step 1 Set out the proforma statement of cash flows with the headings required by IAS 7.
Step 2 Begin with the cash flows from operating activities as far as possible. When preparing
the statement from statements of financial position, you will usually have to calculate
such items as depreciation, loss on sale of non-current assets, profit for the year and tax
paid (see Step 4).
Step 3 Calculate the cash flow figures for the purchase or sale of non-current assets, issue of
shares and repayment of loans if these are not already given to you (as they may be).
Step 4 Start with profit before tax. You will often be given this. If not, it can be calculated by
working back from the movement in retained earnings.
Step 5 You will now be able to complete the statement by slotting in the figures given or
calculated.
Below are the statements of financial position for Thorstved Co at 31 December 20X7 and 31
December 20X8 and the statement of profit or loss and other comprehensive income for the year

20X8 20X7
$’000 $’000
ASSETS
Non-current assets
Development costs 110 92
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20X8 20X7
$’000 $’000
908 730
Current assets
Inventories 313 280
Cash 111 4
632 470

Equity
Share premium 140 80
Revaluation surplus 42 –
1,001 850
4% loan notes 250 100
Deferred tax 76 54
Provision for warranties 30 26
356 180
Current liabilities
Current tax payable 26 24
Interest payable 5 –
183 170
$’000
Revenue 1,100
Cost of sales (750)
Gross profit 350
Expenses (247)
Finance costs (10)
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$’000
Profit on sale of equipment 7
Notes.
1 Depreciation of property, plant and equipment during 20X8 was $54,000 and deferred
development expenditure amortised was $25,000.
2 Proceeds from the sale of equipment were $58,000, giving rise to a profit of $7,000. No other
items of property, plant and equipment were disposed of during the year.
3 Finance costs represent interest paid on the loan notes. New loan notes were issued on 1
January 20X8.
4 The company revalued its property at the year end. Company policy is to treat revaluations
as realised profits when the asset is retired or disposed of.
Required
Prepare a statement of cash flows for Thorstved Co for the year ended 31 December 20X8, using
the indirect method in accordance with IAS 7.
Solution
THORSTVED CO
STATEMENT OF CASH FLOWS FOR YEAR ENDED 31 DECEMBER 20X8
(INDIRECT METHOD)
$’000 $’000
Profit before taxation
Adjustments for:
Depreciation
Amortisation
Interest expense
Profit on disposal of equipment
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$’000 $’000
Increase in inventories (W4)
Increase in trade receivables (W4)
Increase in trade payables (W4)
Increase in provisions (W4)
Interest paid (W3)
Income taxes paid (W3)
Net cash from operating activities
Purchase of property, plant and equipment (W1)
Proceeds from sale of equipment
Development expenditure (W1)
Net cash used in investing activities
Proceeds from issue of share capital (W2)
Proceeds from issue of loan notes (W3)
Dividends paid (W2)
Net cash from financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalent at end of year
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Workings
1 Assets
Property, plant &

equipment Development costs
$’000 $’000
b/d
Depreciation/amortisation
SPLOCI – OCI
Non-cash additions
Disposals
Cash paid/(rec’d) β
c/d
2 Equity

$’000 $’000
b/d
SPLOCI
Non-cash
c/d
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3 Liabilities
Income tax
Loan notes payable Interest payable
$’000 $’000 $’000
b/d
SPLOCI – P/L
– OCI
Non-cash
c/d
4 Working capital changes
Trade Trade
Inventories receivables payables Provisions
$’000 $’000 $’000 $’000
b/d
Increase/ (decrease) β
c/d
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Activity answers
THORSTVED CO
STATEMENT OF CASH FLOWS FOR YEAR ENDED 31 DECEMBER 20X8
(INDIRECT METHOD)
$’000 $’000
Adjustments for:
Depreciation 54
Amortisation 25
Interest expense 10
Profit on disposal of equipment (7)
182
Increase in inventories (W4) (33)
Increase in trade receivables (W4) (22)
Increase in trade payables (W4) 6
Increase in provisions (W4) 4
Cash generated from operations 137
Interest paid (W3) (5)
Income taxes paid (W3) (24)
Purchase of property, plant and equipment (W1) (205)
Development expenditure (W1) (43)
Net cash used in investing activities (190)
Proceeds from issue of share capital (W2) 80
Proceeds from issue of loan notes (W3) 150
Dividends paid (W2) (41)
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Net cash from financing activities 189
Cash and cash equivalents at beginning of year 4
Cash and cash equivalent at end of year 111
Workings
1 Assets
Property, plant &

equipment Development costs
$’000 $’000
b/d 638 92
Depreciation/amortisation (54) (25)
SPLOCI – OCI 60
Non-cash additions – –
Disposals (58 – 7) (51) –
Cash paid/(rec’d) β 205 43
c/d 798 110
2 Equity

$’000 $’000
b/d (200+80) 280 570
SPLOCI 70
Non-cash – –
Cash (paid)/rec’d β 80 (41)
c/d (220+140) 360 599
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3 Liabilities
Income tax
Loan notes payable Interest payable
$’000 $’000 $’000
b/d (54+24=78) 100 78 –
SPLOCI – P/L 30 10
– OCI 18
Non-cash – – –
Cash (paid)/rec’d β 150 (24) (5)
c/d (76+26=102) 250 102 5
Trade Trade
Inventories receivables payables Provisions
$’000 $’000 $’000 $’000
b/d 280 186 146 26
Increase/ (decrease) β 33 22 6 4
c/d 313 208 152 30
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23
Specialised, not-for-
profit and public
sector entities
Essential reading
HB2022

1 Primary aims
Not-for-profit entities have different goals and purposes to profit-making entities and are
responsible to different stakeholders. However, they are dealing in very large sums of money and
it is important that they are properly managed and that their accounts present fairly the results
of their operations.
1.1 Types of organisation

What organisations do we have in mind when we refer to not-for-profit and public sector entities?
These are the most obvious examples:
(a) Central government departments and agencies
(b) Local or national / federal government departments
(c) Publicly funded bodies providing healthcare (in the UK this would be the NHS) and social
housing
(d) Further and higher education institutions
(e) Charitable bodies
The first four are public sector entities. Charities are private not-for-profit entities.
1.2 Characteristics of not-for-profit entities

1.2.1 Private sector
Not-for-profit entities in the private sector have the following characteristics:
• Their primary objective is to provide goods and services to various recipients rather than the
pursuit of making profits for distribution to shareholders.
• They are generally characterised by the absence of defined ownership interests (shares) that
can be sold, transferred or redeemed (many charities are limited liability by guarantee as
opposed to shares).
• They may have a wide group of stakeholders to consider (including the public at large in some
cases).
• Their revenues generally arise from contributions (donations or membership dues) rather than
sales.
• Their capital assets are typically acquired and held to deliver services without the intention of
earning a return on them.
1.2.2 Public sector

Nor-for-profit entities in the public sector have similar key characteristics to those in the private
sector. They are typically established by legislation and:
• Their objective is to provide goods and services to various recipients or to develop or implement
policy on behalf of governments and not to make a profit.
• They are characterised by the absence of defined ownership interests that can be sold,
transferred or redeemed.
• They typically have a wide group of stakeholders to consider (including the public at large).
• Their revenues are generally derived from taxes or other similar contributions obtained through
the exercise of coercive powers
• Their capital assets are typically acquired and held to deliver services without the intention of
earning a return on them.
2 Regulatory framework
Regulation of public not-for-profit entities, principally local and national governments and
governmental agencies, is undertaken by the International Public Sector Accounting Standards
Board (IPSASB), which comes under IFAC.
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2.1 International public sector accounting standards
The IPSASB is developing a set of International Public Sector Accounting Standards (IPSASs),
based on IFRS Standards. To date there are 42 IPSASs in issue, along with a Conceptual
Framework. The standards in issue closely reflect the relevant IFRS Standard. For example, IPSAS 1
Presentation of Financial Statements, is aligned to IAS 1. There are some IPSAS which are specific
to the public sector, such as IPSAS 22, Disclosure of Financial Information about the General
Government Sector, and, issued in January 2019, IPSAS 42, Social Benefits, which do not have
equivalent IFRS Standards.
2.2 Conceptual framework for not-for profit entities

The International Federation of Accountants (IFAC) published The Conceptual Framework for
General Purpose Financial Reporting by Public Sector Entities (2014). In preparing the Public
Sector Conceptual Framework IFAC had to bear in mind that not-for profit entities have different
objectives, different operating environments and other different characteristics to private sector
businesses.
Some of the issues that arise in considering financial reporting by not-for-profit entities are:
Accountability/ • Not-for-profit entities are not reporting to shareholders,

stewardship but it is very important that they can account for funds
received and show how they have been spent.
• Resources may be contributed for specific purposes and
management is required to show that they have been
utilised for that purpose, such as in charity ‘restricted
funds’.
• Taxpayers are entitled to see how the government is
spending their money. The Public Sector
ConceptualFramework aims to show how the entity is
providing an efficient service and using its assets in an
effective manner.
Users and user groups • The primary user group for not-for-profit entities is
providers of funds.
• In the case of public bodies, such as government
departments, this primary group will consist of taxpayers.
• In the case of private bodies such as charities it will be
financial supporters, and also potential future financial
supporters.
• Another user group will be the recipients of the goods and
services provided by the not-for-profit entity
Cash flow focus • The resources the entity has available to deliver future
goods and services
• The cost and effectiveness of the objectives the entity has
delivered in the past
• The degree to which the entity is meeting its objectives
• The financial statements of not-for-profit entities need to
provide information which will enable users to assess an
entity’s ability to generate net cash inflows.
Budgeting • Another issue is whether financial reporting should include

forecast information.
• For not-for-profit entities, budgets and variance analyses
are important. Funding may be supplied on the basis of a
formal, published budget, such as for local or national
governments or legislative bodies. It is important that the
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entity is transparent in its usage of these resources.
3 Performance measurement
Not-for-profit and public sector entities produce financial statements in the same way as profit-
making entities do but, while they are expected to remain solvent, their performance cannot be
measured simply by the bottom line.
A public sector entity is not expected to show a profit or to underspend its budget. In practice,
central government and local government departments know that if they underspend the budget,
next year’s allocation will be correspondingly reduced. This pressure to meet a target can lead to
sub-optimal decision-making, for example, activity designed to ensure that spending or saving
targets are met just before the date at which performance is assessed. This leads to a rash of
digging up the roads and other expenditure just before the end of the financial year as councils
strive to spend any remaining funds.
Private and public sector entities are sometimes judged principally on the basis of what they have
achieved, not how much or how little they have spent in achieving it.
Activity 2: Analysing the performance of a charity
Which ONE of the following is a potential problem when analysing the performance of the
financial statements of a charity?
 Lack of consistent accounting standards
 Inability to see how restricted funds have been used by the charity
 Difficulty in comparing similarly sized charities, for example a charity supporting homeless
people, and one supporting hospice care
 As the charity is non-profit making, it is not a going concern
Activity 3: Public sector KPIs
The Royal Charlotte Hospital files financial statements with details of its key performance
indicators. Which of the following key performance indicators are expected to be found in its
 Return on capital employed
 Dividend yield
 Interest cover
 PE ratio
Activity 4: Not-for-profit KPIs
List suggested key performance indicators for an educational not-for-profit business.
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Solution
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Activity answers
Activity 2: Analysing the performance of a charity

The correct answer is: Difficulty in comparing similarly sized charities, for example a charity
supporting homeless people, and one supporting hospice care
This is because the charities are likely to have different aims and different key performance
indicators, so that it is difficult to compare the efficiency of one charity with another at face
value.
Charities do follow a set of accounting standards, such as those issued by IPSAS which build on
the IFRS Standards but also cover other key areas not covered by IFRS Standards.
Charities are expected to be self-sufficient, and there will be requirements to state how they will
cover the costs going forward just as any other company would be required to state. Charities are
also required to state where the assets will go in the event of it being wound up (such as another
local charity).
Restricted funds must be disclosed in the financial statements of the charity, including stating
what they may be used for and whether there has been any movement in the year.
Activity 3: Public sector KPIs

The correct answer is: Interest cover
The other indicators are profitability measures. Interest cover may be an indicator if the hospital
has loans or a mortgage. This is useful for users of the financial statements to show that the
hospital can service its debt commitments.
Activity 4: Not-for-profit KPIs

• Percentage of students passing the exams they are sitting,
• Staff and pupil absenteeism
• Pupil attendance and the final result in their exam
• Cost of teaching specific courses, such as science costs against the costs of teaching
humanity subjects
• Costs of teaching per pupil
• Qualification of tutor and the percentage of students who pass the exam
• Utilisation of resources, such as classrooms, student computers or libraries
Any similar types of KPIs provided they are focusing on the objectives of the school (students
passing the exams with the best use of the available resources.
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Further question
practice
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Section A (2 marks each)
1 Which one of the following is an enhancing qualitative characteristic of financial information
according to the Conceptual Framework?
 Timeliness
 Materiality
 Relevance
 Accruals
2 Which one of the following is not an item which is required to be shown on the face of the
statement of financial position according to IAS 1 Presentation of Financial Statements?
 Inventories
 Biological assets
 Irrecoverable debt allowance
 Investment property
3 What is the correct treatment of equity dividends paid under IAS 1 Presentation of Financial
Statements?
 Dividends paid are shown on the face of the statement of profit or loss
 Dividends paid are deducted from retained earnings
 Dividends paid are included in administrative expenses
 Dividends paid are deducted from ‘other comprehensive income’
4 Watson Co acquired a property on 1 January 20X1 for $250,000, being $200,000 for the building
and $50,000 for the land. The building was estimated to have a useful life of 50 years. On 1
January 20X6 the property was independently valued which resulted in an increase of $100,000
to the carrying amount of the building and $50,000 to the carrying amount of the land. The
useful life is unchanged.
Required
What is the depreciation charge for the year ended 31 December 20X6?
 $5,520
 $6,222
 $6,273
 $6,818
5 Demetrios Co disposed of Venus Co, an 80%-owned subsidiary, on 31 December 20X8. Sale

proceeds were $1.5 million. At the date of disposal Venus Co had 1 million $1 shares in issue and
retained earnings of $460,000. The carrying amount of goodwill relating to the acquisition of
Venus Co was $76,000. Demetrios measures non-controlling interest at its share of net assets.
Required
What amount should be recognised as profit/(loss) on disposal in the consolidated financial
statements of Demetrios Co?
 $256,000 profit
 $36,000 loss
 $40,000 profit
 $332,000 profit
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6 An asset has a carrying amount of $1.2 million. Its replacement cost is $1 million, its fair value is
$800,000 and its value in use is $950,000. The legal expenses involved in selling the asset are
estimated at $20,000.
Required
What is the amount of the impairment loss suffered by the asset?
 $250,000
 $420,000
 $200,000
 $270,000
7 A discontinued operation was disposed of in the current year. How should this be presented in the
statement of profit or loss?
 A one-line entry showing post-tax profit or loss of the operation and the post-tax gain or loss
on disposal
 A separate column showing the results of the discontinued operation, with the gain or loss on
disposal included under ‘other income’
 A one-line entry showing the pre-tax profit or loss of the operation and the pre-tax gain or loss
on disposal included under ‘other income’. Tax effects included in ‘income tax expense’
 A one-line entry showing pre-tax profit or loss of the operation and pre-tax gain or loss on
disposal, with tax effects included under ‘income tax expense’
8 Mammoth Co acquired 80% of the 100,000 $1 equity shares of Minor Co on 1 January 20X7. The
consideration consisted of one Mammoth Co share for each two shares in Minor Co and
$300,000 cash. The market price of a Mammoth Co share at 1 January 20X7 was $2.50 and the
market price of a Minor Co share on the same date was $1.75. Mammoth Co measure non-
controlling interest at fair value based on share price. At the acquisition date Minor Co had
retained earnings of $85,000 and $100,000 in revaluation surplus. Its head office building had a
fair value $60,000 in excess of its carrying amount.
Required
What was the goodwill on acquisition?
 $190,000
 $55,000
 $90,000
 $75,000
9 Catfish Co has owned 75% of Shark Co for a number of years. During the year to 31 December
20X8 Shark Co sold goods to Catfish Co for $75,000. Catfish Co had resold 40% of these goods
by the year end. Shark Co applies a 25% mark-up on all sales.
Required
By what amount should the consolidated retained earnings of Catfish Co at 31 December 20X8
be reduced in respect of these intragroup sales?
 $33,750
 $6,750
 $8,438
 $9,000
10 Frog Co acquired 80% of Tadpole Co on 1 April 20X7. The individual financial statements of Frog
Co and Tadpole Co for the year ended 31 December 20X7 showed revenue of $280,000 and
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24: FQP Chapter 721

$190,000 respectively. In the post-acquisition period Tadpole Co sold goods priced at $40,000 to
Frog Co. 50% of these goods were still held in inventory by Frog Co at the end of the year.
Required
What was group revenue in the consolidated statement of profit or loss for the year ended 31
December 20X7?
 $392,500
 $402,500
 $450,000
 $382,500
11 Python Co obtained 30% of the equity shares of Cobra Co on 1 June 20X8 for $700,000. It is able
to exercise significant influence over Cobra Co. During the year to 31 May 20X9 Python Co made
sales of $200,000 to Cobra Co, priced at cost plus 25% mark-up. Cobra Co still had 50% of these
goods in inventory at the year end. Cobra Co’s statement of profit or loss for the year ended 31
May 20X9 shows profit for the year of $650,000.
Required
What amount should be shown as ‘Investment in associate’ in the consolidated statement of
financial position of Python Co as at 31 May 20X9?
 $889,000
 $895,000
 $901,000
 $875,000
12 Which of the following will be treated as part of the cost of inventories?

(1) Import duties on raw materials
(2) Labour involved in production
(3) Distribution costs
(4) Fixed production overheads
(5) Storage costs of finished goods
(6) Cost of wasted materials
 (1), (2), (4), (6)
 (2), (4), (5)
 (3), (4), (6)
 (1), (2), (4)
13 A contract in which performance obligations are satisfied over time was commenced on 1 April
20X7 for a price of $2.5 million. At 31 December 20X7 the contract was certified as 40% complete
and costs incurred to date amounted to $0.8 million. The contract is expected to be profit making
overall.
Invoices amounting to $300,000 have been issued but no payment has yet been received.
Required
What amount should be shown in the statement of financial position as at 31 December 20X7 in
respect of ‘contract asset/liability’?
 $700,000 contract liability
 $700,000 contract asset
 $100,000 contract liability
 $100,000 contract asset
HB2022

14 Cracker Co set up a gas exploration site on 1 January 20X1 which will operate for five years. At
the end of five years the site will need to be dismantled and the landscape restored. The amount
required for dismantling and restoration, discounted at the company’s cost of capital of 8%, is
$1.2 million and a provision is set up for this amount.
Required
What is the total amount charged to profit or loss for the year ended 31 December 20X2 in
respect of these dismantling and restoration costs?
 $343,680
 $336,000
 $103,680
 $96,000
15 How are financial assets initially measured under IFRS 9 Financial Instruments (excluding assets
held for trading or subject to a specific designation)?
 Fair value
 Fair value plus transaction costs
 Fair value minus transaction costs
 Amortised cost
16 On 1 April 20X7 Lastgo Co rents a warehouse under a ten-month lease for $24,000 per month and
elects to use the short term lease exemption under IFRS 16 Leases. As an incentive to sign the
contract it is given the first month rent-free.
Required
What amount in respect of lease rental should be charged to profit or loss for the quarter ended
30 June 20X7?
 $64,800
 $48,000
 $72,000
 $43,200
17 Tangier Co had 200,000 shares in issue at 1 January 20X4. On 1 April 20X4 it made a 1 for 4 rights
issue at a price of $1.20. The market value immediately prior to the issue was $1.80. Profit for the
year ended 31 December 20X4 was $560,000.
Required
What is EPS for the year?
 $2.32
 $2.24
 $2.61
 $2.80
18 Which one of the following is not an advantage of cash flow accounting?

 It directs attention towards an entity’s ability to generate cash, which is needed for survival
 It provides valuable information for creditors and lenders
 It matches related items in accordance with the accruals concept
 It provides a better means of comparing the results of different entities than the other
HB2022
24: FQP Chapter 723

19 On 1 April 20X5 Thames Co acquired 80% of Avon Co’s 100,000 $1 ordinary shares. Goodwill
recognised in the business combination was $50,000, of which 40% had been written off by 31
March 20X7. Thames Co measures non-controlling interest at fair value.
On 1 April 20X7 Thames Co sold all of its shares in Avon Co for $200,000, when Avon Co’s
retained earnings amounted to $140,000. NCI at the date of disposal was measured at $58,000.
Required
What is the loss on disposal that should be recognised in the consolidated statement of profit or
loss of Thames Co for the year ended 31 March 20X7?
 $16,000
 $12,000
 $22,000
 $70,000
HB2022

Section B (2 marks each)
20 The following scenario relates to questions (a)–(e).
Figaro Co is preparing its financial statements for the year ended 31 December 20X6. A number of
issues must be accounted for before they can be finalised.
The following circumstances have arisen during the year:
(1) Figaro Co has entered into a contract to supply a company in China with specialised vehicle
components. Unfortunately, the raw material that it needs to manufacture these components
has risen substantially in price and Figaro Co now expects to produce and sell the
components at a loss.
(2) Figaro Co has a machine that needs regular overhauls every year in order to be allowed to
operate. Each overhaul costs $5,000.
(3) Figaro Co has set up a new division to produce a product for which the market is still small. It
expects this division to run at a loss for two years.
(4) Figaro Co sells goods with a one-year warranty which guarantees the goods will perform as
expected during the warranty period. Customers are not required to pay additional amounts
for the warranty. Goods may require minor or major repairs during the warranty period. If all
of the goods sold during the year to 30 December 20X6 were to require minor repairs, the
total cost would be $50,000. If all of the goods sold required major repairs the cost would be
$120,000. In any year Figaro Co expects 5% of goods sold to be returned for major repairs
and 16% to be returned for minor repairs.
(5) Figaro Co has acquired 100% of a new subsidiary. At the date of acquisition, the acquiree
had a contingent liability which was reliably valued at $150,000.
Required
(a) Which of circumstances (1) to (3) above will give rise to a provision?
 (1) only
 (2) only
 (1) and (2)
 (2) and (3)
(b) How do provisions differ from other liabilities?
 They do not arise as a result of past events.
 They involve uncertain timing or amount.
 An outflow of resources is not probable.
 They are not charged to profit for the year.
(c) What amount should be shown as a warranty provision in the statement of financial position
of Figaro Co at 31 December 20X6?
 $2,500
 $8,000
 $14,000
 $19,200
(d) A provision arises from a legal or constructive obligation. In the case of Figaro Co which of
the following would be an obligation giving rise to a provision?
 A new law will be enacted on 1 August 20X6 to combat air pollution. Figaro Co must fit new
air filters to be in compliance with this law.
 The Board of Figaro Co, in a meeting on 27 June 20X6, decided to restructure and close
one of its divisions on 1 September 20X6. This will involve redundancies, but the decision
has not yet been communicated outside the Board.
HB2022
24: FQP Chapter 725

 Figaro Co carries out certain work that entails environmental damage. It is not a legal
requirement to clean up this damage but most firms in the industry do so. Figaro Co does
not.
 Figaro Co is being sued by an ex-employee on health and safety grounds. Lawyers have
advised that the employee has a 55% chance of success.
(e) How should the contingent liability in (5) above be accounted for by Figaro Co?
 It should be disclosed, but not recognised
 It should be recognised
 It should be recognised if an outflow of resources is probable, otherwise just disclosed
 It should not be recognised or disclosed

Fenice Co is preparing its financial statements for the year ended 30 June 20X6. Fenice Co has
the right to use the following non-current assets under arrangements which meet the definition of
a lease under IFRS 16 Leases:
• A company car held under an agreement that was taken out on 1 July 20X5. The interest rate
implicit in the lease is 6%. The present value of the future lease payments is $25,274. It has a
five-year useful life. Fenice Co will repay $6,000 pa in arrears for five years. The first payment
was made on 30 June 20X6.
• A warehouse which has a remaining useful life of ten years. Fenice Co took out a three-year
lease on 1 January 20X6. Under the lease agreement Fenice Co received an incentive of
$5,000, made a payment of $20,000 on commencement of the lease, and must make further
payments of £20,000 per annum on 1 January 20X7 and 1 January 20X8. The interest rate
implicit in the lease is 8% The present value of future lease payments of the lease is $35,660.
• A machine which Fenice Co sold to a finance house on 1 July 20X5 and then immediately
leased back. The sale of the machine met the requirements of a sale under IFRS 15 Revenue
from Contracts with Customers.
- The carrying amount of the machine at the date of sale was $140,000.
- The sale proceeds were $200,000, the estimated fair value.
- The remaining useful life of the machine was five years.
- The present value of future lease payments on commencement of the leaseback was
$175,234.
Required
(a) Which one of the following circumstances would indicate that an agreement should not be
classified as a lease?
 It is unlikely that the lessee will exercise any option to purchase the asset.
 The lessor can direct how the asset is used during the lease term.
 The asset is not so specialised in nature that it can only be used by the lessee.
 The lease term is for less than 50% of the useful life of the asset.
(b) What amount should be shown under non-current liabilities at 30 June 20X6 in respect of the
company car?
 $25,274
 $20,790
 $16,037
 $4,753
HB2022

