Internationa Financial Reporting Standards IFRSA Practical Approach 9780071067898, 0071067892

Table of contents :
Cover
Contents
CHAPTER 1 INTRODUCTION TO IFRS
CHAPTER 2 FRAMEWORK
CHAPTER 3 A BRIEF OVERVIEW OF ACCOUNTING STANDARDS
IAS 1: Presentation of Financial Statements
IAS 2: Inventories
IAS 7: Cash Flow Statements
IAS 8: Accounting Policies, Changes in Accounting Estimates and Errors
IAS 10: Events After the Reporting Period
IAS 11: Construction Contracts
IAS 12: Accounting Treatment for Income Taxes
IAS 16: Property, Plant and Equipment
IAS 17: Leases
IAS 18: Revenue Recognition
IAS 19: Employee Benefits
IAS 20: Accounting for Government Grants and Disclosure of Government Assistance
IAS 21: The Eff ect of Changes in Foreign Exchange Rates
IAS 23: Borrowing Costs
IAS 24: Related Party Disclosure
IAS 26: Retirement Benefit Plans
IAS 27: Consolidated and Separate Financial Assets
IAS 28: Investment in Associates
IAS 31: Investment in Joint Ventures
IAS 32: Financial Instruments Presentation
IAS 33: Earnings Per Share
IAS 34: Interim Financial Reporting
IAS 36: Impairment of Assets
IAS 37: Provisions, Contingent Liabilities and Contingent Assets
IAS 38: Intangible Assets
IAS 39: Financial Instruments: Measurement and Recognition
IAS 40: Investment Property
IAS 41: Agriculture
IFRS 1: First Time Adoption of International Financial Reporting Standards
IFRS 2: Share—Based Payment
IFRS 3: Business Combinations
IFRS 5: Non-current Assets Held for Sale
IFRS 7: Financial Instruments—Disclosure
IFRS 8: Segment Reporting
CHAPTER 4 DIFFERENCES BETWEEN IFRS/GAAP AND ACCOUNTING STANDARDS
CHAPTER 5 PRESENTATION OF FINANCIAL STATEMENTS (IAS 1)
CHAPTER 6 INVENTORIES (IAS 2)
CHAPTER 7 CASH FLOW STATEMENT (IAS 7)
CHAPTER 8 ACCOUNTING POLICY, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS (IAS 8)
CHAPTER 9 EVENTS AFTER BALANCE SHEET DATE (IAS 10)
CHAPTER 10 CONSTRUCTION CONTRACTS (IAS 11)
CHAPTER 11 PROPERTY, PLANT AND EQUIPMENT (IAS 16)
CHAPTER 12 REVENUE RECOGNITION (IAS 18)
CHAPTER 13 PROVISIONS, CONTINGENT ASSETS AND CONTINGENT LIABILITIES (IAS 37)
CHAPTER 14 INTANGIBLE ASSETS (IAS 38)
Glossary

Citation preview

Assistant Professor Shri Ram College of Commerce University of Delhi

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.

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To Dear God my husband, Jagatjeet my two little angels, Tashfee and Ishnoor my ever-loving in-laws and parents

A book on IFRS has become a necessity for all accounting students. There are a lot of books on IFRS available in market. But they all are full of complex data and concepts. This book is written in a simple and easy-tounderstand manner and is written specifically for the Indian students. This book was conceptualised when I realised the increasing need to familiarise students with the reporting standards issued by the International Accounting Standards Board (IASB), which are being widely accepted across the world. Going down the memory lane, I remember that I was always inspired to have those teachers who were able to give the content in a manner that was compact, interesting, quick to understand and easily digestible. As students, we all look forward to a book that not only help us in understanding the key points of the subject but also provides us memory tips and guidance useful in preparing for the examination. With my 15 years of teaching experience, I presume that you are looking for a book that has the following key features: ∑

Makes IFRS / IAS accessible for you

∑

Emphasises on must-to-know standards

∑

Elaborates the need for and the story behind the standards

∑

Focuses on key essential points that help you in preparing for the examination

∑

Provides memory devices

Therefore, while writing this book, I have tired to keep all the above parameters under consideration.

About the Book

� Examples

�

Key Definitions

�

Memory Devices

�

Student Corner

�

Common Mistake

Preface About the Book Abbreviations

vii viii xi

CHAPTER 1

INTRODUCTION TO IFRS

03

CHAPTER 2

FRAMEWORK

23

CHAPTER 3

A BRIEF OVERVIEW OF ACCOUNTING STANDARDS

31

IAS 1: IAS 2: IAS 7: IAS 8:

Presentation of Financial Statements Inventories Cash Flow Statements Accounting Policies, Changes in Accounting Estimates and Errors IAS 10: Events After the Reporting Period IAS 11: Construction Contracts IAS 12: Accounting Treatment for Income Taxes IAS 16: Property, Plant and Equipment IAS 17: Leases IAS 18: Revenue Recognition IAS 19: Employee Benefits IAS 20: Accounting for Government Grants and Disclosure of Government Assistance IAS 21