(c) A sale and leaseback transaction involves the sale of an asset and the leasing back of the
same asset. If the arrangement meets the IFRS 15 Revenue from Contracts with Customers
criteria to be recognised as a sale, how should any profit on the sale be treated?
 Defer profit and amortise over the lease term
 Recognise proportion relating to right-of-use transferred
 Recognise proportion relating to right-of-use retained
 Recognise whole amount of profit immediately in profit or loss
(d) What is the initial measurement of the right-of-use asset in respect of the warehouse?
 $35,660
 $55,660
 $50,660
 $30,660
(e) What is the gain that will be recognised in the statement of profit or loss in respect of the sale
and leaseback of the machine?
 $60,000
 $52,570
 $42,000
 $7,430

The accountant of Orfeo Co is preparing financial statements for the year ended 31 December
20X7. Before these can be completed a number of issues need to be resolved.
(1) Orfeo Co’s head office building was revalued on 1 July 20X7, giving rise to a revaluation
surplus of $100,000. The building had an original cost of $1 million on 1 January 20X0 and a
50-year life at that date. The useful life of the building remains unchanged.
(2) During the year one of Orfeo Co’s machines broke down and could not be fixed. The carrying
amount of the machine at that date was $30,000. The accountant must now consider the
issue of impairment.
(3) On 10 November 20X7 Orfeo Co bought a consignment of goods from an Italian company,
priced at €150,000. Payment was due in two equal instalments – on 10 December 20X7 and
10 January 20X8. The first instalment was paid on time.
Euro to dollar rates for the last two months of 20X7 were:
10.11.20X7 €1.13 : $
10.12.20X7 €1.18 : $
31.12.20X7 €1.12 : $
Required
(a) What amount should be charged as depreciation on the building in (1) for the year ended 31
December 20X7?
 $22,300
 $22,128
 $22,000
 $21,176
HB2022
24: FQP Chapter 727

(b) What are the deferred tax implications of this revaluation?
 Deferred tax on the surplus of $100,000 should be charged to profit or loss for the year.
 Deferred tax on the surplus of $100,000 should be charged to the revaluation surplus.
 Deferred tax on the surplus will not arise until the building is sold.
 There are no deferred tax implications.
(c) When carrying out an impairment review, assets are measured at their recoverable amount.
Which of these options describes recoverable amount?
 Higher of fair value less costs of disposal and value in use
 Higher of carrying amount and fair value less costs of disposal
 Lower of fair value less costs of disposal and value in use
 Lower of carrying amount and fair value less costs of disposal
(d) Because of the loss of production caused by the damaged machine, Orfeo Co lost customers
and it was decided that the whole factory unit was impaired by $120,000. Orfeo Co’s
accountant has to decide how to allocate this impairment loss.
The carrying amounts of the assets of the factory unit at the date of the impairment review,
including the damaged machine, were:
$
Goodwill 20,000
Factory building 440,000
Plant and machinery 160,000
Net current assets 100,000
720,000
Required
What will be the carrying amount of plant and machinery when the impairment loss has been
allocated?
 $129,000
 $130,000
 $144,000
 $114,000
(e) What should be the total amount of exchange gain or loss recognised during the year to 31
December 20X7 in respect of the transaction in (3) above?
 $592 loss
 $2,813 gain
 $2,221 gain
 $1,186 gain
HB2022

Practice questions
It should be noted that these questions are not intended to replicate the type of exam questions
you may face in Section C of the Financial Reporting exam (which will comprise 2 × 20-mark
questions covering the preparation of financial statements and interpretation of financial
statements).
Instead, these questions are intended as useful practice to test your understanding of the material
in the chapters. The Practice & Revision Kit has a large number of exam format questions.
23 Conceptual framework (18 mins)

(a) Explain and give an example of the effect on a set of published financial statements if the
going concern convention is held not to apply. (6 marks)
(b) Explain in general terms what the IASB’s Conceptual Framework is trying to achieve.
(4 marks)
(Total = 10 marks)
24 Regulators (18 mins)

State three different regulatory influences on the preparation of the published accounts of quoted
companies and briefly explain the role of each one. Comment briefly on the effectiveness of this
regulatory system.
(Total = 10 marks)
25 Standard setters (18 mins)

There are those who suggest that any standard setting body is redundant because accounting
standards are unnecessary. Other people feel that such standards should be produced, but by
the government, so that they are a legal requirement.
Required
(a) Discuss the statement that accounting standards are unnecessary for the purpose of
regulating financial statements. (5 marks)
(b) Discuss whether or not the financial statements of not-for-profit entities should be subject to
regulation. (5 marks)
(Total = 10 marks)
26 Polymer Co (45 mins)

The following list of account balances has been prepared by Polymer Co, a plastics
manufacturer, on 31 May 20X8, which is the end of the company’s accounting period.
$ $
Authorised and issued 300,000 ordinary shares of $1 each, fully
paid 300,000
100,000 8.4% cumulative redeemable preference shares of $1
each, fully paid 100,000
Share premium 100,000
Other components of equity 50,000
HB2022
24: FQP Chapter 729

$ $
Retained earnings – 31 May 20X7 283,500
Patents and trademarks 215,500
Land at cost 250,000
Head office at cost 75,000
Accumulated depreciation – head office – 31 May 20X7 15,000
Factory plant and equipment at cost 150,000
Accumulated depreciation – plant and equipment – 31 May 20X7 68,500
Furniture and fixtures at cost 50,000
Accumulated depreciation – furniture and fixtures – 31 May 20X7 15,750
Motor vehicles at cost 75,000
Accumulated depreciation – motor vehicles – 31 May 20X7 25,000
10% loan notes (20Y0 – 20Y5) 100,000
Trade receivables/ trade payables 177,630 97,500
Bank overdraft 51,250
Inventories – raw materials at cost – 31 May 20X7 108,400
Purchases – raw materials 750,600
Carriage inwards – raw materials 10,500
Manufacturing wages 250,000
Manufacturing overheads 125,000
Cash 5,120
Work in progress – 31 May 20X7 32,750
Sales 1,526,750
Administrative expenses 158,100
Selling and distribution expenses 116,800
Legal and professional expenses 54,100
Allowance for irrecoverable debts– 31 May 20X8 5,750
Inventories – finished goods – 31 May 20X7 184,500 -
2,789,000 2,789,000
(1) Inventories at 31 May 20X8 were:
$
Raw materials 112,600
Finished goods 275,350
Work in progress 37,800
(2) Depreciation for the year is to be charged as follows:
Buildings 2% on cost – charged to admin
HB2022

Plant and equipment 8% on cost – charged to production
Furniture and fixtures 10% on cost – charged to admin
Motor vehicles 20% on reducing balance
– 25% admin
– 75% selling and distribution
(3) Financial, legal and professional expenses include:
$
Solicitors’ fees for purchase of freehold land during year 5,000
(4) Provision is to be made for a full year’s interest on the loan notes.
(5) Income tax on the profits for the year is estimated at $40,000 and is due for payment on 28
February 20X9.
(6) The directors recommended on 30 June that a dividend of 3.5c per share be paid on the
ordinary share capital. No ordinary dividend was paid during the year ended 31 May 20X7.
Required
From the information given above, prepare the statement of profit or loss and other
comprehensive income of Polymer for the year to 31 May 20X8 and a statement of financial
position at that date for publication in accordance with IFRS Standards.
(Total = 25 marks)
27 Gains Co (18 mins)

(1) Gains Co
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME (EXTRACT)
$’000
Profit before interest and tax 792
Finance income 24
Finance cost (10)
(2) Non-current assets

- Assets held at cost were impaired by $25,000.
- Freehold land and buildings were revalued to $500,000 (carrying amount $380,000).
- A previously revalued asset was sold for $60,000.
Details of the revaluation are:
HB2022
24: FQP Chapter 731

$
Carrying amount at revaluation 30,000
Revaluation 50,000
80,000
Depreciation (80,000/10) × 3) (24,000)
56,000
Gains Co has been following paragraph 41 of IAS 16 which allows a reserve transfer of the realised
revaluation surplus (the difference between depreciation based on revalued amount and
depreciation based on cost) as the asset is used to retained earnings.
Revaluations during the year related to land.
Details of investment properties are as follows:
$
Value at 1.1.20X9 160,000
The properties had a valuation on 31 December 20X9 of $110,000. Gains Co previously accounted
for its investment properties by crediting gains to a revaluation surplus as allowed by local GAAP.
Gains Co now wishes to apply the fair value model of IAS 40 which states that gains and losses
should be accounted for in profit or loss. The elimination of the previous revaluation surplus is to
be treated as a change in accounting policy in accordance with IAS 8. No adjustment has yet
been made for the change in accounting policy or subsequent fall in value.
(3) Share capital
During the year the company had the following changes to its capital structure:
- An issue of 200,000 $1 ordinary bonus shares capitalising its share premium
- An issue of 400,000 $1 ordinary shares (issue price $1.40 per share)
(4) Equity
The carrying amount of equity at the start of the year was as follows:
$
Share capital 2,800,000
Share premium 1,150,000
Retained earnings 2,120,000
6,820,000
(5) Dividends
Dividends paid during the year amounted to $200,000.
Required
Using the information above prepare the Statement of changes in equity for Gains Co for the
year ended 31 December 20X9.
(Total = 10 marks)
HB2022

28 Biogenics Co (18 mins)
Over the last 20 years many companies have spent a great deal of money internally developing
new intangible assets such as software. The treatment for these assets is prescribed by IAS 38
Intangible Assets.
Biogenics Co is a publicly listed pharmaceutical company. During the year to 31 December 20X9
the following transactions took place:
(1) $6 million was spent on developing a new anti-obesity drug which received clinical approval
on 1 July 20X9 and is proving commercially successful. The directors expect the project to be
in profit within 12 months of the approval date. The patent was registered on 1 July 20X9. It
cost $1.5 million and remains in force for three years.
(2) A research project was set up on 1 October 20X9 which is expected to result in a new cancer
drug. $200,000 was spent on computer equipment and $400,000 on staff salaries. The
equipment has a useful life of four years.
(3) On 1 September 20X9 Biogenics Co acquired an up-to-date list of GPs at a cost of $500,000
and has been visiting them to explain the new obesity drug. The list is expected to generate
sales throughout the life-cycle of the drug.
Required
(a) In accordance with IAS 38, discuss whether internally-developed intangible assets should be
recognised, and if so how they should be initially recorded and subsequently accounted for.
(3 marks)
(b) Prepare extracts from the statement of financial position of Biogenics Co at 31 December
20X9 relating to the above items and summarise the costs to be included in the statement of
profit or loss for that year. (7 marks)
(Total = 10 marks)
29 Multiplex Co (27 mins)

On 1 January 20X0 Multiplex Co acquired Steamdays Co, a company that operates a scenic
railway along the coast of a popular tourist area. The summarised statement of financial position
at fair values of Steamdays Co on 1 January 20X0, reflecting the terms of the acquisition was:
$’000
Goodwill 200
Operating licence 1,200
Property – train stations and land 300
Rail track and coaches 300
Two steam engines 1,000
Purchase consideration 3,000
The operating licence is for ten years. It was renewed on 1 January 20X0 by the transport
authority and is stated at the cost of its renewal. The carrying amount of the property and rail
track and coaches are based on their value in use. The engines are valued at their net selling
prices.
On 1 February 20X0 the boiler of one of the steam engines exploded, completely destroying the
whole engine. Fortunately, no one was injured, but the engine was beyond repair. Due to its age a
replacement could not be obtained. Because of the reduced passenger capacity, the estimated
value in use of the whole of the business after the accident was assessed at $2 million.
Passenger numbers after the accident were below expectations even allowing for the reduced
capacity. A market research report concluded that tourists were not using the railway because of
HB2022
24: FQP Chapter 733

their fear of a similar accident occurring to the remaining engine. In the light of this the value in
use of the business was re-assessed on 31 March 20X0 at $1.8 million. On this date Multiplex Co
received an offer of $900,000 in respect of the operating licence (it is transferable). The realisable
value of the other net assets has not changed significantly.
Required
Calculate the carrying amount of the assets of Steamdays Co (in Multiplex Co’s consolidated
statement of financial position) at 1 February 20X0 and 31 March 20X0 after recognising the
impairment losses.
(Total = 15 marks)
30 Hewlett Co (45 mins)

Hewlett Co is a quoted company reporting under IFRS Standards. During the year to 31 December
20X2, the company changed its accounting policy with respect to property valuation. There are
also a number of other issues that need to be finalised before the financial statements can be
published.
Hewlett Co’s trial balance from the general ledger at 31 December 20X2 showed the following
balances:
$m $m
Revenue 2,648
Purchases 1,669
Inventories at 1 January 20X2 444
Distribution costs 514
Administrative expenses 345
Rental income 48
Land and buildings: – cost (including $90m land) 840
– accumulated depreciation at 1 January 20X2 120
Plant and equipment: – cost 258
– accumulated depreciation at 1 January 20X2 126
Investment property at 1 January 20X2 548
Trade receivables 541
50c ordinary shares 100
Share premium 244
Retained earnings at 1 January 20X2 753
Interim dividend paid 6
4% loan note repayable 20X8 (issued 20X0) 150
Trade and other payables 434
5,200 5,200
HB2022

Further information to be taken into account:
(1) Closing inventories were counted and amounted to $388 million at cost. However, shortly
after the year end out-of-date inventories with a cost of $21 million were sold for $14 million.
(2) At the beginning of the year, Hewlett Co disposed of some malfunctioning equipment for $7
million. The equipment had cost $15 million and had accumulated depreciation brought
forward at 1 January 20X2 of $3 million.
There were no other additions or disposal to property, plant and equipment in the year.
(3) The company treats depreciation on plant and equipment as a cost of sale and on land and
buildings as an administrative cost. Depreciation rates as per the company’s accounting
policy note are as follows:
Buildings Straight line over 50 years

Plant and equipment 20% reducing balance
Hewlett Co’s accounting policy is to charge a full year’s depreciation in the year of an asset’s
purchase and none in the year of disposal. Hewlett Co’s buildings were eight years old on 1
January 20X2.
(4) On 31 December 20X2 the company revalued its land and buildings to $760 million (including
$100 million for the land). The company follows the revaluation model of IAS 16 for its land
and buildings, but no revaluations had previously been necessary. The company wishes to
treat the revaluation surplus as being realised on disposal of the assets. The company has
previously undertaken no revaluations.
(5) Due to a change in Hewlett Co’s product portfolio plans, an item of plant with a carrying
amount $22 million at 31 December 20X2 (after adjusting for depreciation for the year) may
be impaired due to a change in use. An impairment test conducted at 31 December, revealed
its fair value less costs of disposal to be $16 million. The asset is now expected to generate an
annual net income stream of $3.8 million for the next five years at which point the asset
would be disposed of for $4.2 million. An appropriate discount rate is 8%. Five-year discount
factors at 8% are:
Simple Cumulative
0.677 3.993
(6) The income tax charge (current and deferred tax) for the year is estimated at $45 million (of
which $17 million relates to future payable tax on the revaluation, to be charged to other
comprehensive income (and the revaluation surplus)).
(7) An interim dividend of 3c per share was paid on 30 June 20X2. A final dividend of 1.5c per
share was declared by the directors on 28 January 20X3. No dividends were paid or declared
in 20X1.
(8) During the year on 1 July 20X2, Hewlett Co made a 1 for 4 bonus issue, capitalising its other
components of equity. This transaction had not yet been accounted for. The fair value of the
company’s shares on the date of the bonus issue was $7.50 each.
(9) Hewlett uses the fair value model of IAS 40. The fair value of the investment property at 31
December 20X2 was $588 million.
Required
Prepare the statement of profit or loss and other comprehensive income and statement of
changes in equity for Hewlett Co for the year to 31 December 20X2 and a statement of financial
position at that date in accordance with IFRS Standards insofar as the information permits.
Notes.
1 Notes to the financial statements are not required, but all workings should be clearly shown.
2 Work to the nearest $1m. Comparative information is not required.
(Total = 25 marks)
HB2022
24: FQP Chapter 735

31 Barcelona Co and Madrid Co (22 mins)
Barcelona Co acquired 60% of Madrid Co’s ordinary share capital on 1 October 20X2 at a price of
$1.06 per share. The balance on Madrid Co’s retained earnings at that date was $115 million.
Their respective statements of financial position as at 30 September 20X6 are:
Barcelona Co Madrid Co
$m $m
Non-current assets
Property, plant & equipment 2,848 354
Patents 45 –
Investment in Madrid 159 –
3,052 354
Current assets
Inventories 895 225
Trade and other receivables 1,348 251
2,455 510
5,507 864
Equity
Share capital (20c ordinary shares) 920 50
3,781 490
Long-term borrowings 558 168
Current liabilities
Current portion of long-term borrowings – 23
1,168 206
5,507 864
At the date of acquisition the fair values of some of Madrid Co’s assets were greater than their
carrying amounts. One line of Madrid Co’s inventory had a fair value of $8 million above its
carrying amount. This inventory had all been sold by 30 September 20X6. Madrid Co’s land and
buildings had a fair value $26 million above their carrying amount. $20 million of this is
attributable to the buildings, which had a remaining useful life of ten years at the date of
acquisition.
It is group policy to value non-controlling interests at full (or fair) value. The fair value of the non-
controlling interests at acquisition was $86 million.
Annual impairment tests have revealed cumulative impairment losses relating to recognised
goodwill of $20 million to date.
HB2022

Required
Produce the consolidated statement of financial position for the Barcelona Group as at 30
September 20X6.
(Total = 12 marks)
32 Reprise Group (25 mins)

Reprise Co purchased 75% of Encore Co for $2,000,000 ten years ago when the balance on its
retained earnings was $1,044,000. The statements of financial position of the two companies as
at 31 March 20X4 are:
Reprise Co Encore Co
$’000 $’000
Non-current assets
Investment in Encore 2,000 –
Land and buildings 3,350 –
Plant and equipment 1,010 2,210
Motor vehicles 510 345
6,870 2,555
Current assets
Inventories 890 352
Trade receivables 1,372 514
2,351 917
9,221 3,472
Equity
Share capital – $1 ordinary shares 1,000 500
Revaluation surplus 2,500 –
7,725 3,110
10% debentures 500 –
Current liabilities
9,221 3,472
The following additional information is available:

(1) Included in trade receivables of Reprise Co are amounts owed by Encore Co of $75,000. The
current accounts do not at present balance due to a payment for $39,000 being in transit at
the year end from Encore Co.
(2) Included in the inventories of Encore Co are items purchased from Reprise Co during the year
for $31,200. Reprise Co marks up its goods by 30% to achieve its selling price.
(3) $180,000 of the recognised goodwill arising is to be written off due to impairment losses.
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24: FQP Chapter 737

(4) Encore Co shares were trading at $4.40 just prior to acquisition by Reprise Co and this price
is used to value non-controlling interests.
Required
Prepare the consolidated statement of financial position for the Reprise group of companies as at
31 March 20X4. It is the group policy to value the non-controlling interests at full (or fair) value.
(Total = 14 marks)
33 Fallowfield Co and Rusholme Co (27 mins)

Fallowfield Co acquired a 60% holding in Rusholme Co three years ago when Rusholme Co’s
retained earnings balance stood at $16,000. Both businesses have been very successful since the
acquisition and their respective statements of profit or loss for the year ended 30 June 20X8 are:
Fallowfield Co Rusholme Co
$ $
Revenue 403,400 193,000
Cost of sales (201,400) (92,600)
Gross profit 202,000 100,400
Dividends from Rusholme 15,000
STATEMENT OF CHANGES IN EQUITY (EXTRACT)
Retained Retained
earnings earnings
$ $
Balance at 1 July 20X7 163,000 61,000
Dividends (40,000) (25,000)
Balance at 30 June 20X8 238,000 82,000
During the year Rusholme Co sold some goods to Fallowfield Co for $40,000, including 25%
mark-up. Half of these items were still in inventories at the year end.
Required
Produce the consolidated statement of profit or loss of Fallowfield Co and its subsidiary for the
year ended 30 June 20X8, and an extract from the statement of changes in equity, showing
retained earnings. Goodwill is to be ignored.
(Total = 15 marks)
HB2022

34 Panther Group (27 mins)
Panther Co operated as a single company, but in 20X4 decided to expand its operations. Panther
Co acquired a 60% interest in Sabre Co on 1 July 20X4 for $2,000,000.
The statements of profit or loss and other comprehensive income of Panther Co and Sabre Co
for the year ended 31 December 20X4 are:
Panther Co Sabre Co
$’000 $’000
Revenue 22,800 4,300
Cost of sales (13,600) (2,600)
Distribution costs (2,900) (500)
Administrative expenses (1,800) (300)
Finance income 50 –
Profit before tax 4,350 830
PROFIT FOR THE YEAR 3,050 610
Other comprehensive income for the year, net of tax 1,600 180
TOTAL COMPREHENSIVE INCOME FOR THE YEAR 4,650 790
Historically, Sabre Co had been a significant trading partner of Panther Co. During 20X4,
Panther Co purchased $640,000 of goods from Sabre Co. Of these, $60,000 remained in
inventories at the year end. Sabre Co makes a mark-up on cost of 20% under the transfer pricing
agreement between the two companies. The fair value of the identifiable net assets of Sabre Co
on purchase were $200,000 greater than their carrying amounts. The difference relates to
properties with a remaining useful life of 20 years.
On 1 January 20X4 (to protect its supply lines), Panther Co had advanced a loan to Sabre Co
amounting to $800,000 at a market interest rate of 5%. The loan is due for repayment in 20X9.
Statement of changes in equity (extracts) for the two companies:
Panther Co Sabre Co
Reserves Reserves
$’000 $’000
Balance at 1 January 20X4 12,750 2,480
Dividend paid (900) –
Total comprehensive income for the year 4,650 790
Balance at 31 December 20X4 16,500 3,270
Panther Co and Sabre Co had $400,000 and $150,000 of share capital in issue throughout the
period respectively.
Required
Prepare the consolidated statement of profit or loss and other comprehensive income and
statement of changes in equity (extract for reserves) for the Panther Group for the year ended 31
December 20X4.
HB2022
24: FQP Chapter 739

Notes.
1 No adjustments for impairment losses were necessary in the group financial statements.
2 Assume income and expenses (other than intragroup items) accrue evenly.
(Total = 15 marks)
35 Hever Co (36 mins)

Hever Co has held shares in two companies, Spiro Co and Aldridge Co, for a number of years. As
at 31 December 20X4 they have the following statements of financial position:
Hever Co Spiro Co Aldridge Co

$’000 $’000 $’000
Non-current assets
Property, plant & equipment 370 190 260
Investments 218 – –
588 190 260
Current assets
380 230 290
968 420 550
Equity
Share capital ($1 ordinary shares) 200 80 50
Share premium 100 80 30
Retained earnings 568 200 400
868 360 480
Current liabilities
968 420 550
You ascertain the following additional information:

(1) The investments in the statement of financial position comprise solely Hever’s investment in
Spiro Co ($128,000) and in Aldridge Co ($90,000).
(2) The 48,000 shares in SpiroCo were acquired when Spiro Co’s retained earnings stood at
$20,000.
The 15,000 shares in Aldridge Co were acquired when that company had a retained earnings
balance of $150,000.
(3) When Hever Co acquired its shares in Spiro Co the fair value of Spiro Co’s net assets equalled
their carrying amounts with the following exceptions:
HB2022

$’000
Property, plant and equipment 50 higher
Inventories 20 lower (sold during 20X4)
Depreciation arising on the fair value adjustment to non-current assets since this date is $5,000.
(4) During the year, Hever Co sold inventories to Spiro Co for $16,000, which originally cost Hever
Co $10,000. Three‑quarters of these inventories have subsequently been sold by Spiro Co.
(5) No impairment losses on goodwill had been necessary by 31 December 20X4.
(6) It is group policy to value non-controlling interests at full (or fair) value. The fair value of the
non-controlling interests at acquisition was $90,000.
Required
Prepare the consolidated statement of financial position for the Hever group (incorporating the
associate).
(Total = 20 marks)
36 Highveldt Co (45 mins)

Highveldt Co, a public listed company, acquired 75% of Samson Co’s ordinary shares on 1 April
20X4. Highveldt Co paid an immediate $3.50 per share in cash and agreed to pay a further
amount on 1 April 20X5 contingent upon the post-acquisition performance of Samson Co. At the
date of acquisition, the fair value of this contingent consideration was assessed at $108 million,
but by 31 March 20X5 it had become clear that the amount due would be $116 million (ignore
discounting). Highveldt Co has recorded the cash consideration of $3.50 per share and provided
for the initial estimate of contingent consideration of $108 million.
The summarised statements of financial position of the two companies at 31 March 20X5 are
shown below:
Highveldt Co Samson Co
$m $m $m $m
Tangible non-current assets (note(1)) 420 320
Development costs (note (4)) nil 40
Investments (note (2)) 300 20
720 380
Current assets 133 91
Total assets 853 471
Ordinary shares of $1 each 270 80
Reserves:
Share premium 80 40
Revaluation surplus 45 nil
Retained earnings – 1 April 20X4 160 134
– year to 31 March 20X5 190 350 76 210

745 330
HB2022
24: FQP Chapter 741

$m $m $m $m
10% intercompany loan (note (2)) nil 60
Current liabilities 108 81
Total equity and liabilities 853 471

(1) Highveldt Co has a policy of revaluing land and buildings to fair value. At the date of
acquisition Samson Co’s land and buildings had a fair value $20 million higher than their
carrying amount and at 31 March 20X5 this had increased by a further $4 million (ignore
any additional depreciation).
(2) Included in Highveldt Co’s investments is a loan of $60 million made to Samson Co at the
date of acquisition. Interest is payable annually in arrears. Samson Co paid the interest due
for the year on 31 March 20X5, but Highveldt Co did not receive this until after the year end.
Highveldt Co has not accounted for the accrued interest from Samson Co.
(3) Samson Co had established a line of products under the brand name of Titanware. Acting on
behalf of Highveldt Co, a firm of specialists, had valued the brand name at a value of $40
million with an estimated life of ten years as at 1 April 20X4. The brand is not included in
Samson Co’s statement of financial position.
(4) Samson Co’s development project was completed on 30 September 20X4 at a cost of $50
million. $10 million of this had been amortised by 31 March 20X5. Development costs
capitalised by Samson Co at the date of acquisition were $18 million. Highveldt Co’s directors
are of the opinion that Samson Co’s development costs do not meet the criteria in IAS 38
Intangible Assets for recognition as an asset.
(5) Samson Co sold goods to Highveldt Co during the year at a profit of $6 million. One-third of
these goods were still in the inventory of Highveldt Co at 31 March 20X5.
(6) An impairment test at 31 March 20X5 on the consolidated goodwill concluded that it should
be written down by $22 million. No other assets were impaired.
(7) It is the group policy to value the non-controlling interest at full fair value. At the date of
acquisition, the directors estimated the fair value of the non-controlling interest to be $74
million.
Required
(a) Calculate the following figures as they would appear in the consolidated statement of
financial position of Highveldt Co at 31 March 20X5:
(i) Goodwill (8 marks)
(ii) Non-controlling interest (4 marks)
(iii) The following consolidated reserves:

• Share premium
• Revaluation surplus
• Retained earnings
Note. Show your workings. (8 marks)
(b) Explain why consolidated financial statements are useful to the users of financial statements
(as opposed to just the parent company’s separate (entity) financial statements). (5 marks)
(Total = 25 marks)
HB2022

37 Villandry Co (18 mins)
(a) Villandry Co’s inventory includes three items for which the following details are available.
Supplier’s list price Net realisable value

$ $
Product Arctic 3,600 5,100
Product Brassy 2,900 2,800
Product Chilly 4,200 4,100
The company receives a 2.5% trade discount from its suppliers and it also takes advantage of
a 2% discount for prompt payment.
Required
Calculate the total value of products Arctic, Brassy and Chilly which should be shown in
inventory in the statement of financial position.
(b) Explain the difference that changing from a weighted average to FIFO method of inventory
valuation is likely to have on an entity’s profit or loss.
(Total = 10 marks)
38 Biological assets (18 mins)

IAS 41 Agriculture prescribes the accounting treatment and disclosures related to agricultural
activities. An entity is encouraged, but not required, to provide a quantified description of each
group of biological assets, distinguishing between consumables and bearer biological assets, or
between mature and immature biological assets, as appropriate.
Required
(a) Distinguish between a biological asset and an item of agricultural produce.
(b) Explain how agricultural produce is measured in the financial statements of an entity.
(c) Give five examples of biological assets and their relative agricultural produce.
(d) Explain what is meant by consumable and bearer biological assets, giving one example for
each.
(Total = 10 marks)
39 Provisions (36 mins)

Larry Co operates in the quarrying business, and was awarded a licence to quarry gravel in a
conservation area.
As part of the agreement, Larry Co was required to build access roads as well as the structures
necessary for the quarrying and extraction process. The total cost of these was $70 million. The
quarry came into operation on 31 December 20X3 and the operating licence was for 20 years
from that date. Under the terms of the operating licence, Larry Co is obliged to remove the access
roads and structures and restore the natural environmental habitat at the end of the quarry’s 20-
year life. At 31 December 20X3, the estimated cost of the restoration work was $20 million, and
this estimate did not change by 31 December 20X4. An appropriate discount rate reflecting
market assessments of the time value of money and risks specific to the operation is 5%.
The value of $1 in 20 years’ time is estimated to be $0.377.
Required
Explain the treatment of the cost of the assets and associated obligation relating to the quarry:
(a) As at 31 December 20X3
HB2022
24: FQP Chapter 743

(b) For the year ended 31 December 20X4
Note. Work to the nearest $1,000.
(Total = 12 marks)
40 Financial assets and liabilities (18 mins)

(a) On 1 January 20X2, an entity issued a debt instrument with a coupon rate of 3.5% at a
nominal value of $6,000,000. The directly attributable costs of issue were $120,000. The debt
instrument is repayable on 31 December 20X7 at a premium of $1,100,000.
Required
What is the total amount of the finance cost associated with the debt instrument? (3 marks)
(b) On 1 January 20X3 Dashing Co issued $600,000 loan notes. Issue costs were $200. The loan
notes do not carry interest, but are redeemable at a premium of $152,389 on 31 December
20X4. The effective finance cost of the loan notes is 12%.
Required
What is the finance cost in respect of the loan notes for the year ended 31 December 20X4?
(3 marks)
(c) On 1 January 20X1, Flustered Co issued 10,000 5% convertible bonds at their par value of
$50 each. The bonds will be redeemed on 1 January 20X6. Each bond is convertible to equity
shares at the option of the holder at any time during the five year period. Interest on the
bond will be paid annually in arrears.
The prevailing market interest rate for similar debt without conversion options at the date of
issue was 6%.
The discount factor for 6% at year 5 is 0.747.
The cumulative discount factor for years 1–5 at 6% is 4.212.
Required
At what value should the equity element of the hybrid financial instrument be recognised in
the financial statements in Flustered Co at the date of issue? (4 marks)
(Total = 10 marks)
41 Alpha (45 mins)

In producing the Conceptual Framework and some of the current IFRS Standards, the IASB has
had to address the potential problem that the management of some companies may choose to
adopt inappropriate accounting policies. These could have the effect of portraying an entity’s
financial position in a favourable manner. In some countries this is referred to as ‘creative
accounting’.
Required
(a) Describe in broad terms common ways in which management can manipulate financial
statements to indulge in ‘creative accounting’ and why they would wish to do so. (7 marks)
(b) Explain with examples how IFRS seeks to limit creative accounting in each of the following
areas of accounting.
(i) Group accounting
(ii) Measurement and disclosure of current assets (8 marks)
(c) Alpha Co, a public listed corporation, is considering how it should raise $10m of finance
which is required for a major and vital non-current asset renewal scheme that will be
undertaken during the current year to 31 December 20X6. Alpha Co is particularly concerned
HB2022

about how analysts are likely to react to its financial statements for the year to 31 December
20X6. Present forecasts suggest that Alpha Co’s earnings per share and its financial gearing
ratios may be worse than market expectations. Mr Wong, Alpha Co’s Finance Director, is in
favour of raising the finance by issuing a convertible loan. He has suggested that the coupon
(interest) rate on the loan should be 5%; this is below the current market rate of 9% for this
type of loan. In order to make the stock attractive to investors the terms of conversion into
equity would be very favourable to compensate for the low interest rate.
Required
(i) Explain why the Finance Director believes the above scheme may favourably improve
Alpha Co’s earnings per share and gearing.
(ii) Describe how the requirements of IAS 33 Earnings per Share and IAS 32 Financial
Instruments: Presentation are intended to prevent the above effects. (10 marks)
(Total = 25 marks)
42 Jenson Co (32 mins)

(a) The timing of revenue (income) recognition has long been an area of debate and
inconsistency in accounting. It has now become the subject of a new standard, IFRS 15
Revenue from Contracts with Customers.
The IASB in the Conceptual Framework has defined the ‘elements’ of financial statements,
and it uses these to determine when a gain or loss occurs.
Required
Explain what is meant by a performance obligation in relation to revenue recognition and
discuss the criteria used in the Conceptual Framework for determining when a gain or loss
arises. (5 marks)
(b) Jenson Co has entered into the following transactions/agreements in the year to 31 March
20X5.
(1) Jenson Co owns the rights to a fast food franchise. On 1 April 20X4 it sold the right to
open a new outlet to Mr Verstappen. The franchise is for five years. Jenson Co received
an initial fee of $50,000 for the first year and will receive $5,000 per annum thereafter.
Jenson Co has continuing service obligations on its franchise for advertising and product
development that amount to approximately $8,000 per annum for each franchised
outlet. A reasonable profit margin on the provision of the continuing services is deemed
to be 20% of revenues received.
(2) On 1 September 20X4 Jenson Co received subscriptions in advance of $240,000. The
subscriptions are for 24 monthly publications of a magazine produced by Jenson Co. At
the year-end Jenson Co had produced and despatched 6 of the 24 publications.
Required
Describe how Jenson Co should treat each of the above examples in its financial statements
in the year to 31 March 20X5. (13 marks)
(Total = 18 marks)
43 Trontacc Co (18 mins)

Trontacc Co is a company whose activities are in the field of major construction projects. During
the year ended 30 September 20X7, it enters into three separate contracts, each with a fixed
contract price of $1,000,000 and each expected to be profitable overall. These are contracts in
which performance obligations are satisfied over time. Control over the assets being constructed
passes to the customer as the construction takes place and Trontacc Co has no alternative use for
the assets. Trontacc Co has an enforceable right to payment for performance completed to date.
The following information relates to these contracts at 30 September 20X7.
HB2022
24: FQP Chapter 745

Aspire Bigga Construct
$’000 $’000 $’000
Amounts invoiced up to 30.9.X7 540 475 400
Amounts received from customers to 30.9.X7 420 400 Nil
Costs incurred to date 500 500 320
Value of work certified to date 60% 50% 35%
Required
(a) Show how each contract would be reflected in the statement of financial position of Trontacc
Co at 30 September 20X7 under IFRS 15 Revenue from Contracts with Customers.
(b) Show how each contract would be reflected in the statement of profit or loss of Trontacc Co
for the year ended 30 September 20X7 under IFRS 15.
(Total = 10 marks)
44 Telenorth Co (45 mins)

The following trial balance relates to Telenorth Co at 30 September 20X1.
$’000 $’000
Revenue 283,460
Inventory 1 October 20X0 12,400
Purchases 147,200
Distribution expenses 22,300
Administration expenses 34,440
Interim dividends: ordinary 2,000
preference 480
Investment income 1,500
Building 56,250
Plant and equipment – cost 55,000
Computer system – cost 35,000
Investments at valuation 34,500
Depreciation 1 October 20X0 (note (2))
Building 18,000
Computer system 9,600
Trade accounts receivable 35,700
Trade accounts payable 17,770
Deferred tax (note (3)) 5,200
Ordinary shares of $1 each 20,000
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$’000 $’000
Suspense account (note (4)) 26,000
6% loan notes (issued 1 October 20X0) 10,000
8% preference shares (redeemable) 12,000
Revaluation surplus (note (3)) 3,400
Retained earnings 1 October 20X0 - 14,160
435,570 435,570
The following notes are relevant.

(1) An inventory count was not conducted by Telenorth Co until 4 October 20X1 due to
operational reasons. The value of the inventory on the premises at this date was $16 million at
cost. Between the year end and the inventory count the following transactions have been
identified.
$
Normal sales at a mark-up on cost of 40% 1,400,000
Sales on a sale or return basis at a mark-up on cost of 30% 650,000
Goods received at cost 820,000
All sales and purchases had been correctly recorded in the period in which they occurred.
(2) Telenorth Co has a building depreciated over the useful term of 25 years on a straight line
basis. Depreciation has not yet been calculated for the current year.
Telenorth Co has the following depreciation policies.
Plant and equipment – five years straight line with residual values estimated at $5,000,000
Computer system – 40% per annum reducing balance
Depreciation of the building and plant is treated as cost of sales; depreciation of the
computer system is an administration cost.
(3) An income tax liability of $23.4 million for the year to 30 September 20X1 is required. The
deferred tax liability is to be increased by $2.2 million, of which $1 million is to be charged
direct to the revaluation surplus.
(4) The suspense account contains the proceeds of two share issues.
(i) The exercise of all the outstanding directors’ share options of four million shares on 1
October 20X0 at $2 each
(ii) A fully subscribed rights issue on 1 July 20X1 of 1 for 4 held at a price of $3 each. The
stock market price of Telenorth’s shares immediately before the rights issue was $4.
(iii) The finance charge relating to the preference shares is equal to the dividend payable.
Required
(a) The statement of profit or loss of Telenorth Co for the year to 30 September 20X1. (8 marks)
(b) A statement of financial position as at 30 September 20X1 in accordance with IFRS Standards
as far as the information permits. (12 marks)
(c) Calculate the earnings per share in accordance with IAS 33 for the year to 30 September
20X1 (ignore comparatives). (5 marks)
(Total = 25 marks)
HB2022
24: FQP Chapter 747

45 Bulwell Aggregates Co (18 mins)
Bulwell Aggregates Co entered into a three-year contract to obtain three lorries on 1 January
20X1. The contract met the IFRS 16 Leases criteria to be classified as a lease and the initial
measurement of the right-of-use asset was $54,000. The agreement states that Bulwell
Aggregates Co will pay a deposit of $9,000 on 1 January 20X1, and two annual instalments of
$24,000 on 31 December 20X1, 20X2 and a final instalment of $20,391 on 31 December 20X3.
Ownership will pass to Bulwell Aggregates Co at the end of the lease term. The scrap value of the
lorries after four years is expected to be $4,000.
Interest is to be calculated at 25% on the balance outstanding on 1 January each year and paid
on 31 December each year.
The depreciation policy of Bulwell Aggregates Co is to depreciate the right-of-use asset arising
from the lease of the vehicles over a four year period using the straight line method.
Required
Show the entries in the statement of profit or loss and statement of financial position for the years
20X1, 20X2, 20X3. This is the only lease transaction undertaken by this company.
Note. Calculate to the nearest $
(Total = 10 marks)
46 Lis Co (18 mins)

On 1 January 20X3 Lis Co entered into a lease agreement to lease an asset for a six-year period,
at which point it will be returned to the lessor and scrapped, with annual payments of $18,420
made in advance commencing on 1 January 20X4. The present value of the future lease
payments amount to $66,404, discounted at the implicit interest rate shown in the lease
agreement of 12%. An initial deposit of £17,596 is made on 1 January 20X3 in addition to these
payments.
Lis Co expects to sell goods produced by the asset during the first five years of the lease term, but
has leased the asset for six years as this is the requirement of the lessor, and in case this
expectation changes. Lis Co has the right to determine the use of the asset during the lease term
and will obtain substantially all the economic benefit from its use.
Required
Explain how the above lease would be accounted for the year ending 31 December 20X3 including
producing relevant extracts from the statement of profit or loss and statement of financial
position.
Note. You are not required to prepare the notes to the financial statements.
(Total = 10 marks)
47 Carpati Co (11 mins)

The following information relates to Carpati Co:
(1) The carrying amount of plant and equipment at 30 September 20X6 is $1,185,000.
(2) The tax written down value of plant and equipment at 1 October 20X5 was $405,000.
(3) During the year ended 30 September 20X6, the company bought plant and equipment of
$290,000, which is eligible for tax depreciation.
(4) Carpati Co bought its freehold property in 20W5 for $600,000. It was revalued in the 20X6
accounts to $1,500,000. Ignore depreciation on buildings. No tax allowances were available
to Carpati Co on the buildings.
Required
Draft the note to the statement of financial position at 30 September 20X6 omitting
comparatives, in respect of deferred tax. Work to the nearest $’000. Assume a current income tax
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rate of 30%. Tax depreciation is at 25% on a reducing balance basis. The income tax rate enacted
for 20X7 is 28%.
(Total = 6 marks)
48 Pilum Co (18 mins)

A statement showing the retained profit of Pilum Co for the year ended 31 December 20X4 is set
out below.
$ $
Profit before tax 2,530,000
Less income tax expense (1,127,000)
1,403,000
Transfer to reserves (230,000)
Dividends:
Paid preference interim dividend 138,000
Paid ordinary interim divided 414,000
Declared preference final dividend 138,000
(690,000)
Retained 483,000
On 1 January 20X4 the issued share capital of Pilum Co was 4,600,000 6% preference shares of
$1 each and 4,120,000 ordinary shares of $1 each.
Required
Calculate the earnings per share (on basic and diluted basis) in respect of the year ended 31
December 20X4 for each of the following circumstances (each of the three circumstances (1) to (3)
is to be dealt with separately).
(a) On the basis that there was no change in the issued share capital of the company during the
year ended 31 December 20X4.
(b) On the basis that the company made a rights issue of $1 ordinary shares on 1 October 20X4
in the proportion of 1 for every 5 shares held, at a price of $1.20. The market price for the
shares at close of trade on the last day of quotation cum rights was $1.78 per share.
(c) On the basis that Pilum Co made no new issue of shares during the year ended 31 December
20X4 but on that date it had in issue $1,500,000 10% convertible loan stock 20X8 – 20Y1. This
loan stock will be convertible into ordinary $1 shares as follows.
20X8 90 $1 shares for $100 nominal value loan stock

20X9 85 $1 shares for $100 nominal value loan stock
20Y0 80 $1 shares for $100 nominal value loan stock
20Y1 75 $1 shares for $100 nominal value loan stock
Note. Assume where appropriate that the income tax rate is 30%.
(Total = 10 marks)
49 Biggerbuys Co (45 mins)

Biggerbuys Co has carried on business for a number of years as a retailer of a wide variety of
consumer products. The entity operates from a number of stores around the country. In recent
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24: FQP Chapter 749

years the entity has found it necessary to provide credit facilities to its customers in order to
maintain growth in revenue. As a result of this decision the liability to its bankers has increased
substantially. The statutory financial statements for the year ended 30 June 20X9 have recently
been published and extracts are provided below, together with comparative figures for the
previous two years.
HB2022

STATEMENTS OF PROFIT OR LOSS FOR THE YEARS ENDED 30 JUNE
20X7 20X8 20X9

$m $m $m
Revenue 1,850 2,200 2,500
Cost of sales (1,250) (1,500) (1,750)
Gross profit 600 700 750
Other operating costs (550) (640) (700)
Operating profit 50 60 50
Interest from credit sales 45 60 90
Interest payable (25) (60) (110)
Profit before taxation 70 60 30
Tax payable (23) (20) (10)
STATEMENTS OF FINANCIAL POSITION AT 30 JUNE
20X7 20X8 20X9

$m $m $m
Property, plant and equipment 278 290 322
1,182 1,392 1,590
Share capital 90 90 90
Reserves 282 292 282
372 382 372
Bank loans 320 520 610
Other interest bearing borrowings 200 200 320
Tax payable 20 20 8
1,182 1,392 1,590
Other information
(1) Depreciation charged for the three years in question was:
Year ended 30 June 20X7 20X8 20X9

$m $m $m
55 60 70
(2) The other interest bearing borrowings are secured by a floating charge over the assets of
Biggerbuys Co. Their repayment is due on 30 June 20Y9.
HB2022
24: FQP Chapter 751

(3) Dividends of $30 million were paid in 20X7 and 20X8. A dividend of $20 million has been
proposed.
(4) The bank loans are unsecured. The maximum lending facility the bank will provide is $630
million.
(5) Over the past three years the level of credit sales has been:
Year ended 30 June 20X7 20X78 20X9

$m $m $m
300 400 600
The entity offers extended credit terms for certain products to maintain market share in a highly
competitive environment.
Given the steady increase in the level of bank loans which has taken place in recent years, the
entity has recently written to its bankers to request an increase in the lending facility. The request
was received by the bank on 15 October 20X9, two weeks after the financial statements were
published. The bank is concerned at the steep escalation in the level of the loans and has asked
for a report on the financial performance of Biggerbuys Co for the last three years.
Required
As a consultant management accountant employed by the bankers of Biggerbuys Co, prepare a
report to the bank which analyses the financial performance of the company for the period
covered by the financial statements. Your report may take any form you wish, but you are aware
of the particular concern of the bank regarding the rapidly increasing level of lending. Therefore,
it may be appropriate to include aspects of prior performance that could have contributed to the
increase in the level of bank lending.
(Total = 25 marks)
50 Webster Co (36 mins)

Webster Co is a publicly listed diversified holding company that is looking to acquire a suitable
engineering company. Two private limited engineering companies, Cole Co and Darwin Co, are
available to purchase. The summarised financial statements for the year to 31 March 20X9 of both
companies are:
Cole Co Darwin Co
$’000 $’000 $’000 $’000
Sales revenue (note (1)) 3,000 4,400
Opening inventory 450 720
Purchases (note (2)) 2,030 3,080
2,480 3,800
(1,940) (2,950)
Operating expenses (480) (964)
Profit from operations 580 486
Loan note interest (80) –
Overdraft interest – (10)
HB2022

Cole Co Darwin Co
$’000 $’000 $’000 $’000
Net profit for year 500 476
STATEMENT OF FINANCIAL POSITION
Cole Co Darwin Co
$’000 $’000 $’000 $’000
Non-current assets
Property, plant and equipment (notes (3)
and (4) 2,340 3,100
Current assets
Inventories 540 850
Cash and cash equivalent 20 –
1,082 1,600
Equity
Equity shares of $1 each 1,000 500
Reserves
Revaluation surplus – 700
Retained earnings – 1 April 20X8 684 1,912
Profit – year to 31 March 20X9 500 476
2,184 3,588
10% Loan note 800 –
Current liabilities
Overdraft – 550
438 1,112
Webster bases its preliminary assessment of target companies on certain key ratios. These are
listed below together with the relevant figures for Cole Co and Darwin Co calculated from the
above financial statements:
Cole Co Darwin Co
Return on capital
employed (500 + 80)/(2,184 + 800) (476/3,588)
× 100 19.4 % × 100 13.3 %
HB2022
24: FQP Chapter 753

Cole Co Darwin Co
Asset turnover (3,000/2,984) 1.01 times (4,400/3,588) 1.23 times
Gross profit margin 35.3 % 33.0 %
Net profit margin 16.7 % 10.8 %
Trade receivables
collection period 64 days 62 days
Trade payables payment
period 79 days 67 days
Capital employed is defined as shareholders’ funds plus non-current debt at the year-end; asset
turnover is sales revenues divided by gross assets less current liabilities.
The following additional information has been obtained.
(1) Cole Co is part of the Velox Group. On 1 March 20X9 it was permitted by its holding company
to sell goods at a price of $500,000 to Brander Co, a fellow subsidiary. The sale gave Cole
Co a gross profit margin of 40% instead of its normal gross margin of only 20% on these
types of goods. In addition Brander Co was instructed to pay for the goods immediately.
Cole Co normally allows three months credit.
(2) On 1 January 20X9 Cole Co purchased $275,000 (cost price to Cole Co) of its materials from
Advent Co, another member of the Velox Group. Advent Co was also instructed by the Velox
Group to depart from its normal trading terms, which would have resulted in a charge of
$300,000 to Cole Co for these goods. The Group’s finance director also authorised a four-
month credit period on this sale. Cole Co normally receives two months credit from its
suppliers. Cole Co had sold all of these goods at the year end.
(3) Non-current assets:
Details relating to the two companies’ non-current assets are:
Carrying
Cost/revaluation Depreciation amount
$’000 $’000 $’000
Cole Co: property 3,000 1,860 1,140
plant 6,000 4,800 1,200
2,340
Darwin Co: property 2,000 100 1,900
plant 3,000 1,800 1,200
3,100
The two companies own very similar properties. Darwin Co’s property was revalued to $2,000,000
at the beginning of the current year (ie 1 April 20X8). On this date Cole Co’s property, which is
carried at cost less depreciation, had a carrying amount of $1,200,000. Its current value (on the
same basis as Darwin Co’s property) was also $2,000,000. On this date (1 April 20X8) both
properties had the same remaining life of 20 years.
(4) Darwin Co purchased new plant costing $600,000 in February 20X9. In line with company
policy a full year’s depreciation at 20% per annum has been charged on all plant owned at
year end. The equipment is still being tested and will not come on-stream until next year. The
purchase of the plant was largely financed by an overdraft facility, which resulted in the
interest cost shown in the statement of profit or loss. Both companies depreciate plant over a
five-year life and treat all depreciation as an operating expense.
HB2022

(5) The bank overdraft that would have been required but for the favourable treatment towards
Cole Co in respect of items in (1) and (2) above, would have attracted interest of $15,000 in
the year to 31 March 20X9.
Required
(a) Restate the financial statements of Cole Co and Darwin Co in order that they may be
considered comparable for decision making purposes. State any assumptions you make.
(10 marks)
(b) Recalculate the key ratios used by Webster Co and, referring to any other relevant points,
comment on how the revised ratios may affect the assessment of the two companies.
(10 marks)
(Total = 20 marks)
51 Xpand Co (27 mins)

Xpand Co is a publicly listed company which has experienced rapid growth in recent years
through the acquisition and integration of other companies. Xpand Co is interested in acquiring
Hydan Co, a retailing company, which is one of several companies owned and managed by the
same family.
The summarised financial statements of Hydan Co for the year ended 30 September 20X4 are:
$’000
Revenue 70,000
Operating costs (7,000)
Directors’ salaries (1,000)
STATEMENT OF FINANCIAL POSITION
$’000 $’000
ASSETS
Non-current assets
Property, plant and equipment 32,400
Current assets
Inventories 7,500
7,600
Total assets 40,000
Equity
HB2022
24: FQP Chapter 755

$’000 $’000
Equity shares of $1 each 1,000
19,700
Directors’ loan accounts (interest free) 10,000
Current liabilities
Current tax payable 2,800
10,300
From the above financial statements Xpand Co has calculated for Hydan Co the ratios below for
the year ended 30 September 20X4. It has also obtained the equivalent ratios for the retail sector
average which can be taken to represent Hydan Co’s sector.
Hydan Co Sector average

Return on equity (ROE) (including directors’ loan accounts) 47.1% 22.0%
Net asset turnover 2.36 times 1.67 times
Net profit margin 20.0% 12.0%
From enquiries made, Xpand Co has learned the following information:

(1) Hydan Co buys all of its trading inventory from another of the family companies at a price
which is 10% less than the market price for such goods.
(2) After the acquisition, Xpand Co would replace the existing board of directors and need to pay
remuneration of $2.5m per annum.
(3) The directors’ loan accounts would be repaid by obtaining a loan of the same amount with
interest at 10% per annum.
(4) Xpand Co expects the purchase price of Hydan Co to be $30m.
Required
(a) Recalculate the ratios for Hydan Co after making appropriate adjustments to the financial
statements for notes (1) to (4) above. For this purpose, the expected purchase price of $30m
should be taken as Hydan Co’s equity and net assets are equal to this equity plus the loan.
(b) In relation to the ratios calculated in (1) above, and the ratios for Hydan Co given in the
question, comment on the performance of Hydan Co compared to its retail sector average
(Total = 15 marks)
52 Dundee Co (25 mins)

The summarised accounts of Dundee Co for the year ended 31 March 20X7 are:
HB2022

STATEMENTS OF FINANCIAL POSITION AT 31 MARCH
20X7 20X6
$m $m
Non-current assets
Current assets
3,700 3,400
7,900 7,100
Equity
Share capital 1,200 1,200
3,400 3,100
Deferred tax 1,070 850
Lease liabilities 1,300 1,200
2,370 2,050
Current liabilities
Trade payables 1,250 1,090
Current tax 225 205
2,130 1,950
7,900 7,100
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 MARCH 20X7
$m
Revenue 4,300
Gross profit 2,300
Operating expenses (1,000)
Finance costs (250)
Dividends paid in the year 300
HB2022
24: FQP Chapter 757

Further information:
(1) Depreciation charged for the year totalled $970m. There were no disposals of property, plant
and equipment in the period.
(2) There was no accrual of interest at the beginning or at the end of the year.
(3) Dundee Co finances a number (but not all) of its property, plant and equipment purchases
using leases. In the period, property, plant and equipment which would have cost $600m to
purchase outright was acquired under leases.
Required
Prepare the statement of cash flows for Dundee Co for the year ended 31 March 20X7 as per IAS 7
using the indirect method.
(Total = 14 marks)
53 Elmgrove Co (45 mins)

As financial accountant for Elmgrove Co, you are responsible for the preparation of a statement
of cash flows for the year ended 31 March 20X9.
The following information is available.
20X9 20X8
$m $m
Non-current assets
Current assets
Inventories 123 176
Short term investments 65 30
Cash at bank and in hand 29 –
312 293
639 557
Equity
Share capital – $1 shares 200 120
Share premium 30 –
Revaluation surplus 66 97
367 258
10% Debentures 100 150
Current liabilities 172 149
639 557
HB2022

STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 MARCH 20X9
$m
Revenue 473
Cost of sales (229)
Gross profit 244
Finance income 6
Finance costs (17)
Dividends paid in the period 32
The following notes are also relevant.

(1) Property, plant and equipment
Property, plant and equipment held by Elmgrove Co are items of plant and equipment and
freehold premises. During 20X9 items of plant and equipment which have a carrying amount
of $28m at the date of disposal were disposed of, resulting in a loss of $6m. The assets had
previously been revalued taking the credit to the revaluation surplus of $31m.
(2) Short term investments
The short-term investments meet the definition of cash equivalents per IAS 7 Statement of
Cash Flows.
(3) Current liabilities
Current liabilities consist of the following. 20X9 20X8

$m $m
Bank overdraft – 22
Interest payable 7 3
Income tax payable 39 54
172 149
(4) 10% debentures

On 1 August 20X8 $50m of 10% debentures was converted into $50m of $1 ordinary shares.
(5) Depreciation
The depreciation charge for the year included in the statement of profit or loss was $43m.
Required
(a) Using the information provided, prepare a statement of cash flows for Elmgrove Co for the
year ended 31 March 20X9 using the indirect method. (20 marks)
(b) Write a memorandum to a director of Elmgrove Co summarising the major benefits a user
receives from a published statement of cash flows. (5 marks)
(Total = 25 marks)
HB2022
24: FQP Chapter 759

54 Measurement (16 mins)
(a) Explain the difference between historical cost and current value accounting. (3 marks)
(b) Give three disadvantages to the use of historical cost accounting in the financial statements.
(3 marks)
(c) Briefly explain the factors that management must consider when choosing a measurement
basis for the assets and liabilities in the financial statements (3 marks)
(Total = 9 marks)
55 Not-for-profit (9 mins)
A new Academy school, Aspiration High School, has been opened in an area of high social
deprivation, replacing a school which was closed as a result of poor academic performance.
Aspiration High School is funded directly by central government and some critics claim that too
much money has been spent on it.
Required
In what ways would you expect the Department of Education to monitor the performance of this
school?
(Total = 5 marks)
56 Armstrong Co (25 mins)

Armstrong Co has purchased another company, Miller Co on 1 January 20X7.
These are the individual draft statements of financial position of each company at 31 December
20X8:
Armstrong Co Miller Co
$000 $000
Non-current assets
Investments 240,000 -
Current assets 123,000 89,300
Total assets 755,000 257,300
Equity
Share capital – $1 shares 210,000 120,000
541,700 201,000
HB2022

Armstrong Co Miller Co
$000 $000
Deferred consideration 40,000 -
Current liabilities 173,300 56,300
213,300 56,300
The following information is relevant

(1) Armstrong Co has acquired 80% of Miller Co on 1 January 20X7. Cash was paid in respect of
Miller Co of $200 million. It was agreed that Armstrong Co would pay another $40 million on
1 January 20X9.
(2) At the date of acquisition, Miller Co had $68 million in retained earnings, and a revaluation
surplus of $8 million. The non-controlling interest, as valued by Armstrong Co at 1 October
20X7 was taken at the fair value of $30 million.
(3) Armstrong Co’s cost of capital is 6%, and the appropriate discount rate is 0.890
(4) During the year, Armstrong Co sold $7.5 million of widgets to Miller Co, at a gross profit
margin of 20%. External sales made by Armstrong Co have a gross profit margin of 35%. At
31 December 20X8, Miller Co still had 30% of these widgets held in inventory.
Required
Prepare a consolidated statement of financial position for the Armstrong Group as at 31
December 20X8.
(Total = 14 marks)
HB2022
24: FQP Chapter 761

Further question
solutions
HB2022

Section A (2 marks each)
1 The correct answer is: Timeliness
2 The correct answer is: Irrecoverable debt allowance

Inventories, biological assets and investment property should be separately presented
3 The correct answer is: Dividends paid are deducted from retained earnings
They are a distribution, not an expense. They are not shown on the face of the statement of profit
or loss or deducted from other comprehensive income.

The depreciation charge:
$
Original cost – building 200,000
Depreciation X1 – X6 (200,000 × 5/50) (20,000)
180,000
Revaluation 1.1.X6 100,000
280,000
Depreciation (280,000 / 44*) = $6,222 *45 years remaining
5 The correct answer is: $256,000 profit

Profit/(loss)
$’000 $’000
Proceeds 1,500
Less carrying amount of goodwill (76)
Less group share of carrying amount of net assets at date of disposal
Share capital 1,000
1,460
Less NCI (1,460 × 20%) (292) (1,168)
Profit on disposal 256

Impairment loss
$
Fair value less disposal cost (800,000 – 20,000) 780,000
Value in use 950,000
So recoverable amount (higher) is $950,000, giving an impairment loss of $250,000 (1,200,000 –

950,000).
HB2022
24: FQP Chapter 763

7 The correct answer is: A one-line entry showing post-tax profit or loss of the operation and the
post-tax gain or loss on disposal
The discontinued operation should be shown as a one-line entry representing the profits for the
period of the operation and the post-tax gain or loss on disposal.

Goodwill on acquisition
$ $
Consideration – cash 300,000
– shares (40,000 × 2.50) 100,000
400,000
Non-controlling interest (20,000 × 1.75) 35,000
435,000
Fair value of net assets:
Fair value adjustments 60,000
(345,000)
90,000

$75,000 × 60% × 25/125 × 75% = $6,750

Group revenue
$
Frog Co 280,000
Tadpole Co (190,000 × 9/12) 142,500
Intragroup (40,000)
382,500

Investment in associate
$
Cost of investment 700,000
Share of post-acquisition retained earnings 195,000
Unrealised profit in inventory (200,000 × 25/125 × 50% × 30%) (6,000)
889,000
HB2022

The unrealised profit within inventory of Cobra Co is adjusted for in the Investment in associate
line as the inventory of the associate is not presented separately.
12 The correct answer is: (1), (2), (4)

Distribution, storage and wastage costs will all be treated as expenses and not subsumed into
inventory.
13 The correct answer is: $700,000 contract asset

Contract asset/liability
$
Revenue recognised ($2.5 million × 40%) 1,000,000
Amounts invoiced (300,000)
Contract asset 700,000

Dismantling and restoration costs
$
Depreciation (1.2m / 5) 240,000
Unwinding of discount (1.2m × 1.08) × 8% 103,680
343,680
Note. This is the second year of unwinding the discount.
15 The correct answer is: Fair value plus transaction costs

Financial assets are initially recognised at fair value plus transaction costs.

$24,000 × 9/10 = $21,600 (adjustment as the first month is free)
$21,600 × 3 = $64,800
Being under 12 months, the short-term lease exemption can be applied and the lease accounted
for as an expense in profit or loss rather than being recognised in the statement of financial
position. The lease amount paid is adjusted to take account of the first month being free, so the
total amount payable will be $24,000 × 9 = $216,000, equivalent to $21,600 per month, of which
only three months have been expensed by the year-end of 30 June 20X7.
17 The correct answer is: $2.32

EPS for the year
TERP
4 × 1.8 7.2
1 × 1.2 1.2
8.4 / 5 = 1.68
Shares
200,000 × 1.8/1.68 × 3/12 53,571
HB2022
24: FQP Chapter 765

Shares
250,000 × 9/12 187,500
241,071
EPS = $560,000/241,071 = $2.32
18 The correct answer is: It matches related items in accordance with the accruals concept
Cash flow accounting does not apply the accruals concept. It deals with items at the point when
they are received or paid.

Loss on disposal
$ $
Consideration received 200,000
Net assets (100,000 + 140,000) 240,000
Goodwill (50,000 × 60%) 30,000
Less NCI (58,000)
(212,000)
Loss on disposal (12,000)
HB2022

Section B (2 marks each)
(a) The correct answer is: (1) only
(1) is an onerous contract and should be provided for.
In the case of (2) the overhauls should be capitalised as part of the cost of the machine and
amortised over the period to the next overhaul. This applies the accruals concept to the costs
of the overhaul – the overhaul will result in future benefits and the costs of the overhaul are
recognised in the same accounting period as the associated expected benefits (matching).
IAS 37 does not allow provisions to be made for expected future losses, so (3) would not be a
valid provision.
(b) The correct answer is: They involve uncertain timing or amount.
Provisions are liabilities of uncertain timing or amount.
(c) The correct answer is: $14,000
((50,000 × 16%) + (120,000 × 5%))
(d) The correct answer is: Figaro Co is being sued by an ex-employee on health and safety
grounds. Lawyers have advised that the employee has a 55% chance of success.
This would be a valid provision.
A is not valid as the law has not yet been enacted. B is not valid as the restructuring has not
yet been announced to those affected by it. In the case of C, Figaro Co has avoided the
constructive obligation, so no provision is needed.
(e) The correct answer is: It should be recognised
A contingent liability is normally simply disclosed but IAS 37 makes an exception for
contingent liabilities assumed as part of a business combination.

(a) The correct answer is: The lessor can direct how the asset is used during the lease term.
This indicates that the lessee does not have control of the right-of-use asset during the lease
term.
(b) The correct answer is: $16,037
$
Initial measurement of liability 25,274
Interest 6% 1,516
Paid 30 June 20X6 (6,000)
Balance 30 June 20X6 20,790
Interest 6% 1,247
Paid 30 June 20X7 (6,000)
Liability due after one year 16,037
(c) The correct answer is: Recognise proportion relating to right-of-use transferred
(d) The correct answer is: $50,660
HB2022
24: FQP Chapter 767

$
Initial measurement of lease liability 35,660
Initial payment 20,000
Incentive received (5,000)
Measurement of right-of-use asset 50,660
(e) The correct answer is: $7,430

Total gain = 200,000 – 140,000 = 60,000
Gain on rights retained = 60,000 × 175,234/200,000 = 52,570
Gain on rights transferred = 60,000 – 52,570 = $7,430

(a) The correct answer is: $21,176
$ $
Original cost 1.1.X0 1,000,000
Depreciation to 31.12.X6 (1,000,000 × 7/50) (140,000)
860,000
Depreciation to 30.6.X7 ((1,000,000/50) × 6/12) (10,000) 10,000
850,000
950,000
Depreciation to 31.12.X7 (950,000 × 0.5/42.5) (11,176) 11,176
Total depreciation year to 31.12.X7 21,176
(b) The correct answer is: Deferred tax on the surplus of $100,000 should be charged to the
revaluation surplus.
As the revaluation surplus goes directly to equity, the same treatment is applied to the
deferred tax.
(c) The correct answer is: Higher of fair value less costs of disposal and value in use
(d) The correct answer is: $114,000
Original amount Impairment Post-impairment

$ $ $
Goodwill 20,000 (20,000) –
Building 440,000 (54,000) 386,000
Plant and machinery 160,000 (30,000 + 16,000) 114,000
Net current assets 100,000 –
720,000 120,000
The goodwill and the damaged machine are written off in full and the balance is allocated
between the building and the rest of the plant and machinery.
(e) The correct answer is: $2,221 gain
HB2022

€ £ Gain/(loss)
Contract 10 Nov 150,000 132,743
Payment 10 Dec (75,000) (63,559) 2,813
At closing rate 31 Dec 75,000 66,964 (592)
Net gain for year 2,221
HB2022
24: FQP Chapter 769

Practice questions
It should be noted that these questions are not intended to replicate the type of exam questions
you may face in Section C of the Financial Reporting exam (which will comprise 2 × 20-mark
questions covering the preparation of financial statements and interpretation of financial
statements).
Instead, these questions are intended as useful practice to test your understanding of the material
in the chapters. The Practice & Revision Kit has a large number of exam format questions.
23 Conceptual framework (18 mins)

(a) The going concern assumption is that an entity will continue in operational existence for the
foreseeable future. This means that the financial statements of an entity are prepared on the
assumption that the entity will continue trading. If this were not the case, various
adjustments would have to be made to the accounts: provisions for losses; revaluation of
assets to their possible market value; all non-current assets and liabilities would be
reclassified as current; and so forth.
Unless it can be assumed that the business is a going concern, other accounting assumptions
cannot apply.
For example, it is meaningless to speak of consistency from one accounting period to the next
when this is the final accounting period.
Accrual accounting states that items are recognised as assets, liabilities, equity, income and
expenses when they satisfy the definitions and recognition criteria in the Conceptual
Framework. The effect of this is that revenue and expenses which are related to each other
are matched, so as to be dealt with in the same accounting period, without regard to when
the cash is actually paid or received. This is particularly relevant to the purchase of non-
current assets. The cost of a non-current asset is spread over the accounting periods
expected to benefit from it, thus matching costs and revenues. In the absence of the going
concern convention, this cannot happen, as an example will illustrate.
Suppose a company has a machine which cost $10,000 two years ago and now has a
carrying amount of $6,000. The machine can be used for another three years, but as it is
highly specialised, there is no possibility of selling it, and so it has no market value.
If the going concern assumption applies, the machine will be shown at cost less depreciation
in the accounts (ie $6,000), as it still has a part to play in the continued life of the entity.
However, if the assumption cannot be applied, the machine will be given a nil value and other
assets and liabilities will be similarly revalued on the basis of winding down the company’s
operations.
(b) One of the ideas behind the Conceptual Framework is to avoid the fire-fighting approach,
which has characterised the development of accounting standards in the past, and instead
develop an underlying philosophy as a basis for consistent accounting principles so that
each standard fits into the whole framework. The Conceptual Framework has gone behind
the requirements of existing accounting standards, which define accounting treatments for
particular assets, liabilities, income and expenditure, to define the nature of assets, liabilities,
income and expenditure.
24 Regulators (18 mins)

Stock Exchange
A quoted company is a company whose shares are bought and sold on a stock exchange. This
involves the signing of an agreement which requires compliance with the rules of that stock
exchange. This would normally contain amongst other things the stock exchange’s detailed rules
on the information to be disclosed in quoted companies’ accounts. This, then, is one regulatory
influence on a quoted company’s accounts. The stock exchange may enforce compliance by
monitoring accounts and reserving the right to withdraw a company’s shares from the stock
HB2022

exchange: ie the company’s shares would no longer be traded through the stock exchange. In
many countries there is, however, no statutory requirement to obey these rules.
Local legislation
In most countries, companies have to comply with the local companies legislation, which lays
down detailed requirements on the preparation of accounts. Company law is often quite detailed,
partly because of external influences such as EU Directives. Another reason to increase statutory
regulation is that quoted companies are under great pressure to show profit growth and an
obvious way to achieve this is to manipulate accounting policies. If this involves breaking the law,
as opposed to ignoring professional guidance, company directors may think twice before bending
the rules – or, at least, this is often a government’s hope.
Standard-setters
Professional guidance is given by the national and international standard-setters. Prescriptive
guidance is given in accounting standards which must be applied in all accounts intended to show
a ‘true and fair view’ or ‘present fairly in all material respects’. International Financial Reporting
Standards and national standards are issued after extensive consultation and are revised as
required to reflect economic or legal changes. In some countries, legislation requires details of
non‑compliance to be disclosed in the accounts. ‘Defective’ accounts can be revised under court
order if necessary and directors signing such accounts can be prosecuted and fined (or even
imprisoned).
The potential for the IASB’s influence in this area is substantial. It must pursue excellence in
standards with absolute rigour to fulfil that potential.
Tutorial note. It is best to use headings to divide up your answer, as we do here.
25 Standard setters (18 mins)

(a) The users of financial information – creditors, management, employees, business contacts,
financial specialists, government and the general public – are entitled to information about a
business entity to a greater or lesser degree. However, the needs and expectations of these
groups will vary.
The preparers of the financial information often find themselves in the position of having to
reconcile the interests of different groups in the best way for the business entity. For example,
whilst shareholders are looking for increased profits to support higher dividends, employees
will expect higher wage increases; and yet higher profits without corresponding higher tax
allowances (increased capital allowances for example) will result in a larger tax bill.
Without accounting standards to prescribe how certain transactions should be treated,
preparers would be tempted to produce financial information which meets the expectations
of the favoured user group. For example, creative accounting methods, such as off balance
sheet finance could be used to enhance a company’s statement of financial position to make
it more attractive to investors/lenders.
The aim of accounting standards is that they should regulate financial information in order
that it is relevant and a faithful representation. It should also exhibit the following enhancing
characteristics.
(1) Comparability
(2) Verifiability
(3) Timeliness
(4) Understandability
Comparability is a good example of why accounting standards are necessary. In the
absence of regulation, entities would be able to present items in the financial statements in
whatever form would produce the most favourable result for that reporting period. Different
entities would therefore be using different accounting policies and could change them from
one period to the next. Analysts and investors would be unable to meaningfully compare the
HB2022
24: FQP Chapter 771

performance of an entity over time or to compare the performance and results of one entity
against the performance and results of another entity.
(b) A number of reasons could be advanced why the financial statements of not-for-profit
entities should not be subject to regulation:
• They do not have shares that are being traded, so their financial statements are not
produced with a share price in mind.
• They do not have chief executives with share options seeking to present favourable figures
to the market.
• They are not seeking to make a profit, so whether they have or not is perhaps irrelevant.
• They are perceived to be on slightly higher moral ground than profit-making entities, so
are less in need of regulation.
However, a closer look at this brings up the following points.
• Public sector bodies, such as local government organisations, are spending taxpayers’
money and should be required to account for it.
• The chief executives of public sector bodies are often highly rewarded and their
performance should be verified.
• Charities may not be invested in by the general public, but they are funded by the public,
often through direct debits.
• Charities are big business. In addition to regular public donations they receive large
donations from high-profile backers.
• They employ staff and executives at market rates and have heavy administrative costs.
Supporters are entitled to know how much of their donation has gone on administration.
• Any misappropriation of funds is serious in two ways. It is taking money from the donating
public, who thought they were donating to a good cause, and it is diverting resources
from the people who should have been helped.
• Not all charities are bona fide. For instance, some are thought to be connected to
terrorism.
For these reasons, it is important that the financial statements of not-for-profit entities are
subject to regulation.
26 Polymer Co (45 mins)

POLYMER CO: STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31 MAY 20X8
$
Revenue 1,526,750
Cost of sales (W3) (1,048,000)
Distribution costs (W4) (124,300)
Finance costs (W6) (18,400)
HB2022

POLYMER CO: STATEMENT OF FINANCIAL POSITION AS AT 31 MAY 20X8
$
ASSETS
Non-current assets
Intangible assets 215,500
667,750
Current assets
Inventories (W8) 425,750
Trade receivables (W9) 171,880
Cash and cash equivalents 5,120
602,750
Total assets 1,270,500
Equity
Share premium 100,000
Retained earnings (283,500 + 79,850) 363,350
Other equity 50,000
863,350
10% debentures 100,000
8.4% cumulative redeemable preference shares* 100,000
200,000
Current liabilities
Trade and other payables (W10) 115,900
Short-term borrowings 51,250
207,150
Total equity and liabilities 1,270,500
Workings
1 Depreciation
$
Cost of sales: 8% × 150,000 12,000
Administration: 10% × 50,000 5,000
HB2022
24: FQP Chapter 773

$
1/4 × 20% × 50,000 2,500
7,500
Distribution: 3/4 × 20% × 50,000 7,500
2 Depreciation of building
$75,000 × 2% = 1,500
3 Cost of sales
$
Opening inventories (108,400 + 32,750 + 184,500) 325,650
Purchases 750,600
Carriage inwards 10,500
Manufacturing wages 250,000
Manufacturing overheads 125,000
Depreciation of plant (W1) 12,000
Closing inventories (W9) (425,750)
1,048,000
4 Distribution costs
$
Per question 116,800
Depreciation (W1) 7,500
124,300
$ $
Per question 158,100
Legal expenses 54,100
Less: solicitors’ fees capitalised (5,000)
49,100
Depreciation of building (W2) 1,500
216,200
6 Finance costs
$
Interest expense on loan notes ($100,000 × 10%) 10,000
Dividend on redeemable preference shares ($100,000 × 8.4%) 8,400
18,400
HB2022

Freehold Head Plant & Furniture Motor

land office equipment & fixtures vehicles Total
$ $ $ $ $ $
Carrying amount
per TB
Cost or valuation 250,000 75,000 150,000 50,000 75,000
Accumulated
dep’n – (15,000) (68,500) (15,750) (25,000)
Carrying amount 250,000 60,000 81,500 34,250 50,000

Solicitor’s fees 5,000
Depreciation
charge – (1,500) (12,000) (5,000) (10,000)
Carrying amount
31 May 20X8 255,000 58,500 69,500 29,250 40,000 452,250
8 Inventories
$
Raw materials 112,600
Work in progress 37,800
Finished goods 275,350
425,750
9 Trade receivables
$
Trade receivables (177,630 – 5,750 irrecoverable debts allowance) 171,880
10 Trade and other payables
$
Loan interest payable 10,000
Preference dividend payable 8,400
115,900
Tutorial note. Redeemable preference shares are presented under IAS 32 Financial Instruments:
Presentation as a loan payable, and dividends on them as interest payable. This point is
covered in Chapter 12.
HB2022
24: FQP Chapter 775

27 Gains Co (18 mins)
GAINS CO – STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 20X9
Share Share Retained Revaluation

$’000 $’000 $’000 $’000 $’000
Balance at 1 January 20X9 2,800 1,150 2,120 750 6,820
Change in accounting policy – – 40 (40) –
Restated balance 2,800 1,150 2,160 710 6,820
Changes in equity for 20X9
Issue of share capital 600 (40) – – 560
Dividends (200) (200)
Total comprehensive income for the

year (566 – (W1) 50) – – 516 120 636
Transfer to retained earnings (W2) – – 35 (35) –
Balance at 31 December 20X9 3,400 1,110 2,511 795 7,816
Workings
1 Loss on investment property
(160 – 110) = (50)
2 Calculation of profit realised on sale of revalued asset
$
Revaluation recognised in past 50,000
Less: amounts transferred to retained earnings:
(80,000/10 – 30,000/10) × 3 (15,000)
35,000
28 Biogenics Co (18 mins)

(a) To be recognised, an intangible asset must first of all meet the definition of an intangible
asset in IAS 38. It must be controlled by the entity, it must be separately identifiable and it
must be something from which the entity expects future economic benefits to flow. It must
then meet the recognition criteria of having a cost that can be measured reliably.
For this reason internally-generated intangibles are not normally recognised as assets. They
have not been acquired for a consideration and therefore do not have a cost or value that
can be measured reliably. For this reason, a brand name that has been acquired can be
capitalised, a brand name that has been internally developed cannot be capitalised. The
exception to this is development costs which can be capitalised if/when they meet the IAS 38
criteria. They are initially recognised at cost.
After initial recognition development costs are amortised over the life cycle of the product. If
at any point it becomes apparent that the development costs no longer meet the
capitalisation criteria, they should be written off. Intangible assets with an indefinite useful
life are not amortised but tested annually for impairment.
HB2022

(b) STATEMENT OF FINANCIAL POSITION (extracts)
$
Non-current assets
Intangible assets (W2) 6,691,000
COSTS CHARGED TO PROFIT OR LOSS
$
Amortisation (W2) 1,309,000
Staff salaries 400,000
Workings
1 Computer equipment
$
Computer equipment
Cost 200,000
Depreciation (200 × 3/48) (12,500)
2 Intangible assets
Development
Patent costs Customer list Total
$’000 $’000 $’000 $’000
Cost 1,500 6,000 500 8,000
Amortisation:
$1.5m × (6/36) (250) – (250)
$5m × (6/36) (1,000) (1,000)
$500,000 × (4/34) – – (59) (59)
1,250 5,000 441 6,691
29 Multiplex Co (27 mins)

The impairment losses are allocated as required by IAS 36 Impairment of Assets.
Asset @ Assets @ Revised

1.1.20X0 1st loss (W1) 1.2.20X0 2nd loss (W2) asset
$’000 $’000 $’000 $’000 $’000
Goodwill 200 (200) – – –
Operating licence 1,200 (200) 1,000 (100) 900
Property: stations/land 300 (50) 250 (50) 200
HB2022
24: FQP Chapter 777

Asset @ Assets @ Revised
1.1.20X0 1st loss (W1) 1.2.20X0 2nd loss (W2) asset
$’000 $’000 $’000 $’000 $’000
Rail track/coaches 300 (50) 250 (50) 200
Steam engines 1,000 (500) 500 – 500
3,000 (1,000) 2,000 (200) 1,800
Workings
1 First impairment loss
$500,000 relates directly to an engine and its recoverable amount can be assessed directly (ie
zero) and it is no longer part of the cash-generating unit.
IAS 36 then requires goodwill to be written off. Any further impairment must be written off the
remaining assets pro rata, except the engine which must not be reduced below its net selling
price of $500,000.
2 Second impairment loss
The first $100,000 of the impairment loss is applied to the operating licence to write it down to
net selling price.
The remainder is applied pro rata to assets carried at other than their net selling prices, ie
$50,000 to both the property and the rail track and coaches.
30 Hewlett Co (45 mins)

HEWLETT CO
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE YEAR ENDED
31 DECEMBER 20X2
$m
Revenue 2,648
Gross profit 883
Distribution costs (W1) (514)
Administrative expenses (W1) (360)
Finance costs (150 × 4%) (6)
Fair value gain on investment properties (588 – 548) 40
Rental income 48
Income tax expense (Note 6) (45 – 17) (28)
Gain on property revaluation (W2) 55
Other comprehensive income, net of tax 38
HB2022

HEWLETT CO
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20X2
$m
ASSETS
Non-current assets
Property, plant and equipment (W2) 852
Investment properties (Note 9) 588
1,440
Current assets
Inventories (388 – (21 – 14)) 381
Trade receivables 541
954
2,394
Equity
Share capital 125
Share premium 244
Revaluation surplus ((W2) 55 – 17) 38
1,762
4% loan notes 20X8 150
Deferred tax 17
Current liabilities
Trade payables 434
Income tax payable (Note 6) 28
Interest payable ((4% × 150) – 3) 3
465
2,394
HB2022
24: FQP Chapter 779

HEWLETT CO
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 20X2
Other
Share Share Retained comps Reval
capital premium earnings of equity surplus Total
$m $m $m $m $m $m
Balance at 1 January 20X2 100 244 753 570 – 1,667
Changes in equity for 20X2
Issue of share capital (W4) 25 (25) –
Dividends (W5) (6) (6)
Total comprehensive
income
for the year - - 63 - 38 101
20X2 125 244 810 545 38 1,762
Workings
1 Expenses
Cost of sales Distribution Admin

$m $m $m
Per TB 1,669 514 345
Opening inventories 444
Depreciation of buildings (W2) 15
Depreciation of plant and equipment (W2) 24
Impairment loss on plant (W3) 4
Loss on sale of equipment ((15 – 3) – 7) 5
Closing inventories (388 – (21 – 14)) (381) - -
1,765 514 360
Plant &
Land Buildings equipment Total
$m $m $m $m
Cost 90 750 258
Accumulated depreciation b/d – (120) (126)
Carrying amount b/d at 1 January 20X2 90 630 132
Disposal of equipment (15 – 3) - - (12)
90 630 120
Depreciation during year
Buildings ($750m / 50 years) (15)
Plant & equipment ($120m × 20%) (24)
HB2022

Plant &
Land Buildings equipment Total
$m $m $m $m
Impairment loss on plant (W3) - - (4)
90 615 92
Revaluation (balancing figure) 10 45 55
Carrying amount c/d at 31 December
20X2 (Buildings 760 – 100) 100 660 92 852
3 Impairment loss on plant
$m
Carrying amount 22
Recoverable amount (Value in use: (3.8m × 3.993) + (4.2m × 0.677)) (18)
(4)
Recoverable amount is the higher of value in use ($18m) and fair value less costs of disposal
($16m).
4 Bonus issue
Dr Other components of equity ($100m /$0.50 × 1/4 = 50m shares × $0.50) $25m
Cr Share capital $25m
5 Dividends (proof)
$m
Interim ($100m /$0.50 = 200m shares × $0.03) 6 per trial balance
The final dividend has not been paid and is not a liability of the company at the year end.
31 Barcelona Co and Madrid Co (22 mins)

BARCELONA GROUP
CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 30 SEPTEMBER 20X6
$m
Non-current assets
Property, plant & equipment (2,848 + 354 + (W4) 18) 3,220
Patents 45
Goodwill (W1 26
3,291
Current assets
Inventories (895 + 225) 1,120
Trade and other receivables (1,348 + 251) 1,599
Cash and cash equivalents (212 + 34) 246
2,965
HB2022
24: FQP Chapter 781

$m
6,256
Share capital 920
3,954
4,156
Long-term borrowings (558 + 168) 726
Current liabilities
Current portion of long-term borrowings 23
1,374
6,256
Workings
1 Goodwill
$m $m
Consideration transferred (250m × 60% × $1.06) 159
Non-controlling interests at fair value 86
Net assets at acquisition as represented by:
Share capital 50
Fair value adjustments (W4) 34
(199)
Goodwill at acquisition 46
Impairment losses to date (20)
Goodwill at year end 26
2 Retained earnings
Barcelona Madrid
$m $m
Per question 2,861 440
Pre-acquisition (115)
Movement on fair value adjustment (W4) (16)
309
Group share of post-acquisition retained earnings:
Madrid Co (309 × 60%) 185
HB2022

Barcelona Madrid
$m $m
Less group impairment losses to date (20 × 60%) (12)
3,034
$m
NCI at acquisition (W1 86
NCI share of post-acquisition:
Retained earnings ((W2) 309 × 40%) 124
Goodwill impairment (20 × 40%) (8)
202
Acquisition date Movement Year end

$m $m $m
Land 6 – 6
Buildings 20 *(8) 12
34 (16) 18
*20 / 10 years × 4
32 Reprise Group (25 mins)

REPRISE GROUP – CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 MARCH 20X4
$’000
Non-current assets
Land and buildings 3,350
Plant and equipment (1,010 + 2,210) 3,220
Motor vehicles (510 + 345) 855
Goodwill (W1) 826
8,251
Current assets
Inventories (890 + 352 – (W4) 7.2) 1,234.8
Trade receivables (1,372 + 514 – 39 – (W5) 36) 1,811
Cash and cash equivalents (89 + 39 + 51) 179
3,224.8
11,475.8
HB2022
24: FQP Chapter 783

$’000
Share capital 1,000
Retained earnings (W2) 5,257.3
8,757.3
Non-controlling interests (W3) 896.5
9,653.8
10% debentures 500
Current liabilities
Trade and other payables (996 + 362 – (W5) 36) 1,322
11,475.8
Workings
1 Goodwill
$’000 $’000
Non-controlling interests (at ‘full’ FV) (125k shares × $4.40) 550
Net assets at acquisition as represented by:
Share capital 500
(1,544)
1,006
Impairment losses to date (180)
826
Reprise Co Encore Co
$’000 $’000
PUP (W4) (7.2)
1,566
Encore Co (1,566 × 75%) 1,174.5
Group share of impairment losses (180 × 75%) (135)
5,257.3
HB2022

$’000
NCI at acquisition (W1) 550
NCI share of post-acquisition retained earnings ((W3) 1,566 × 25%) 391.5
NCI share of impairment losses (180 × 25%) (45)
896.5
4 Unrealised profit on inventories

Unrealised profit included in inventories is: 31,200 × 30/130 = 7,200
5 Trade receivables/trade payables
Intragroup balance of $75,000 is reduced to $36,000 once cash-in-transit of $39,000 is
followed through to its ultimate destination.
33 Fallowfield Co and Rusholme Co (27 mins)

FALLOWFIELD GROUP
CONSOLIDATED STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 30 JUNE 20X8
$
Revenue (403,400 + 193,000 – 40,000) 556,400
Cost of sales (201,400 + 92,600 – 40,000 + 4,000) (258,000)
Distribution costs (16,000 + 14,600) (30,600)
Administrative expenses (24,250 + 17,800) (42,050)
Income tax expense (61,750 + 22,000) (83,750)
142,000
STATEMENT OF CHANGES IN EQUITY (EXTRACT)
Retained
earnings
$
Balance at 1 July 20X7 (W2) 190,000
Dividends (40,000)
Balance at 30 June 20X8 (W3) 275,200
HB2022
24: FQP Chapter 785

Workings
$
Rusholme – profit for the year 46,000
Less PUP (40,000 × ½ × 25/125) 4,000
42,000
Non-controlling interest share 40% 16,800
2 Retained earnings brought forward
$ $
45,000
Rusholme Co (45,000 × 60%) 27,000
190,000
3 Retained earnings carried forward
$ $
PUP – (4,000)
62,000
Rusholme Co (62,000 × 60%) 37,200
275,200
34 Panther Group (27 mins)

PANTHER GROUP

$’000
Revenue (22,800 + (4,300 × 6/12) – (640 × 6/12)) 24,630
Cost of sales (13,600 + (2,600 × 6/12) – (640 × 6/12) + (W2) 10 + (W4) 5) (14,595)
Distribution costs (2,900 + (500 × 6/12)) (3,150)
Administrative expenses (1,800 + (300 × 6/12)) (1,950)
HB2022

$’000
Finance costs (200 + (70 × 6/12) – (W3) 20 cancellation) (215)
Finance income (50 – (W3) 20 cancellation) 30
Other comprehensive income for the year, net of tax (1,600 + (180 × 6/12)) 1,690
Total comprehensive income for the year 5,030
Owners of the parent (3,340 – 124) 3,216
3,340
Owners of the parent (5,030 – 160) 4,870
5,030
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
FOR THE YEAR ENDED 31 DECEMBER 20X4 (EXTRACT)
$’000
Reserves
Balance at 1 January 20X4 (Panther only) 12,750
Dividend paid (900)
Total comprehensive income for the year 4,878
Balance at 31 December 20X4 (W6) 16,728
Workings
PFY TCI
$’000 $’000
Profit/TCI for the year (610 × 6/12) / (790 × 6/12) 305 395
Less PUP (W2) (10) (10)
Add back intragroup interest (W3) 20 20
Additional depreciation on fair value adjustment (W4) (5) (5)
310 400
NCI share (× 40%) 124 160
HB2022
24: FQP Chapter 787

2 Unrealised profit on intragroup trading
Adjust cost of sales and non-controlling interests in books of seller (Sabre Co).
Sabre Co to Panther Co= $60,000 × 20%/120% = $10,000
3 Interest on intragroup loan
The loan is an intragroup item for the last six months of the year (ie only since Sabre Co’s
acquisition by Panther Co):
Cancel in books of Panther Co and Sabre Co
At acq’n 1.7.X4 Movement At year end 31.12.X4

$’000 $’000 $’000
Property 200 (200/20 × 6/12) = (5) 195
5 Group reserves carried forward (proof)
Sabre
Panther Co Co
$’000 $’000
Reserves per question 16,500 3,270
PUP (W2) (10)
Fair value movement (W) (5)
Pre-acquisition reserves [2,480 + ((610 + 180) × 6/12)] (2,875)
380
Group share of post-acquisition reserves:
Sabre Co (380 × 60%) 228
16,728
35 Hever Co (36 mins)

$’000
Non-current assets
Property, plant & equipment (370 + 190 + (W6) 45) 605
Goodwill (W1) 8
Investment in associate (W2) 165
778
Current assets
Inventories (160 + 100 – (W5) 1.5) 258.5
Trade receivables (170 + 90) 260
Cash and cash equivalents (50 + 40) 90
608.5
HB2022

$’000
1,386.5
Share capital 200
Share premium 100
Retained earnings (W3) 758.5
1,058.5
1,226.5
Current liabilities
Trade and other payables (100 + 60) 160
1,386.5
Workings
1 Goodwill on consolidation – Spiro Co
$’000 $’000
Consideration transferred 128
Non-controlling interests (at ‘full’ fair value) 90
Net assets at acquisition:
Share capital 80
Share premium 80
Fair value adjustments (W6) 30
(210)
Goodwill arising on consolidation 8
$’000
Cost of associate 90
Share of post-acquisition retained reserves (W3) 75
165
3 Retained earnings

$’000 $’000 $’000
Per question 568 200 400
PUP (W) (1.5) – –
Fair value movement (W7) 15
Pre-acquisition retained earnings (20) (150)
HB2022
24: FQP Chapter 789

$’000 $’000 $’000
195 250
Group share of post-acquisition ret’d earnings:
$’000
Spiro Co (195 × 60%) 117
Aldridge Co (250 × 30%) 75
Less group share of impairment losses to date (0)
758.5
$’000
NCI at acquisition (W1) 90
NCI share of post-acquisition ret’d earnings ((W4) 195 × 40%) 78
168
5 Unrealised profit on inventories

Mark-up: $16,000 – $10,000 = $6,000  ¼ × $6,000 = $1,500
6 Fair values – adjustment to net assets
At acquisition Movement At year end

Property, plant and equipment 50 (5) 45
Inventories (20) 20 0
30 15 45
36 Highveldt Co (45 mins)

(a)
(a) (i) Goodwill in Samson Co

(a) (a)
(a) $m $m
(a) (a) (a)
(a) (a) (a)
80m shares × 75% × $3.50 210

(a) (a) (a)
Contingent consideration 108

(a) (a) (a)
318
(a) (a) (a)
Non-controlling interest 74
(a) (a) (a)
Fair value of net assets at acquisition:

(a) (a) (a)
Carrying amount of net assets at 1.4.20X4:

(a) (a) (a)
Ordinary shares 80
HB2022

(a) (a)
(a) $m $m
(a) (a) (a)
Share premium 40
(a) (a) (a)

(a) (a) (a)
Fair value adjustments (W) 42

(a) (a) (a)
(296)
(a) (a) (a)
96
(a) (a) (a)
Impairment charge given in question (22)

(a) (a) (a)
Carrying amount at 31 March 20X5 74
Notes (not required in the exam)

The contingent consideration is recognised at fair value. The increase in contingent
consideration arose post-acquisition so will not affect the goodwill calculation. The
additional amount is added to the liability and charged to group retained earnings.
Only the initial $20 million fair value adjustment to land and buildings is relevant at the
date of acquisition. The $4 million arising post acquisition will be treated as a normal
revaluation and credited to the revaluation surplus.
Samson Co was right not to capitalise an internally developed brand name because,
without an active market, its value cannot be measured reliably. However, the fair value
of a brand name can be measured as part of a business combination. Therefore the $40
million fair value will be recognised at acquisition and an additional $4 million
amortisation will be charged in the consolidated statement of profit or loss.
At acquisition Samson Co had capitalised $18 million of development expenditure.
Highveldt Co does not recognise this as an asset, so the net assets at acquisition are
reduced by $18 million. A further $32 million is capitalised by Samson Co post-
acquisition; this will be written off in the consolidated statement of profit or loss (net of
the $10 million amortisation already charged).
(ii) Non-controlling interest in Samson Co’s net assets
$m
NCI at acquisition (per question) 74
NCI share of post-acquisition retained earnings ((W3) 48 × 25%) 12
NCI share of post-acquisition revaluation surplus ((W3) 4 × 25%) 1
NCI share of goodwill impairment (22 × 25%) (6)
81
(iii) Consolidated reserves

Share premium
The share premium of a group, like the share capital, is the share premium of the parent
only ($80m)
Revaluation surplus
$m
Parent’s own revaluation surplus 45
Group share of Samson Co’s post acquisition revaluation ($4m ×
75%) 3
HB2022
24: FQP Chapter 791

$m
48
Retained earnings attributable to owners of the parent
$m $m
Per question 350 76
Accrued interest from Samson Co ($60m × 10%) 6 –
Additional contingent consideration (116 – 108) (8) –
Amortisation of brand ($40m / 10 years) – (4)
Write off development expenditure as incurred ($50m –
$18m) – (32)
Write back amortisation of development expenditure – 10
Unrealised profit – (2)
348 48
Group share (75%) 36
Impairment of goodwill in Samson Co – group share
(22 × 75%) (16)
368
Working
$m $m
Fair value adjustment:
Revaluation of land and buildings 20
Recognition of fair value of brands 40
Derecognition of capitalised development expenditure (18)
42
(b) Usefulness of consolidated financial statements

The main reason for preparing consolidated accounts is that groups operate as a single
economic unit, and it is not possible to understand the affairs of the parent company without
taking into account the financial position and performance of all the companies that it
controls. The directors of the parent company should be held fully accountable for all the
money they have invested on their shareholders behalf, whether that has been done directly
by the parent or via a subsidiary.
There are also practical reasons why parent company accounts cannot show the full picture.
The parent company’s own financial statements only show the original cost of the investment
and the dividends received from the subsidiary. As explained below, this hides the true value
and nature of the investment in the subsidiary, and, without consolidation, could be used to
manipulate the reported results of the parent.
HB2022

Tutorial note. Make sure that you read the requirement carefully before doing anything.
You are not asked to prepare a statement of financial position; just the goodwill and
reserves. This makes the question easier to manage effectively as you are just doing the
workings without having to tie it all together in a set of financial statements. There are
quite a few complications to consider. For each calculation go through each of the six
additional pieces of information and make appropriate adjustments when relevant.
ACCA Examining Team’s Comments

This question was unusual in asking for extracts from the statement of financial position.
Many candidates were confused by this and wasted time preparing a full statement of
financial position. Other common errors were: fair value adjustments; consolidated
reserves; revaluation and share premium reserves; and the cost of the investment.
37 Villandry Co (18 mins)

(a) Calculations:
Cost less
2½% trade discount NRV Valuation
$ $ $
Product Arctic 3,510.00 5,100.00 3,510.00
Product Brassy 2,827.50 2,800.00 2,800.00
Product Chilly 4,095.00 4,100.00 4,095.00
10,405.00
(b) The weighted average method values items withdrawn from inventory at the average price of
all goods held in inventory at the time. Thus, it smooths out any fluctuations due to rising or
falling prices.
The FIFO method of inventory valuation assumes that items sold are the oldest ones received
from suppliers. Thus, any goods held at the year end will be assumed to have been
purchased recently. Thus, changing from weighted average to FIFO (assuming inventory
purchase prices are rising over time) is likely to increase the value of closing inventory (from
historical to current price levels). This would reduce the cost of sales figure in profit or loss and
increase the reported profit figure.
38 Biological assets (18 mins)

(a) A biological asset is a living animal or plant. Agricultural produce is the harvested product
obtained from a biological asset.
(b) Agricultural produce is measured at its fair value less estimated point-of-sale costs at the
point of harvest.
(c) Examples of biological assets and agricultural produce are:
Biological asset Agricultural produce

Sheep Wool
Pigs Meat
Dairy cattle Milk
Fruit tree Oranges etc
HB2022
24: FQP Chapter 793

Biological asset Agricultural produce
Plant Cotton
Bush Tea leaves
Vine Grapes
Chicken Eggs
(d) Consumable biological assets are those that are to be harvested as agricultural produce or
sold as biological assets. Examples include livestock intended for the production of meat,
livestock held for sale, fish in farms, crops such as maize and wheat and trees being grown
for lumber.
Bearer biological assets are those other than consumable biological assets. Examples include
livestock from which milk is produced or livestock held for breeding, vines, fruit trees and trees
from which firewood is harvested without felling.
Plant-based bearer biological assets are accounted for under IAS 16. These are assets which
are not in themselves consumed, but are used solely to grow produce over several periods.
This would apply to grape vines, tea bushes and fruit trees from the list above.
39 Provisions (36 mins)

(a) As at 31 December 20X3
At 31 December 20X3, a provision should be recognised for the dismantling costs of the
structures already built and restoration of the environment where access roads to the site
have been built. This is because the construction of the access roads and structures,
combined with the requirement under the operating licence to restore the site and remove the
access roads, create an obligating event at the end of the period. As the time value of money
is material, the amount must be discounted resulting in a provision of $7.54 million ($20m ×
0.377).
As undertaking this obligation gives rise to future economic benefits (from selling the gravel),
the amount of the provision should be included in the initial measurement of the assets
relating to the quarry as at 31 December 20X3:
$m
Non-current assets
Quarry structures and access roads at cost
Construction cost 70.000
Provision for dismantling and restoration costs ($20m × 0.377) 7.540
77.540
(b) For the year ended 31 December 20X4

The overall cost of the quarry structures and access roads (including the discounted
provision) would be depreciated over the quarry’s 20 year life resulting in a charge for the
year of $77.540m/20 = $3.877m recognised in profit or loss and a carrying amount of
$77.540m – $3.877m = $73.663m
The provision would increase due to the effect of the finance charge of $0.377m (5% ×
$7.540m) which will be a finance expense in the statement of profit or loss.
Therefore, the outstanding provision in the statement of financial position as at 31 December
20X4 is made up as follows:
$m
Provision for dismantling and restoration costs b/d 7.540
HB2022

$m
Interest ($7.54 × 5%) 0.377
Provision for dismantling and restoration costs c/d at 31 December 20X4 7.917
The overall charge to profit or loss for the year is:
$m
Depreciation 3.877
Finance costs 0.377

Total 4.254
Any change in the expected present value of the provision would be made as an adjustment
to the provision and to the asset value (affecting future depreciation charges).
40 Financial assets and liabilities (18 mins)

(a) Total amount of the finance cost associated with the debt instrument:
$
Issue costs 120,000
Interest $6,000,000 × 3.5% × 7 1,470,000
Premium on redemption 1,100,000
Total finance cost 2,690,000
(b) The premium on redemption of the loan notes represents a finance cost. The effective rate of
interest must be applied so that the debt is measured at amortised cost (IFRS 9: para. 4.2.1).
At the time of issue, the loan notes are recognised at their net proceeds of $599,800 (600,000
– 200).
The finance cost for the year ended 31 December 20X4 is calculated as follows.
$
1.1.20X3 Proceeds of issue (600,000 – 200) 599,800
Interest at 12% 71,976
Balance 31.12.20X3 671,776
Interest at 12% 80,613
Balance at 31.12.20X4 752,389
The finance cost for the year ended 31.12.20X4 is $80,613.

(c) Value:
$
Present value of principal $500,000 × 0.747 373,500
Present value of interest $25,000 × 4.212 105,300
Liability value 478,800
HB2022
24: FQP Chapter 795

$
Principal amount 500,000
Equity element 21,200
Tutorial note. The method to use here is to find the present value of the principal value of
the bond, $500,000 (10,000 × $50) and the interest payments of $25,000 annually (5% ×
$500,000) at the market rate for non-convertible bonds of 6%, using the discount factors.
The difference between this total and the principal amount of $500,000 is the equity
element.
41 Alpha (45 mins)

Tutorial note. Creative accounting and attempts to deal with it are important issues. You must
relate your answer to the situation given in part 3 of the question and not just write a general
essay. One or two examples would be enough in part 1.
(a) Creative accounting, the manipulation of figures for a desired result, takes many forms. Off-
balance sheet finance is a major type of creative accounting and it probably has the most
serious implications.
It is very rare for a company, its directors or employees to manipulate results for the purpose
of fraud. The major consideration is usually the effect the results will have on the share price
of the company. If the share price falls, the company becomes vulnerable to takeover.
Analysts, brokers and economists, whose opinions affect the stock markets, are often
perceived as having an outlook which is both short-term and superficial. Consequently,
companies will attempt to produce the results the market expects or wants. The companies
will aim for steady progress in a few key numbers and ratios and they will aim to meet the
market’s stated expectation.
The number of methods available for creative accounting and the determination and
imagination of those who wish to perpetrate such acts are endless. It has been seen in the
past that, wherever an accounting standard or law closes a loophole, another one is found.
This has produced a change of approach in regulators and standard setters, towards general
principles rather than detailed rules.
Here are a few examples of creative accounting.
(1) Income recognition and cut-off
Manipulation of cut-off is relatively straightforward. For instance, a company may delay
invoicing in order to move revenue into the following year.
(2) Revaluations
The optional nature of the revaluation of non-current assets leaves such practices open
to manipulation. The choice of whether to revalue can have a significant impact on a
company’s statement of financial position.
(3) Window dressing
This is where transactions are passed through the books at the year end to make figures
look better, but in fact they have not taken place and are often reversed after the year
end. An example is where cheques are written to creditors, entered in the cash book, but
not sent out until well after the year end.
(4) Change of accounting policies
This tends to be a last resort because companies which change accounting policies know
they will not be able to do so again for some time. The effect in the year of change can
be substantial and prime candidates for such treatment are depreciation, inventory
valuation, changes from current cost to historical cost (practised frequently by privatised
public utilities) and foreign currency losses.
HB2022

(5) Manipulation of accruals, prepayments and contingencies
These figures can often be very subjective, particularly contingencies. In the case of
impending legal action, for example, a contingent liability is difficult to estimate, the
case may be far off and the lawyers cannot give any indication of likely success, or
failure. In such cases companies will often only disclose the possibility of such a liability,
even though the eventual costs may be substantial.
(b) ‘Faithful representation’ requires that transactions and other events should be accounted for
and presented in accordance with their substance and financial reality and not merely with
their legal form.
This is a very important concept and it has been used to determine accounting treatment in
financial statements through accounting standards and so prevent off balance sheet
transactions.
(i) Group accounting is perhaps the most important area of off-balance sheet finance
which has been prevented by the application of this concept.
The most important point is that the definition of a subsidiary (under IAS 27 and IFRS 10)
is based upon the principle of control rather than purely ownership. Where an entity is
controlled by another, the controlling entity can ensure that the benefits accrue to itself
and not to other parties. Similarly, one of the circumstances where a subsidiary may be
excluded from consolidation is where there are severe long-term restrictions that prevent
effective control.
(ii) With regard to measurement or disclosure of current assets, a common example where
the distinction between financial reality and legal form is relevant are sale and
repurchase agreements. These are arrangements under which the company sells an
asset to another person on terms that allow the company to repurchase the asset in
certain circumstances. A common example of such a transaction is the sale and
repurchase of maturing whisky inventories. The key question is whether the transaction is
a straightforward sale, or whether it is, in effect, a secured loan. It is necessary to look at
the arrangement to determine who has the rights to the economic benefits that the asset
generates, and the terms on which the asset is to be repurchased.
If the seller has the right to the benefits of the use of the asset, and the repurchase terms
are such that the repurchase is likely to take place, the transaction should be accounted
for as a loan.
Another example is the factoring of trade receivables. Where debts are factored, the
original creditor sells the receivables to the factor. The sales price may be fixed at the
outset or may be adjusted later. It is also common for the factor to offer a credit facility
that allows the seller to draw upon a proportion of the amounts owed.
In order to determine the correct accounting treatment it is necessary to consider
whether the benefit of the receivables has been passed on to the factor, or whether the
factor is, in effect, providing a loan on the security of the receivables. If the seller has to
pay interest on the difference between the amounts advanced to him and the amounts
that the factor has received, and if the seller bears the risks of non-payment by the
debtor, then the indications would be that the transaction is, in effect, a loan.
(c)
(c) (i) The Finance Director may be right in believing that renewing the non-current assets of
the company will contribute to generating higher earnings and hence improved earnings
per share. However, this will not happen immediately as the assets will need to have been
in operation for at least a year for results to be apparent. Earnings will be higher
because of the loan being at a commercially unrealistic rate, namely 5% instead of 9%.
As regards gearing, the Finance Director may well wish to classify the convertible loan
stock as equity rather than debt; thus gearing will be lower. He may argue that because
the loan is very likely to be converted into shares, the finance should be treated as equity
rather than as debt.
(ii) IAS 33 Earnings per Share requires the calculation of basic earnings per share (para. 9).
The Finance Director believes that the convertible loan he is proposing will not affect EPS
and that an interest cost of 5% will not impact heavily on gearing.
HB2022
24: FQP Chapter 797

However, IAS 32 will require the interest cost to be based on 9% and IAS 33 also requires
the calculation and disclosure of diluted EPS (IAS 32: paras. 28–32).
The need to disclose diluted earnings per share arose because of the limited value of a
basic EPS figure when a company is financed partly by convertible debt. Because the
right to convert carries benefits, it is usual that the interest rate on the debt is lower than
on straight debt. Calculation of EPS on the assumption that the debt is non-convertible
can, therefore, be misleading since:
(1) Current EPS is higher than it would be under straight debt
(2) On conversion, EPS will fall – diluted EPS provides some information about the extent
of this future reduction, and warning shareholders of the reduction which will
happen in the future
IAS 32 Financial Instruments: Presentation affects the proposed scheme in that IAS 32
requires that convertible loans such as this should be split in the statement of financial
position and presented partly as equity and partly as debt. Thus the company’s gearing
will probably increase as the convertible loan cannot be ‘hidden’ in equity.
42 Jenson Co (32 mins)

(a) IFRS 15 Revenue from Contracts with Customers defines a performance obligation as a
promise in a contract with a customer to transfer to the customer goods and/or services (App.
A). A performance obligation is satisfied when the customer obtains control of the asset.
Each good or service that is distinct is treated as a separate performance obligation and
revenue is recognised as performance obligations are satisfied. A contract can include a
number of separate performance obligations.
A performance obligation can be satisfied at a point in time, such as a contract for the sale of
goods, or satisfied over time, as in a construction contract. When a performance obligation is
satisfied over time, an entity must allocate revenue according to the amount of the
performance obligation that has been satisfied during a period.
The Conceptual Framework defines income and expenses in terms of increases in economic
benefits (income) and outflow or depletion of assets (expenses), not in terms of an earnings or
matching process (paras. 4.29–4.35). The statement of financial position thus assumes
primary importance in the recognition of earnings and profits. Income can only be
recognised if there is an increase in the equity (ie net assets) of an entity not resulting from
contributions from owners. Similarly, an expense is recognised if there is a decrease in the
ownership interest of an entity not resulting from distributions to owners. Thus, income arises
from recognition of assets and derecognition of liabilities, and expenses arise from
derecognition of assets and recognition of liabilities. The IASB explains that it is not possible to
reverse this definitional process, ie by defining assets and liabilities in terms of income and
expenses, because it has not been possible to formulate robust enough base definitions of
income and expenses (partly because the choice of critical event can be subjective).
Nevertheless, commentators often attempt to link the two approaches by asserting that
sufficient evidence for recognition or derecognition will be met at the critical event in the
operating cycle.
Tutorial note. Understanding how IFRS Standards are linked to the Conceptual Framework
is an important skill that will be developed further in Strategic Business Reporting.
(b) Jenson Co’s treatments:

(1) The franchise agreement represents a performance obligation satisfied over time, so the
initial fee of $50,000 should be spread evenly over the term of the franchise. This will give
revenue of $10,000 in year 1 and $15,000 thereafter. The profit will therefore be 20% for
year 1 and approximately 46% for years 2–5.
(2) Jenson Co has received payment for 24 publications but only six have been despatched.
It has satisfied six out of 24 performance obligations. It can therefore recognise revenue
HB2022

of $60,000 (240,000 × 6/24) and the remaining $180,000 should be presented as a
liability.
43 Trontacc Co (18 mins)

(a) Treatment of contracts with customers in which performance obligations are satisfied over
time in the statement of financial position of Trontacc Co at 30 September 20X7.
Aspire Bigga Construct Total

$’000 $’000 $’000 $’000
Contract asset (Note 1) 60 25 – 85
Trade receivables (Note 2) 120 75 400 595
Contract liabilities (Note 1) – - (150) (50)
Notes.
(1) Contract asset / liability

$’000 $’000 $’000
Revenue recognised (based on % completion) 600 500 350
Amounts invoiced 540 475 400
Contract asset/(liability) 60 25 (50)
(2) Trade receivables

$’000 $’000 $’000
Invoices raised to date 540 475 400
Less cash received (420) (400) (-)
120 75 400
Treatment of contracts in the statement of profit or loss of Trontacc Co for the year ended
30 September 20X7:
Contract
Aspire Bigga Construct Total
$’000 $’000 $’000 $’000
(W1) (W2) (W3)
Revenue 600 500 350 1,450
Expenses (500) (500) (320) (1,320)
Gross profit 100 30 130
44 Telenorth Co (45 mins)

(a) TELENORTH CO
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 30 SEPTEMBER 20X1
HB2022
24: FQP Chapter 799

$’000
Revenue 283,460
Other income 1,500
Distribution costs (22,300)
Finance costs: (W10) (1,560)
Income tax expense (W9) (24,600)
Working
Cost of sales
$’000
Opening inventory 12,400
Purchases 147,200
159,600
Closing inventory (W4) (16,680)
142,920
Depreciation of building and plant (W3) 12,250
155,170
(b) TELENORTH CO
STATEMENT OF FINANCIAL POSITION AS AT 30 SEPTEMBER 20X1
$’000 $’000
Assets
Non-current assets
Investments 34,500
117,940
Current assets
Inventories (W4) 16,680
52,380
Equity
Ordinary shares of $1 each (W7) 30,000
HB2022

$’000 $’000
Revaluation surplus 3,400 – 1,000 2,400
Share premium (W7) 16,000
97,290
8% preference shares 12,000
6% loan notes 10,000
Deferred tax: 5,200 + 2,200 7,400
29,400
Current liabilities
Trade and other payables (W5) 18,070
Preference dividend payable (W6) 480
43,630
Workings
$’000
Per question 34,440
Depreciation of computer system (W3) 10,160
44,600
Cost Depn Carrying amount

$’000 $’000 $’000
Building 56,250 20,250* 36,000
Plant and equipment 55,000 22,800* 32,200
Computer system 35,000 19,760* 15,240
83,440
*Depreciation charge:
Building: 56,250 / 25 years 2,250
Plant: (55,000 – 5,000)/5 years 10,000
Charge cost of sales 12,250
Computer equipment: charged to administration (35m – 9.6m) ×
40% 10,160
HB2022
24: FQP Chapter 801

3 Closing inventory
No inventory count took place at the year end. To arrive at the figure for closing inventory,
the count needs to be adjusted for the movements between 30 September and 4 October,
making appropriate adjustments for mark ups.
$’000
Balance as at 4 October 20X1 16,000
Normal sales at cost: $1.4m × 100/140 1,000
Sale or return at cost: 650,000 × 100/130 500
Less goods received at cost (820)
Adjusted inventory value 16,680
4 Current liabilities
$’000
Per question 17,770
Interest on loan note 300
18,070
5 Dividend payable
$’000
Preference: ($12m × 8%) – 480 480
6 Share capital and suspense account

Elimination of suspense account:
Dr Cr
$’000 $’000
Suspense account (per trial balance) 26,000
Directors’ options: share capital (4m at $1) 4,000
share premium (4m at $1) 4,000
Rights issue: share capital
20m + 4m
4 6,000
Share premium 6m × (3 – 1) 12,000
26,000 26,000
Share capital: $20m + $4m + $6m = $30m

Share premium: $4m + $12m = $16m
7 Retained earnings
$’000
As at 1 October 20X0 14,160
Net profit for the year (Part (a)) 36,730
HB2022

$’000
Dividend: ordinary (2,000)
48,890
8 Income tax
$’000 $’000
Provision for year 23,400
Increase in deferred tax provision 2,200
Less charged to revaluation surplus (1,000)
1,200
24,600
9 Finance costs
$’000
8% Preference shares 960
6% Loan notes 600
1,560
(c) TELENORTH CO
EARNINGS PER SHARE FOR THE YEAR TO 30 SEPTEMBER 20X1
Bonus Weighted
‘000
1.10.X0 Share b/f 20,000
1.10.X0 Options exercised 4,000
24,000 9/12 4/3.80 (W) 18,947
1.7.X1 Rights issue (1/4) 6,000
30,000 3/12 7,500
26,447
Working
Calculation of theoretical ex rights price
$
4 shares @ $4 16
1 share @ $3 3
19
 Theoretical ex-rights price =
19
= $3.80
5
 Bonus fraction =
HB2022
24: FQP Chapter 803

4
3.80
 EPS =
36,730
= $1.39
26,447
45 Bulwell Aggregates Co (18 mins)

STATEMENTS OF PROFIT OR LOSS (EXTRACTS)
20X1 20X2 20X3 20X4

$ $ $ $
Finance cost 11,250 8,063 4,078
Depreciation on lorries 13,500 13,500 13,500 13,500
Depreciation on the Right of Use asset will be calculated as $54,000 – $4,000/4 years = $12,500
per annum. The depreciation is calculated over 4 years (useful life) not 3 years (lease term)
because the company obtains ownership of the asset at the end of the lease term.
STATEMENTS OF FINANCIAL POSITION AT 31 DECEMBER (EXTRACTS)
20X1 20X2 20X3 20X4

$ $ $ $
Non-current assets
Right-of-use assets 54,000 54,000 54,000 54,000
Depreciation 2,500 25,000 37,500 50,000
41,500 29,000 16,500 4,000
Current liabilities
Lease liabilities *15,937 16,313 – –
Lease liabilities 16,313 – – –
*(24,000 – 8,063)
Working
$
Lease
Original measurement of right-of-use asset 54,000
Deposit (9,000)
Balance 1.1.20X1 (lease liability) 45,000
Interest 25% 11,250
Payment 31.12.20X1 (24,000)
Balance 31.12.20X1 32,250
Interest 25% 8,063
HB2022

$
Payment 31.12.20X2 (24,000)
Balance 31.12.20X2 16,313
Interest 25% 4,078
Payment 31.12.20X3 (20,391)
-
46 Lis Co (18 mins)

The right-of-use asset should be capitalised in the statement of financial position. The asset
should be depreciated over the shorter of its useful life (five years) and the lease term (six years).
A lease liability will be shown in the statement of financial position reduced by lease payments
made in advance and increased by interest calculated using the interest rate implicit in the lease,
12%.
The lease liability will initially be recognised at $66,404 ($84,000 – 17,596). The right-of-use asset
will be measured at $84,000 (the initial measurement of $66,404 + the deposit of $17,596 made at
commencement of the lease).
Financial statement extracts
STATEMENT OF PROFIT OR LOSS (extract) $

Finance costs (W2) 7,968
$
Non-current assets
Right-of-use asset (W1) 67,200
Current liabilities
Lease liability (W2) (74,372 – 55,952) 18,420
Workings
1 Carrying amount of right-of-use asset
$
PVFLP 66,404
Non-refundable deposit paid on 1 January 20X3 17,596
84,000
Depreciation of asset: $84,000 / 5 years useful life (16,800)
Carrying amount at year end ($84,000 – $16,800) 67,200
The asset is depreciated over the shorter of its useful life (five years) and lease term (six years).
HB2022
24: FQP Chapter 805

2 Lease liability
$
1.1.X3 PVFLP 66,404
Interest at 12% ($66,404 ×
1.1.X3 – 31.12.X3 12%) 7,968
31.12.X3 Lease liability c/d 74,372

1.1.X4 Payment in advance (18,420)
Lease liability c/d after next
1.1.X4 instalment 55,952
The interest element ($7,968) of the current liability can also be shown separately as interest
payable.
47 Carpati Co (11 mins)

Deferred tax liability
20X6
$’000
Accelerated tax depreciation (W1) 186
Revaluation (W2)* 252
438
*The deferred tax on the revaluation gain will be charged to the revaluation surplus as IAS 12
requires deferred tax on gains recognised in other comprehensive income to be charged or
credited to other comprehensive income.
Workings
1 Tax depreciation
$’000 $’000
At 30 September 20X6:
Tax base:
At 1 October 20X5 405
Expenditure in year 290
695
Less tax depreciation (25%) (174)
(521)
Cumulative temporary difference 664
@ 28% = 186
2 Revaluation surplus
Temporary difference ($1,500,000 – $600,000) @ 28% = $252,000
HB2022

Tutorial note. IAS 12 requires the deferred tax liability on revaluations to be recognised even if
the entity does not intend to dispose of the asset since the value of the asset is recovered
through use which generates taxable income in excess of tax depreciation allowable.
48 Pilum Co (18 mins)

(a) Earnings per share
$
Profit before tax 2,530,000
Less income tax expense (1,127,000)
Profit for the year 1,403,000
Less preference dividends (276,000)
Earnings 1,127,000
Earnings per share = 1,127,000 / 4,120,000
(b) The first step is to calculate the theoretical ex-rights price. Consider the holder of 5 shares.
No. $
Before rights issue 5 8.90
Rights issue 1 1.20
After rights issue 6 10.10
The theoretical ex-rights price is therefore $10.10/6 = $1.68.

The number of shares in issue before the rights issue must be multiplied by the fraction:
1.78/1.68
Weighted average number of shares in issue during the year:
Date Narrative Shares Time period Bonus fraction Total

1.1.X4 b/d 4,120,000 × 9/12 1.78/1.68 3,273,929
1.10.X4 Rights issue 824,000
4,944,000 × 3/12 1,236,000
4,509,929
EPS =
$1,127,000
4,509,929
=$0.25
(c) The maximum number of shares into which the loan stock could be converted is 90% ×
1,500,000 = 1,350,000. The calculation of diluted EPS should be based on the assumption
that such a conversion actually took place on 1 January 20X4. Shares in issue during the
year would then have numbered (4,120,000 + 1,350,000) = 5,470,000 and revised earnings
would be:
$ $
Earnings from (1) above 1,127,000
Interest saved by conversion (1,500,000 × 10%) 150,000
HB2022
24: FQP Chapter 807

$ $
Less attributable tax (150,000 × 30%) (45,000)
105,000
1,232,000
... Diluted EPS = 1,232,000 / 5,470,000 $0.23
49 Biggerbuys Co (45 mins)

REPORT
To: The bankers of Biggerbuys Co

From: Consultant management accountant
Date: Financial performance 20X7 - 20X9
Subject: 30 October 20X9
Introduction
In accordance with your instructions, I set out below a review of the entity’s financial performance
over the last three years.
The main focus of this report is on the reasons for the increase in the level of bank loans.
Appropriate accounting ratios are included in the attached appendix.
Bank lending
The main reason for the steep increase in bank lending is due to the entity not generating
sufficient cash from its operating activities over the past three years.
For the year ended 30 June 20X8, the entity had a net cash deficiency on operating activities of
$18 million.
In addition, for at least the past two years, the cash generated from operating activities has not
been sufficient to cover interest payable. Therefore, those payments, together with tax and
dividends, have had to be covered by borrowings.
As at 30 June 20X9, bank borrowings were $610 million out of a total facility of $630 million.
Payment of the proposed dividends alone would increase the borrowings to the limit.
Operating review
Although revenue has been rising steadily over the period, operating profit has remained almost
static.
Over this period the profit margin has risen, but not as much as would be expected. The cost of
sales have risen in almost the same proportion as sales. This may be due to increased costs of raw
materials, as inventories have risen steeply; but the turnover of inventory has been falling or static
over the same period.
There has also been a large increase in trade receivables. Both the increase in inventories and
trade receivables have had to be financed out of operating activities leading to the present
pressure on borrowings.
Although the number of days sales in trade receivables has fallen steadily over the period, the
trade receivables at the end of June 20X9 still represent nearly a year’s credit sales. This is
excessive and seems to imply a poor credit control policy, even taking into account the extended
credit terms being granted by the company.
Recommendations
The entity needs to undertake an urgent review of its credit terms in order to reduce the levels of
trade receivables.
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Inventory levels are also extremely high (representing over four months’ sales) and should be
reviewed.
Operating costs also need to be kept under control in order to generate more cash from sales.
Please contact me if you need any further information.
Signed: An Accountant
Appendix: Accounting ratios
20X7 20X8 20X9

(50+45)/1,850 (60+60)/2,200 (50+90)/2,500
Profit margin =5.1% = 5.5% = 5.6%
(550/1,850) × (640/2,200)×1 (700/2,500)×1
Operating costs 100 = 29.7% 00 = 29.1% 00 = 28.0%
1,250/400 = 1,500/540 = 1,750/620 =
Inventory turnover 3.1 times 2.8 times 2.8 times
492/(300+45)× 550/(400+60) 633/(600+90)×
365 = 523 ×365 = 436 365 = 334
Trade receivables collection period days days days

$m $m
Profit before interest 120 140
Depreciation 60 70
Increase in inventory (140) (80)
Increase in trade receivables (58) (83)
Increase in trade payables – 10
(18) 57
120/(382+720) 140/(372+930)
95/(372+520)× ×100 = ×100 =
ROCE 100 = 10.6% 10.9% 10.7%
Interest cover 95/25 = 3.8 120/60 = 2.0 = 1.3
520/892 =
Gearing 58.3% = 65.3% = 71.4%
1,850/892= 2.1 2,200/1,102=
Asset turnover times 2.0 times = 1.9 times
50 Webster Co (36 mins)

(a) STATEMENTS OF PROFIT OR LOSS (RESTATED)
Cole Co Darwin Co
$’000 $’000 $’000 $’000
Revenue (3,000 – 125) (Note 1) 2,875 4,400
Opening inventory 450 720
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24: FQP Chapter 809

Cole Co Darwin Co
$’000 $’000 $’000 $’000
Purchases (Note 2) 2,055 3,080
1,965 2,950
Gross profit 910 1,450
Operating expenses 480 964
Depreciation (Note 3) 40 (120)
Loan interest 80 –
Overdraft interest (W3) 15 –
(615) (844)
Profit for the year 295 606
STATEMENT OF FINANCIAL POSITION (RESTATED)
Cole Co Darwin Co
$’000 $’000 $’000 $’000
Assets
Non-current assets
Property, plant, equipment (W1) 3,100 2,620
Current assets
Inventories 540 850
Trade receivables (W2) 897 750
(W3) – 60
1,437 1,660
4,537 4,280
Equity shares ($1) 1,000 500
Revaluation surplus (800 – 40) 760 700
Retained earnings to 31 March
20X9
(684 + 295 + 40) / (1,912 + 606) 1,019 2,518
2,779 3,718
Non current liabilities
10% loan note 800 –
Current liabilities
Trade payables (W4) 163 562
Overdraft (W3) 795 –
4,537 4,280
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Workings
1 Non-current assets
Carrying
Cost/valuation Depreciation amount
$’000 $’000 $’000
Cole Co: property 2,000 100 1,900
plant 6,000 4,800 1,200
3,100
Darwin Co: property 2,000 100 1,900

plant (3,000 – 600) 2,400 1,680 720
2,620
2 Trade receivables
Cole Co: 522 + 375 (note (1)) = 897
3 Cash and cash equivalents
Cole Co Darwin Co
$’000 $’000
As stated 20 (550)
Reversal of sale (Tutorial note (1)) (500)
Payment for purchases (Tutorial note (2)) (300)
Payment for plant (Tutorial note (3)) 600
Payment/saving of interest to statement of financial
position 15 10
(795) 60
4 Trade payables
Cole Co 438 – 275 (note (2)) = 163
(1) Sale to Brander Co is at gross margin 40%, therefore the cost of sale is $500 × 60% =
$300.
Had a normal margin of 20% applied, the cost of this sale would represent 80% of the
selling price. The normal selling price would be $300/0.80 = $375
Sales and receivables would reduce by $125 and the proceeds of $500 would not
have been received.
(2) Purchase of goods from Advent Co on normal terms would have increased purchases
by $25. Using the normal credit period would mean these goods would have been
paid for by the year end, increasing the overdraft and reducing trade payables.
(3) The plant bought in February 20X9 has not yet generated income for Darwin Co, so it
is sensible to ignore it in the acquisition comparison.
The effects are:
- Cost of plant – $600, overdraft affected
- Depreciation reduced $600 × 20% = $120
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24: FQP Chapter 811

The depreciation charged changes:
Cole Co Darwin Co
$’000 $’000
As stated for property (60)
Depreciation on
revaluation 100
Reduction (above) (120)
40 increase (120) (decrease)
(b) Recalculations
Ratios Cole Co Darwin Co

Return on capital
employed: (295 + 80)/(2,779 + 800) = 10.5% 606/3,718 = 16.3%
= 0.8 4,400/(4,280 - 562) = 1.2
Asset turnover 2,875/(4,537 – 958) times times
Gross profit % 910/2,875 = 31.7% (unchanged) = 33%
Net profit % 295/2,875 = 10.3% 606/4,400 = 13.8%
Receivables
collection (days) 897/2,875 × 365 = 114 (unchanged) = 62
Payables period
(days) 163/2,055 × 365 = 29 (unchanged) = 67
Using the unadjusted figures, Cole Co would be preferred, as its key ratios given are better
than those of Darwin Co. Cole Co achieves better profitability due to greater unit margins.
Both companies have poor asset turnover implying under-utilisation or inefficient methods.
Both companies manage working capital in a similar fashion. Webster Co should examine
liquidity ratios:
Cole Co: 1,082/438 = 2.5
Darwin Co: 1,600/1,112 = 1.4
The acid test ratio of Cole Co is 1.23 whereas Darwin Co’s is 0.67.
Using the adjusted accounts, the above position is reversed showing Darwin Co to be more
profitable and to manage its assets more efficiently. Cole Co’s true liquidity position is not so
healthy – Cole Co controls receivables poorly and appears to pay suppliers earlier.
Darwin Co’s poor liquidity position is probably due to financing non-current assets from its
overdraft. Alternative refinancing would be beneficial.
Cole Co’s parent company has produced an initially favourable set of ratios by creating
favourable payment terms and trading conditions, and Darwin Co’s original ratios were
distorted by revaluations and the timing of new plant purchases.
Other factors to consider include:
(1) The asking price
(2) The future prospects, profits and cash flow forecasts
(3) The state of forward order books
(4) The quality of the management and labour force
(5) Other possible acquisitions
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Tutorial note. This question is at the upper end of the scale of difficulty which you are
likely to encounter, particularly part 1. Study the answer carefully.
51 Xpand Co (27 mins)

(a) Adjusted statement of profit or loss for Hydan Co:
$’000
Revenue 70,000
Cost of sales (45,000/0.9 (1)) (50,000)
Operating costs (7,000)
Directors salaries (2) (2,500)
Loan interest (10% × 10,000 (3)) (1,000)
The adjusted ratios, based on the statement of profit or loss as above, the equity of $30m
and the replacement of the directors’ loan accounts by a commercial loan are as follows:
Return on equity ((6,500/30,000) × 100) 21.7%
Net asset turnover (70,000/(30,000 + 10,000)) 1.75 times
Gross profit margin ((20,000/70,000) × 100) 28.6%
Net profit margin ((6,500/70,000) × 100) 9.3%
(b) The ratios based on the original summarised financial statements of Hydan Co show a very
healthy picture, well above the sector average. Hydan Co has high gross and net profit
margins and an impressive net asset turnover, giving a return on equity of more than twice
the sector average. On the face of it, Hydan Co is trading very profitably and efficiently,
keeping costs well under control.
However, when the financial statements are adjusted to show the likely picture post-
acquisition, it becomes clear that Hydan Co has been to quite a large degree cushioned by
the family and by the other family-owned companies. Removing the 10% discount Hydan
enjoys on its purchases reduces the gross profit margin from 35.7% to 28.6%, slightly under
the sector average.
If Xpand Co purchases Hydan Co, it will need to appoint a new board of directors and
replace the directors’ loan accounts with a commercial loan. Both of these expenses have up
to now been subsidised by the family.
Adjusting further for the increased directors’ remuneration and interest on the loan takes the
net profit margin down from 20% to 9.3%, significantly below the sector average of 12%. The
value of equity would not change significantly as a result of the acquisition, as the increase
to $30m is compensated for by the reclassification of the loan as debt. The fall in the return
on equity from 47.1% to 21.7% is therefore driven by the fall in net profit. However, it is worth
noting that 21.7% return on equity is not much below the sector average of 22%.
Xpand Co should take the view that if it acquires Hydan Co it will be acquiring a business
that is performing slightly below the average for its sector. The impressive profitability
pictured in the summarised financial statements is obviously not going to survive the
acquisition. But Hydan Co will still be trading quite profitably and it could be that there are
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24: FQP Chapter 813

cost savings which were not considered necessary by the previous management but which
could now be made, which will bring its performance into line with the average for its sector.
Tutorial note. This is a recent question and looks at the financial statements from the
viewpoint of an acquirer. There are 6 marks for the adjustments and ratios and 9 for the
analysis.
52 Dundee Co (25 mins)

Statement of cash flows for the year ended 31 March 20X7
$m $m
Adjustments for:
Depreciation 970
2,270
Decrease in inventories (W4) 100
Cash generated from operations 2,130
Interest paid (250)
Net cash from operating activities 1,670
Cash flow from investing activities
Payment of lease liabilities (W3) (450)
Dividends paid (300)
Net cash used in financing activities (750)
Cash and cash equivalents at beginning of year (205)
Cash and cash equivalents at end of year (155)
Workings
1 Assets – Property, plant and equipment
$’000
B/d 3,700
Depreciation (970)
Right-of-use assets 600
Acquired for cash (β) 870
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$’000
C/d 4,200
2 Equity
Share capital Retained earnings

$’000 $’000
B/d 1,200 1,900
Profit for year 600
Dividend paid (per Q) – (300)
C/d 1,200 2,200
3 Liabilities
Lease Taxation
$m $m
B/d – (1,200 + 450) / (850 + 205) 1,650 1,055
Addition 600
Charge for year 450
Cash paid (β) (450) (210)
C/d – (500 + 1,300) / (225 + 1,070) 1,800 1,295
Inventories Trade receivables Trade payables

$m $m $m
b/d 1,600 1,800 1,090
Increase / (decrease) (100) 400 160
1,500 2,200 1,250
53 Elmgrove Co (45 mins)

(a) STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 MARCH 20X9
$m
$m
Adjustments for
Loss on disposal 6
Depreciation 43
Interest income (6)
Interest expense 17
169
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24: FQP Chapter 815

$m
$m
Decrease in inventories (W4) 53
Cash generated from operations 270
Interest paid (W3) (13)
Proceeds from sale of property, plant and equipment (28 – 6) 22
Interest received 6
(137)
Net cash used in investing activities
Proceeds from issuance of share capital (W2) 60
Dividend paid (32)
Net cash from financing activities 28
Cash and cash equivalents at beginning of the period 8
Cash and cash equivalents at end of the period 94
Workings
1 Assets – Property, plant and equipment
$m
B/d 264
Depreciation (43)
Disposal (28)
Revaluation surplus (31)
Cash additions (β) 165
C/d 327
2 Equity
Share Share Revaluation Retained

capital premium surplus earnings
$m $m $m $m
B/d 120 – 97 41
Debentures converted 50
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Share Share Revaluation Retained
capital premium surplus earnings
$m $m $m $m
Surplus on disposal (31)
SPL 62
Cash received/(paid) 30 30 – (32)
C/d 200 30 66 71
IAS 7 requires that investing and financing activities that do not require the use of cash,
such as converting debt to equity, should be excluded from the statement of cash flows.
3 Liabilities
Interest Income tax

$m $m
B/f 3 54
Finance costs 17
Tax expense 47
Paid (β) (13) (62)
C/f 7 39
Inventories Trade receivables Trade payables

$m $m $m
b/d 176 87 70
Increase / (decrease) (53) 8 56
c/d 123 95 126
(b) REPORT
To: Memorandum to the directors of Elmgrove Co

From: AN Accountant
Date: 1.4.20X9
Subject: Major benefits to the users of financial statements from the publication of
statements of cash flows
The users of financial statements can basically be divided into the following groups.
(1) Shareholders
(2) Management
(3) Creditors and lenders
(4) Employers
The needs of these groups are not identical and hence not all benefits listed below will be
applicable to all users.
Benefits
(1) Statements of cash flows direct attention to the survival of the entity which depends
on its ability to generate cash.
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24: FQP Chapter 817

(2) Statements of cash flows indicate the ability of an entity to repay its debts.
(3) They give information which can be used in the decision making and stewardship
process.
(4) They are more easily understood than statements of profit or loss that depend on
accounting conventions and concepts.
(5) Statements of cash flows give a better means of comparison between different
companies.
54 Measurement (16 mins)

(a) Historical cost is the price paid for an asset or for the event which gave rise to the liability.
The price will not change.
Current value accounting reflects the valuation of the assets or liabilities based on conditions
and information available at the measurement date. The Conceptual Framework discusses
the bases of measurement, and the factors to be considered when choosing the appropriate
measurement method. There are three alternatives under current value accounting:
(b) It can lead to understatement of assets in the statement of financial position. A building
purchased 50 years ago will appear at the price that was paid for it 50 years ago.
Because assets are understated, depreciation will also be understated. While the purpose of
depreciation is not to set aside funds for replacement of assets, if an asset has to be replaced
at twice the price that was paid for its predecessor, the company may decide that it may
have been prudent to make some allowance for this in earlier years.
When inventory prices are rising, and when the company is operating a FIFO system, the
cheapest inventories are being charged to cost of sales and the most expensive are being
designated as closing inventory in the statement of financial position. This leads to
understatement of cost of sales.
(c) The Conceptual Framework does not explicitly specify which measurement basis is required
in each case rather that management take into account the fundamental qualitative
characteristics of relevance and faithful representation.
The information provided should always be useful to the users of the financial statements,
Therefore, if an asset has a fluctuating value based on active market conditions, such as a
retail outlet, then fair value is likely to be the most suitable basis for measurement. A bespoke
piece of machinery, designed for that particular business is likely to have a minimal value on
the open market, however, the business will gain significant financial benefit from it, so a
value in use measurement is potentially the most suitable.
55 Not-for-profit (9 mins)
There are two main areas in which the Department would be expected to monitor the performance
of the school.
Although the school is a not-for-profit organisation, it still has to account for the funding it
receives. It is spending taxpayers money so the government has a duty to ensure that it is
delivering value for money. This is particularly important in the light of the criticisms that have
been made.
The accounts kept by the school should be regularly audited to ensure that no financial
mismanagement has occurred and it will be expected to prepare and implement budgets. The
school should be expected to show some excess of income over expenditure, which will give it a
surplus for emergencies, even if this will be lower than in a profit-making entity, and a number of
accounting ratios can be used to monitor its performance.
Investor ratios such as ROCE will not be particularly appropriate but working capital ratios, such
as payables days, will be important, as will liquidity ratios. The school may not be expected to
HB2022

make a profit, but it will be expected to remain solvent. Additional ratios, such as expenditure per
pupil, can be calculated and compared to the same ratio for other schools in the area.
Value for money is composed of three elements – economy, efficiency and effectiveness.
Financial performance can be monitored to assess economy and efficiency but in the case of a
school the government will be most interested in effectiveness. This requires looking at the non-
financial indicators.
The mission of the school, however it is worded, will be to maximise the educational attainment of
its pupils and it will need to demonstrate that it is making progress in this direction. The basic
measure of this is the external exam scores of its pupils and this can be directly compared to the
performance of other schools, such as percentage of pupils achieving grade A–C in maths, etc.
However, these scores need to be weighted to take account of the number of pupils from deprived
backgrounds, such as those eligible for free school meals, and the number of pupils with English
as a second language. More subjective measures could also be used, such as feedback from
pupils and parents.
56 Armstrong Co (25 mins)

$000
Non-current assets
Investments (240,000 – 200,000 – 40,000) 0
Goodwill (W1) 69,600
629,600
Current assets (123,000 + 89,300 + 450 (W5)) 211,850
Equity
Share capital – $1 shares 210,000
Revaluation surplus Only Armstrong Co 82,000
Non-controlling interest (W3) 31,000
Non-current liabilities 574,114
Deferred consideration (40,000 × 0.890) + (35,600 × 6%) 37,736
Current liabilities 229,600
267,336
Workings
1 Goodwill computation
$’000
Cash Per question 200,000
Deferred consideration (discounted) 40,000 × 0.890 35,500
HB2022
24: FQP Chapter 819

$’000
NCI at acquisition Per question 30,000
Less net assets at acquisition (W2) (196,000)
69,600
2 Net assets
$’000 $’000 $’000

Share capital 120,000 120,000 –
Retained earnings 68,000 73,000 5,000
Revaluation surplus 8,000 8,000 –
196,000 201,000 5,000
3 Non-controlling interest
$’000
NCI at acquisition Per question 30,000
NCI % of Miller Co post-acquisition 5,000 (W2) × 20% 1,000
31,000
4 Retained earnings
$’000
Armstrong Co retained earnings 249,700
Armstrong Co’s % of Miller Co post-acquisition
profit (5,000 (W1) × 80%) 4,000
Unwinding of discount for deferred consideration (35,600 × 6%) (2,136)
Unrealised profit on the I/G inventory (450)
251,114
5 Inventory adjustment for intergroup inventory
$’000
Armstrong Co sold widgets to Miller Co Per question 7,500
Profit margin on the widgets sold to Miller Co is
20%, therefore:
Cost of inventory sold 7,500 × 80% 6,000
Profit on the sale 1,500
30% of items still in inventory at year end 1,500 × 30% 450
Unrealised profit on the inventory held 450
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Glossary
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Chapter 1: The Conceptual Framework
Asset: A present economic resource controlled by the entity as a result of past events
Comparability: The qualitative characteristic that enables users to identify and understand
similarities in, and differences among, items (Conceptual Framework: para. 2.25).
Current cost of a liability:
The current cost of a liability is the consideration that would be received for an equivalent liability
at the measurement date, minus the transaction costs that would be incurred at that date
Current cost of an asset: The current cost of an asset is the cost of an equivalent asset at the
measurement date, comprising the consideration that would be paid at the measurement date,
plus the transaction costs that would be incurred at that date (Conceptual Framework: para.
6.21).
Equity: The residual interest in the assets of an entity after deducting all its liabilities (Conceptual
Fair value: The price that would be received to sell an asset, or paid to transfer a liability, in an
orderly transaction between market participants at the measurement date (Conceptual
Framework: para. 6.12 and IFRS 13: Appendix A).
Fulfilment value: The present value of the cash, or other economic resources, that an entity
expects to be obliged to transfer as it fulfils a liability (Conceptual Framework: para. 6.17).
Historical cost: Historical cost for an asset is the cost that was incurred when the asset was
acquired or created and, for a liability, is the value of the consideration received when the liability
was incurred.
Expenses:
Decreases in assets, or increases in liabilities, that result in decreases in equity, other than those
relating to distributions to equity participants (Conceptual Framework: para. 4.2).
Income: Increases in assets, or decreases in liabilities, that result in increases in equity, other than
those relating to contributions from equity participants (Conceptual Framework: para. 4.2).
Liability: A present obligation of the entity to transfer an economic resource as a result of past
events (Conceptual Framework: para. 4.2).
Timeliness: This means having information available to decision-makers in time to be capable of
influencing their decisions. Generally, the older information is the less useful it is (Conceptual
Understandability: Classifying, characterising and presenting information clearly and concisely
makes it understandable (Conceptual Framework: para. 2.34).
Value in use: The present value of the cash flows, or other economic benefits, that an entity
expects to derive from the use of an asset and from its ultimate disposal (Conceptual Framework:
para. 6.17).
Verifiability: This helps assure users that information faithfully represents the economic
phenomena it purports to represent. Verifiability means that different knowledgeable and
independent observers could reach consensus, although not necessarily complete agreement,
that a particular depiction is a faithful representation (Conceptual Framework: para. 2.30).
Chapter 3: Tangible non-current assets

Bearer plant:
A living plant that:
• Is used in the production or supply of agricultural produce;
• Is expected to bear produce for more than one period; and
• Has a remote likelihood of being sold as agricultural produce, except for incidental scrap sales
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(IAS 16: para. 6)
Entity specific value: The present value of the cash flows an entity expects to arise from the
continuing use of an asset and from its disposal at the end of its useful life or expects to incur
when settling a liability.
Impairment loss: The amount by which the carrying amount of an asset exceeds its recoverable
amount.
Fair value model: After initial recognition, an entity that chooses the fair value model should
measure all of its investment property at fair value, except in the extremely rare cases where this
cannot be measured reliably. In such cases, it should apply the IAS 16 cost model.
A gain or loss arising from a change in the fair value of an investment property should be
recognised in net profit or loss for the period in which it arises.
The fair value of investment property should reflect market conditions at the end of the reporting
period (IAS 40: paras. 33, 35, 40).
Carrying amount:
The amount at which an asset is recognised in the statement of financial position.
Cost: The amount of cash or cash equivalents paid or the fair value of other consideration given
to acquire an asset at the time of its acquisition or construction.
Investment property: Property (land or a building – or part of a building – or both) held (by the
owner or by the lessee as a right-of-use asset) to earn rentals or for capital appreciation or both,
rather than for:
(a) Use in the production or supply of goods or services or for administrative purposes, or
(b) Sale in the ordinary course of business.
Owner-occupied property: Property held by the owner for use in the production or supply of
goods or services or for administrative purposes.
Carrying amount:
The amount at which an asset is recognised in the statement of financial position after deducting
any accumulated depreciation and accumulated impairment losses.
Cost: The amount of cash or cash equivalents paid or the fair value of the other consideration
Depreciable amount: The depreciable amount of an asset is the historical cost or other amount
substituted for cost in the financial statements, less its estimated residual value. (IAS 16: paras.
50–54)
Depreciation: The result of systematic allocation of the depreciable amount of an asset over its
estimated useful life. Depreciation for the accounting period is charged to net profit or loss for the
period, either directly or indirectly.
Property, plant and equipment: Tangible assets that:
• Are held for use in the production or supply of goods or services, for rental to others, or for
administrative purposes
• Are expected to be used during more than one period
Residual value: The net amount which the entity expects to obtain for an asset at the end of its
useful life after deducting the expected costs of disposal.
Useful life: One of two things:
• The period over which a depreciable asset is expected to be used by the entity, or
• The number of production or similar units expected to be obtained from the asset by the entity.
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Glossary 823

Chapter 4: Intangible assets
Active market: ‘A market in which transactions for the asset or liability take place with sufficient
frequency and volume to provide pricing information on an ongoing basis.’ (IFRS 13: Appendix A)
Business combination: ‘A transaction or other event in which an acquirer obtains control of one or
more businesses.’ (IFRS 3: Appendix A)
Intangible asset: ‘An identifiable non-monetary asset without physical substance.’ (IAS 38: para.
8)
Monetary assets: ‘Money held and assets to be received in fixed or determinable amounts of
money.’ (IAS 38: para. 8)
Development:
‘Application of research findings to a plan or design for the production of new or substantially
improved materials, products, processes, systems or services before the start of commercial
production or use.’ (IAS 38: para. 8)
Research: ‘Original and planned investigation undertaken with the prospect of gaining new
scientific or technical knowledge and understanding.’ (IAS 38: para. 8)
Chapter 5: Impairment of assets

Carrying amount:
The amount at which the asset is recognised after deducting accumulated depreciation and any
impairment losses in the statement of financial position.
Cash-generating unit: The smallest identifiable group of assets that generates cash inflows that
are largely independent of the cash inflows from other assets or groups of assets.
Fair value less costs of disposal: The price that would be received to sell the asset in an orderly
transaction between market participants at the measurement date (IFRS 13 Fair Value
Measurement), less the direct incremental costs attributable to the disposal of the asset.
Impairment loss: The amount by which the carrying amount of an asset or a cash-generating unit
exceeds its recoverable amount.
Recoverable amount: The higher of the fair value less costs of disposal of an asset (or cash-
generating unit) and its value in use.
Value in use of an asset: The present value of estimated future cash flows expected to be derived
from the use of an asset.
(IAS 36: para. 6)
Chapter 6: Revenue and government grants

Contract: An agreement between two or more parties that creates enforceable rights and
obligations.
Performance obligation: A promise in a contract with a customer to transfer to the customer
either:
(a) A good or service (or a bundle of goods or services) that is distinct; or
(b) A series of distinct goods or services that are substantially the same ad that have the same
pattern of transfer to the customer.
Transaction price: The amount of consideration to which an entity expects to be entitled in
exchange for transferring promised goods or services to a customer, excluding amounts collected
on behalf of third parties.
Contract asset: A contract asset is recognised when revenue has been earned but not yet
invoiced (revenue that has been invoiced is a receivable).
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Contract liability: A customer has paid prior to the entity transferring control of the good or
service to the customer.
Forgivable loans:
Loans for which the lender undertakes to waive repayment under certain prescribed conditions
(IAS 20: para. 3).
Government grants: Assistance by government in the form of transfers of resources to an entity in
return for past or future compliance with certain conditions relating to the operating activities of
the entity. They exclude those forms of government assistance which cannot reasonably have a
value placed upon them and transactions with government which cannot be distinguished from
the normal trading transactions of the entity.
Grants related to assets: Government grants whose primary condition is that an entity qualifying
for them should purchase, construct or otherwise acquire non-current assets. Subsidiary
conditions may also be attached restricting the type or location of the assets or the periods
during which they are to be acquired or held (IFRS 15: para. 3).
Chapter 7: Introduction to groups

Associate:
An entity over which an investor has significant influence and which is neither a subsidiary nor an
interest in a joint venture.
(IFRS 10: App. A)
Control: An investor controls an investee when the investor is exposed, or has rights, to variable
returns from its involvement with the investee and has the ability to affect those returns through
power over the investee.
Group: A parent and all its subsidiaries.
Parent: An entity that controls one or more subsidiaries.
Power: Existing rights that give the current ability to direct the relevant activities of the investee.
Significant influence: The power to participate in the financial and operating policy decisions of
an investee but it is not control or joint control over those policies. (IAS 28: para. 3)
Subsidiary: An entity that is controlled by another entity.
Chapter 8: The consolidated statement of financial position

orderly transaction between market participants at the measurement date (IFRS 13: para. 9).
Chapter 11: Accounting for associates

Associate: An associate is an entity over which the investor has significant influence. (IAS 28:
para. 3)
Significant influence: ‘The power to participate in the financial and operating policy decisions of
the investee but is not control or joint control over those policies.’ (IAS 28: para. 3)
Equity method: ‘A method of accounting whereby the investment is initially measured at cost and
adjusted thereafter for the post-acquisition change in the investor’s share of the investee’s net
assets. The investor’s profit or loss includes its share of the investee’s profit or loss and the
investor’s other comprehensive income includes its share of the investee’s other comprehensive
income.’ (IAS 28: para. 3)
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Glossary 825

Chapter 12: Financial instruments
Amortised cost: The amount at which the financial asset (financial liability) is measured at initial
recognition, minus the principal repayments, plus (minus) the cumulative amortisation using the
effective interest.
Effective interest rate: The rate that exactly discounts estimated future cash receipts (payments)
through the expected life of the financial asset (financial liability) to the gross carrying amount of
a financial asset (amortised cost of a financial liability).
Equity instrument:
Any contract that evidences a residual interest in the assets of an entity after deducting all of its
liabilities. (IAS 32: para. 11)
Financial asset: Any asset that is:
(a) Cash
(b) An equity instrument of another entity
(c) A contractual right to receive cash or another financial asset from another entity; or to
exchange financial instruments with another entity under conditions that are potentially
favourable to the entity.
Financial instrument: Any contract that gives rise to both a financial asset of one entity and a
financial liability or equity instrument of another entity.
Financial liability: Any liability that is:
(a) A contractual obligation:
(i) To deliver cash or another financial asset to another entity, or
(ii) To exchange financial instruments with another entity under conditions that are
potentially unfavourable.
Chapter 13: Leasing

Lease: A contract is, or contains, a lease if there is an identifiable asset and the contract conveys
the right to control the use of the identified asset for a period of time in exchange for
consideration (IFRS 16: para. 9).
Underlying asset: An asset that is the subject of a lease, for which the right to use that asset has
been provided by a lessor to a lessee (IFRS 16: Appendix A).
Right-of-use asset: An asset that represents a lessee’s right-to-use an underlying asset for the
lease term.
Chapter 14: Provisions and events after the reporting period

Contingent asset: A possible asset that arises from past events and whose existence will be
confirmed by the occurrence or non-occurrence of one or more uncertain future events not wholly
within control of the entity. (IAS 37: para. 10)
• A contingent asset must not be recognised (IAS 37: para. 31).
• A contingent asset should only be disclosed when an inflow of economic benefits is probable
(IAS 37: para. 34).
• Only when the realisation of the related economic benefits is virtually certain should
recognition take place. At that point, the asset is no longer a contingent asset.
Contingent liability:
• A possible obligation that arises from past events and whose existence will be confirmed only
by the occurrence or non-occurrence of one or more uncertain future events not wholly within
the control of the entity; or
• A present obligation that arises from past events but is not recognised because:
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- It is not probable that an outflow of resources embodying economic benefits will be
required to settle the obligation; or
- The amount of the obligation cannot be measured with sufficient reliability
(IAS 37: para. 10)
Events after the reporting period: Those events, both favourable and unfavourable, that occur
between the end of the reporting period and the date when the financial statements are
authorised for issue.
Onerous contracts: An onerous contract is a contract entered into with another party under
which the unavoidable costs of fulfilling the terms of the contract exceed any revenues expected
to be received from the goods or services supplied or purchased directly or indirectly under the
contract and where the entity would have to compensate the other party if it did not fulfil the
terms of the contract (IAS 37: para. 68). An example might be a three-year contract to make and
supply a service to a third party. The seller can no longer provide the service, so it becomes
‘onerous’, and the costs to the seller would be the costs of outsourcing the provision of the service
or any penalties for non-provision.
Provision: A provision is a liability of uncertain timing or amount. (IAS 37: para. 10)
Restructuring: A programme that is planned and is controlled by management and materially
changes one of two things.
• The scope of a business undertaken by an entity
• The manner in which that business is conducted
(IAS 37: para. 10)
Chapter 15: Inventories and biological assets

Agricultural produce:
The harvested product of an entity’s biological assets.
(IAS 41: para. 5)
Biological assets: Living animals or plants.
Biological transformation: The processes of growth, degeneration, production and procreation
that cause qualitative and quantitative changes in a biological asset.
Inventories: Assets that are:
• Held for sale in the ordinary course of business;
• In the process of production for such sale; or
• In the form of materials or supplies to be consumed in the production process or in the
rendering of services. (IAS 2: para. 6)
Net realisable value: The estimated selling price in the ordinary course of business, less:
• The estimated cost of completion; and
• The estimated costs necessary to make the sale, eg marketing, selling and distribution costs
(IAS 2: para. 6).
Chapter 16: Taxation

Accounting profit: Net profit or loss for a period before deducting tax expense is referred to as the
accounting profit.
Current tax: The amount of income taxes payable (recoverable) in respect of the taxable profit
(tax loss) for a period.
Deferred tax assets: The amounts of income taxes recoverable in future periods in respect of:
• Deductible temporary differences
• The carry forward of unused tax losses
• The carry forward of unused tax credits
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Glossary 827

Deferred tax liabilities: The amounts of income taxes payable in future periods in respect of
taxable temporary differences.
Tax base: The tax base of an asset or liability is the amount attributed to that asset or liability for
tax purposes.
(IAS 12: para. 5)
Tax expense (tax income): The aggregate amount included in the determination of net profit or
loss for the period in respect of current tax and deferred tax.
Taxable profit (tax loss): The profit (loss) for a period, determined in accordance with the rules
established by the taxation authorities, upon which income taxes are payable (recoverable).
Temporary differences: Differences between the carrying amount of an asset or liability in the
statement of financial position and its tax base. Temporary differences may be either:
• Taxable temporary differences, which are temporary differences that will result in taxable
amounts in determining taxable profit (tax loss) of future periods when the carrying amount of
the asset or liability is recovered or settled
• Deductible temporary differences, which are temporary differences that will result in amounts
that are deductible in determining taxable profit (tax loss) of future periods when the carrying
amount of the asset or liability is recovered or settled
Chapter 17: Presentation of published financial statements

Current asset: An asset should be classified as a current asset when it:
• Is expected to be realised in, or is held for sale or consumption in, the normal course of the
entity’s operating cycle; or
• Is held primarily for trading purposes or for the short-term and expected to be realised within
12 months of the end of the reporting period; or
• Is cash or a cash equivalent asset which is not restricted in its use.
All other assets should be classified as non-current assets.
(IAS 1: para. 66)
Current liabilities: A liability should be classified as a current liability when it:
• Is expected to be settled in the normal course of the entity’s operating cycle; or
• Is held primarily for the purpose of trading; or
• Is due to be settled within 12 months after the end of the reporting period; or when
• The entity does not have the right at the end of the reporting period to defer settlement of the
liability for at least 12 months after the end of the reporting period.
All other liabilities should be classified as non-current liabilities.
(IAS 1: para. 69)
Operating cycle: The time between the acquisition of assets for processing and their realisation in
cash or cash equivalents. (IAS 1: para. 68)
Chapter 18: Reporting financial performance

Accounting policies: The specific principles, bases, conventions, rules and practices applied by an
entity in preparing and presenting the financial statements (IAS 8: para. 5).
Changes in accounting estimates: Accounting estimates are monetary amounts in financial
statements that are subject to management uncertainty. (IAS 8: para. 5).
Discontinued operation: A component of an entity that either has been disposed of or is classified
as held for sale and:
(a) Represents a separate major line of business or geographical area of operations; or
(b) Is part of a single co-ordinated plan to dispose of a separate major line of business or
geographical area of operations; or
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(c) Is a subsidiary acquired exclusively with a view to resale.
Cash-generating unit:
The smallest identifiable group of assets for which independent cash flows can be identified and
measured (IFRS 5: App A).
Costs of disposal: The incremental costs directly attributable to the disposal of an asset (or
disposal group), excluding finance costs and income tax expense.
Disposal group: A group of assets to be disposed of, by sale or otherwise, together as a group in a
single transaction, and liabilities directly associated with those assets that will be transferred in
the transaction. (In practice a disposal group could be a subsidiary, a cash-generating unit or a
single operation within an entity.)
Recoverable amount: The higher of an asset’s fair value less costs of disposal and its value in use.
Value in use: The present value of estimated future cash flows expected to arise from the
continuing use of an asset and from its disposal at the end of its useful life (IFRS 5: App A).
Foreign currency: Foreign currency is a currency other than the functional currency of the entity
(IAS 21: para. 8).
Functional currency: Functional currency is the currency of the primary economic environment in
which the entity operates (IAS 21: para. 8).
Presentational currency: Presentation currency is the currency in which the financial statements
are presented (IAS 21: para. 8).
An entity can present its financial statements in any currency (or currencies) it chooses.
Its presentation currency will normally be the same as its functional currency (the currency of the
country in which it operates).
Prior period errors: Omissions from, and misstatements in, the entity’s financial statements for
one or more prior periods arising from a failure to use, or misuse of, reliable information that:
(a) Was available when the financial statements for those periods were authorised for issue; and
(b) Could reasonably be expected to have been obtained and taken into account in the
preparation and presentation of those financial statements.
(IAS 8: para. 5)
Chapter 19: Earnings per share

Dilution:
‘A reduction in earnings per share or an increase in loss per share resulting from the assumption
that convertible instruments are converted, that options or warrants are exercised, or that
ordinary shares are issued upon the satisfaction of specified conditions’. (IAS 33: para. 5)
Equity instrument: ‘Any contract that evidences a residual interest in the assets of an entity after
deducting all of its liabilities’. (IAS 32: para. 11)
Financial instrument: ‘Any contract that gives rise to both a financial asset of one entity and a
financial liability or equity instrument of another entity’. (IAS 32: para. 11)
Options, warrants and their equivalents: ‘Financial instruments that give the holder the right to
purchase ordinary shares’. (IAS 33: para. 5)
Ordinary shares: ‘An equity instrument that is subordinate to all other classes of equity
instruments’. (IAS 33: para. 5)
Potential ordinary share: ‘A financial instrument or other contract that may entitle its holder to
ordinary shares’. (IAS 33: para. 5)
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Glossary 829

Chapter 20: Interpretation of financial statements
Debt ratio: The ratio of a company’s total debts to its total assets.
(a) Assets consist of non-current assets at their carrying amount, plus current assets
(b) Debts consist of all payables, whether they are due within one year or after more than one
year
You can ignore other non-current liabilities, such as deferred taxation.
Liquidity: The amount of cash a company can put its hands on quickly to settle its debts (and
possibly to meet other unforeseen demands for cash payments too) is the amount of cash a
company can put its hands on quickly to settle its debts (and possibly to meet other unforeseen
demands for cash payments too).
Chapter 21: Limitations of financial statements and interpretation techniques

Related party (IAS 24): A person or entity that is related to the entity that is preparing its financial
statements (the ’reporting entity’).
(a) A person or a close member of that person’s family is related to a reporting entity if that
person:
(i) Has control or joint control over the reporting entity;
(ii) Has significant influence over the reporting entity; or
(iii) Is a member of the key management personnel of the reporting entity or of a parent of
the reporting entity
(b) An entity is related to a reporting entity if any of the following conditions apply:
(i) The entity and the reporting entity are members of the same group (which means that
each parent, subsidiary and fellow subsidiary is related to the others).
(ii) One entity is an associate* or joint venture* of the other entity (or an associate or joint
venture of a member of a group of which the other entity is a member).
(iii) Both entities are joint ventures* of the same third party.
(iv) One entity is a joint venture* of a third entity and the other entity is an associate of the
third entity.
(v) The entity is a post-employment benefit plan for the benefit of employees of either the
reporting entity or an entity related to the reporting entity.
(vi) The entity is controlled or jointly controlled by a person identified in (a).
(vii) A person identified in (a)(i) has significant influence over the entity or is a member of the
key management personnel of the entity (or of a parent of the entity).
(viii) The entity, or any member of a group of which it is a part, provides key management
personnel services to the reporting entity or the parent of the reporting entity.
*including subsidiaries of the associate or joint venture
(IAS 24: para. 9)
Chapter 22: Statement of cash flows

Cash equivalents:
Short-term, highly liquid investments that are readily convertible to known amounts of cash and
which are subject to an insignificant risk of changes in value.
Cash flows: Inflows and outflows of cash and cash equivalents.
Cash: Comprises cash on hand and demand deposits.
Financing activities: Activities that result in changes in the size and composition of the
contributed equity and borrowings of the entity.
(IAS 7: para. 6).
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Investing activities: The acquisition and disposal of long-term assets and other investments not
included in cash equivalents.
Operating activities: The principal revenue-producing activities of the entity and other activities
that are not investing or financing activities.
Statement of cash flows: A primary financial statement that explains how an entity’s cash
balance has changed during the year. It shows how an entity has generated and used cash
during the period.
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Glossary 831

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Index
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A Cash, 531
Accounting for revaluations, 73 Cash and cash equivalents, 532
Accounting policies, 426 Cash cycle, 687
Accounting profit, 379 Cash equivalents, 532
Accrual accounting, 5 Cash flows, 532
Acquired intangible assets, 68 Cash-generating unit, 85, 87, 429
Acquisition of another entity, 152 Change in accounting policy, 426
Active market, 73 Changes in accounting estimates, 427
Adjusting events, 642 Changes in accounting policy, 700
Adopting a new accounting policy, 426 Changes in tax rates, 388
Advantages of the historical cost basis for Characteristics of not-for-profit entities, 714
measurement, 11 Classification as held for sale, 430
Advantages of using current value, 12 Comparability, 6, 427
Agricultural produce, 371 Compound financial instruments, 622
Allocating transaction price to performance Conceptual Framework, 4
obligations, 119
Consignment arrangements, 126
Amortisation/impairment tests, 73
Consistency, 650
Amortised cost, 300
Consistent accounting policies, 591
Analysis of cash flow, 499
Constructive obligation, 347, 351
Analysis of consolidated financial statements,
Consumable, 651
498
Contingent asset, 353, 642
Applies the change retrospectively, 426
Contingent liabilities of the acquiree, 596
Asset, 7
Contingent liability, 352, 641
Asset turnover, 487
Contract, 114, 317
Associate, 152, 259
Contract asset, 121
B Contract liability, 121
Bearer, 651 Contractual cash flow, 623
Bearer plant, 566 Control, 152
Bearer plants, 370 Control by the entity, 576
Bill and hold arrangements, 127 Convertible debt, 622
Biological assets, 370, 650 Cost, 39, 49
Biological transformation, 371 Cost constraint, 6, 9
Bonus fraction, 467, 468 Cost model, 72
Bonus issue, 467 Costs of conversion, 367
Borrowing costs, 52, 573 Costs of disposal, 429
Borrowing costs eligible for capitalisation, 53 Costs of purchase, 367
Break-up basis, 5 Creative accounting, 517
Business combination, 69 Creative accounting techniques, 518
Business model test, 623 Criteria for control, 153
C Current asset, 403
Calculation of lease liability, 319 Current cost of a liability, 12
Capitalised provision costs, 348 Current cost of an asset, 12
Carrying amount, 39, 49, 85 Current liabilities, 404
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Index 835

Current ratio, 489 Equity, 8
Current tax, 379, 380 Equity instrument, 295, 465
Current value, 10, 11 Equity method, 260
Events after the reporting period, 355, 642
D
Exclusion of a subsidiary from the consolidated
Debt ratio, 689 financial statements, 589
Decommissioning costs, 348 Exemption from preparing consolidated
Deductible temporary differences, 379 financial statements, 589
Deferred tax, 381 Expenditure incurred in replacing or renewing a
Deferred tax assets, 379 component, 567
Deferred tax liabilities, 379 Expenses, 8
Depreciable amount, 39 Exposure Drafts, 26, 29
Depreciation, 39 Extended warranties, 347
Depreciation and amortisation, 91 F

Depreciation methods, 572 Factoring of receivables, 299
Depreciation of assets with two or more Fair value, 11, 39, 49, 181, 429
significant parts, 47
Fair value less costs of disposal, 85, 579
Derecognition, 10, 568
Fair value model, 572
Development, 69
Fair value through other comprehensive income
Development costs, 385 (FVTOCI), 301
Diluted eps, 470 Fair value through profit or loss (FVTPL), 301
Dilution, 465 Faithful representation, 5
Direct method, 532 Financial Accounting Standards Board (FASB),
Discontinued operation, 431 27
Discounting the provision, 346 Financial asset, 295
Discussion Papers, 26 Financial assets at amortised cost, 302
Disposal group, 429 Financial assets at fair value, 301
Disposal of a revalued asset, 568 Financial instrument, 295, 465
Disposals, 245 Financial liability, 295
Dividend cover, 495 Financing activities, 532
Dividend income from the subsidiary, 221 First in, first out (FIFO), 368
Dividend yield, 495 Foreign currency, 435
Downstream transaction, 262 Forgivable loans, 129
Frequency of revaluations, 73
E
Fulfilment value, 12
Earnings, 465
Functional currency, 435
Earnings per share as a performance indicator,
473 Fundamental qualitative characteristics, 5
Economic resources, 5 Future operating losses, 349
Effect of choice of accounting policies, 700 G

Effective interest rate, 300 G20 economies, 26
Elements of the financial statements, 7 Gain on bargain purchase, 181
Enhancing qualitative characteristics, 5, 6 Gearing, 493
Entity specific value, 566 General purpose financial statements, 4
Environmental costs, 348 Going concern, 5
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Goodwill, 69, 156, 589 IFRS 5 Non-Current Assets Held for Sale and
Goodwill calculation, 177 Discontinued Operations, 566, 429
Government grants, 129 IFRS 7 Financial Instruments: Disclosures, 625,

403
Grants for non-depreciable assets, 130
IFRS 9 Financial Instruments, 152, 611
Grants related to assets, 130
IFRS Interpretations, 29
Grants relating to income, 129
IFRS Interpretations Committee, 29
Gross profit margin, 488
Impairment indicators, 87
Group, 152
Impairment loss, 566, 221, 261
Group financial statements, 155
Impairment losses and inventory losses, 386
H Impairment of carrying amounts of non-current
Historical cost, 10, 11 assets, 567
Impairment loss, 85
I Income, 8
IAS 1 Presentation of Financial Statements, 14, Indirect method, 532
322, 401
Inflation, 520
IAS 10 Events After the Reporting Period, 343,
355 Intangible asset, 67
IAS 12 Income Taxes, 379 Interest cover, 495
IAS 16 Property, Plant and Equipment, 39, 322, Internally generated intangible assets, 68, 69
651 International Accounting Standards (IAS), 25
IAS 2 Inventories, 367 International Accounting Standards Committee
IAS 20 Accounting for Government Grants, 129 (IASC), 25
IAS 24 Related Party Disclosures, 518 International Public Sector Accounting
Standards (IPSAS), 557
IAS 27 Separate Financial Statements, 154, 260
Interpreting asset turnover ratio, 521
IAS 28 Investments in Associates and Joint
Ventures, 260 Intragroup dividends, 221
IAS 36 Impairment of Assets, 85, 322 Inventories, 367
IAS 37 Provisions, Contingent Liabilities and Inventory holding period, 491
Contingent Assets, 343 Investing activities, 532
IAS 38 Intangible Assets, 385 Investment property, 49
IAS 40 Investment Property, 322 Investment property (IAS 40), 49, 572
IAS 41 Agriculture, 370
J
IAS 7 Statement of Cash Flows, 531
Judgement, 426
IAS 8 Accounting Policies, Changes in
Accounting Estimates and Errors, 130, 426 K
IASB Conference, 29 Key Performance Indicators (KPIs), 558
Identifiable non-monetary asset, 67
Identify the performance obligations, 116
L
IFRS 13 Fair Value Measurement, 11, 371 Lease, 317
IFRS 15 Revenue from Contracts with Leases of assets with a low underlying value,
Customers, 325 324
IFRS 15 – Five steps to recognise and measure Legal and constructive obligations, 345
revenue, 115 Legal obligation, 347
IFRS 15, Revenue from Contracts with Let out clause, 354
Customers, 347 Liability, 8
IFRS 3 Business Combinations, 156, 590, 176 Limitations of eps, 473
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Index 837

Limitations of financial statements, 700 Present obligation, 345
Limitations of ratio analysis, 520 Present obligations and obligating events, 345
Limitations of the historical cost basis for Presentational currency, 435
measurement, 11 Price/earnings (P/E) ratio, 496
Limitations of using current value, 12 Primary users, 5
Liquidity, 687 Principle of revenue recognition, 114
M Principles-based versus rules-based, 25
Management’s stewardship, 5 Prior period errors, 428
Matching, 5 Probable that an outflow of resources, 345
Measurement, 10 Probable transfer of economic benefits, 636
Measurement of financial assets, 300 Problems of historical financial information, 517
Measurement of financial liabilities, 303 Procedure for rights issue, 680
Mid‑year acquisitions, 220 Profitability ratios, 485
Monetary assets, 67 Property, plant and equipment, 39
Provision, 345, 387
N
Provisions for restructuring, 350
Negative goodwill, 181
Public sector, 557
Net (operating) profit margin, 486
Purchased goodwill, 589
Net realisable value, 368, 650
Non-cash consideration, 118 Q
Non-current assets, 403 Qualitative characteristics, 5
Not-for-profit, 557 Quick (acid-test) ratio, 490
O R
Objective of general purpose financial Ratio analysis, 484
reporting, 5 Receivables collection period, 491
Objectives of the IASB, 26 Recognition, 9
Obligating event, 345 Recognition criteria, 68
Obsolescence, 650 Recognition of an intangible asset, 576
Onerous contracts, 349 Recognition of impairment losses, 88
Operating activities, 532 Recoverable amount, 85, 429
Operating cycle, 403 Regulatory framework, 25
Options, warrants and their equivalents, 465 Related party (IAS 24), 518
Ordinary shares, 465 Relevance, 5
Owner-occupied property, 49 Reliable estimate, 345
Repayment of grants, 130
P
Replacements and Overhauls, 48
Parent, 152
Reporting dates, 591
Payables payment period, 492
Research, 69
Performance measurement, 716
Research and development costs, 576
Performance obligation, 114
Residual value, 39, 572
Performance obligation is satisfied, 115
Restructuring, 350
Performance obligations satisfied over time, 119
Restructuring and future operating losses, 183,
Potential ordinary share, 465, 470
596
Power, 152
Retirements and disposals, 568
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Return on capital employed, 485 Timeliness, 7
Return on equity, 488 Transaction is not a sale per IFRS 15, 326
Revaluation model, 72 Transaction price, 114
Revaluation of depreciated assets, 44 Transfer of control, 114
Revaluation of non-current assets, 386 Transfers to or from investment property, 50
Revaluation surplus, 42
U
Revaluations, 796
Underlying asset, 317
Reversal of an impairment loss, 91
Understandability, 7
Reversing a previous decrease in value, 43
Uniform accounting policies, 591
Review of the useful life, 571
Upstream transaction, 262
Right-of-use asset, 321
US GAAP, 25
Rights issue, 468
Useful life, 39
S
V
Sale and leaseback transactions, 325
Value in use, 12, 579, 429
Seasonal trading, 700
Value in use of an asset, 85
Self-constructed assets, 567
Variable consideration, 117
Short term liquidity and efficiency, 489
Verifiability, 7
Short-term leases, 324
Significant influence, 153, 259 W
Statement of cash flows, 531 Warranties, 127, 347
Statement of financial position, 401 Weighted average cost, 368
Statement of profit or loss and other Working capital cycle, 492
comprehensive income, 405 World Bank, 26
Statement of Recommended Practice (SORP),
557
Subsequent measurement of the right-of-use
asset, 321
Subsidiary, 152
T
Tax base, 379
Tax expense (tax income), 379
Taxable profit (tax loss), 379
Taxable temporary differences, 379
Temporary difference, 379
The Conceptual Framework for General
Purpose Financial Reporting by Public Sector
Entities, 715
The existence of a significant financing
component, 117
The IFRS Foundation and the International
Accounting Standards Board (IASB), 25
The International Federation of Accountants
(IFAC), 557
The Three Es, 558
Theoretical ex-rights price (TERP), 469
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Index 839

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Bibliography
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ACCA (2018) Analysing a statement of cash flows [Online] Available from:
www.accaglobal.com/uk/en/student/exam-support-resources/fundamentals-exams-study-
resources/f7/technical-articles/analysing-cashflows.html [Accessed October 2021]
IFRS Foundation (2018) IFRS [Online] Available from: http://eifrs.ifrs.org [Accessed October 2021]
International Accounting Standards Board (2001) Statement of Cash Flows IAS 7 [Online] Available
from: http://eifrs.ifrs.org [Accessed October 2021]
International Accounting Standards Board (2001) Income Taxes IAS 12 [Online] Available from:
http://eifrs.ifrs.org [Accessed October 2021]
International Accounting Standards Board (2001) Provisions, Contingent Liabilities and
Contingent Assets IAS 37 [Online] Available from: http://eifrs.ifrs.org [Accessed October 2021]
International Accounting Standards Board (2003) Property, Plant and Equipment IAS 16 [Online]
Available from: http://eifrs.ifrs.org [Accessed October 2021]
International Accounting Standards Board (2003) The Effects of Changes in Foreign Exchange
Rates IAS 21 [Online] Available from: http://eifrs.ifrs.org [Accessed October 2021]
International Accounting Standards Board (2003) Earnings per Share IAS 33 [Online] Available
International Accounting Standards Board (2003) Financial Instruments: Presentation IAS 32
[Online] Available from: http://eifrs.ifrs.org [Accessed October 2021]
International Accounting Standards Board (2003) Inventories IAS 2 [Online] Available from:
International Accounting Standards Board (2003) Accounting policies, Changes in Accounting
Estimates and Errors IAS 8 [Online] Available from: http://eifrs.ifrs.org [Accessed October 2021]
International Accounting Standards Board (2003) Events after the Reporting Period IAS 10 [Online]
Available from: http://eifrs.ifrs.org [Accessed October 2021]
International Accounting Standards Board (2004) Impairment of Assets IAS 36 [Online] Available
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2021]
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HB2022

International Accounting Standards Board (2014) Financial Instruments IFRS 9 [Online] Available
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HB2022
Bibliography 845

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FR - BPP - Text 2023

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ACCA

For exams in June 2022,

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1 The Conceptual Framework 1

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Tangible non-current assets 565

Further question practice 719

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The PER alert

HB2022 v Financial Reporting (FR)

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Real world examples

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Chapter Summary of Essential reading content

4 Intangible assets Revision of research and development costs

5 Impairment of assets Further reading on the deﬁnitions of fair value, value in

6 Revenue and government Further reading and a worked example covering

7 Introduction to groups Exemptions from preparing consolidated ﬁnancial

8 The consolidated statement Forms of consideration (deferred, share exchange and

9 The consolidated statement Example of subsidiary acquired mid-year

12 Financial instruments Further activities on ﬁnancial instruments and

13 Leasing Further reading on identifying and accounting for a

HB2022 vii Financial Reporting (FR)

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15 Inventories and biological Revision of IAS 2 Inventories.

16 Taxation Further activities to consolidate your knowledge of

17 Presentation of published Further reading on IAS 1, including proforma ﬁnancial

18 Reporting ﬁnancial Activities on the following:

19 Earnings per share Activities on the following:

20 Interpretation of ﬁnancial Detailed further reading on ratios, including examples

21 Limitations of ﬁnancial Further reading on the limitations of ﬁnancial

22 Statements of cash ﬂow Revision of the methodology of preparing extracts from

23 Specialised, not-for-proﬁt Detail behind the primary aims and regulatory

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Brought forward knowledge

A The conceptual and regulatory framework for ﬁnancial reporting

B Accounting for transactions in ﬁnancial statements

D Preparation of ﬁnancial statements

E Employability and technology skills

B Account for transactions in accordance with IFRS Standards

C Analyse and interpret ﬁnancial statements

E Demonstrate employability and technology skills

Links to other exams

Strategic Business Strategic Business

Corporate and Financial Audit and

HB2022 ix Financial Reporting (FR)

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Achieving ACCA’s Study Guide Outcomes

A The conceptual and regulatory framework for ﬁnancial reporting

A1 The need for a conceptual framework and the characteristics Chapter 1

A2 Recognition and measurement Chapter 1

A3 Regulatory framework Chapter 2

A4 The concepts and principles of groups and consolidated Chapters 7–11

B Accounting for transactions in ﬁnancial statements

B1 Tangible non-current assets Chapter 3

B2 Intangible non-current assets Chapter 4

B3 Impairment of assets Chapter 5

B4 Inventory and biological assets Chapter 15

B5 Financial instruments Chapter 12

B7 Provisions and events after the reporting period Chapter 14

B9 Reporting ﬁnancial performance Chapters 18 and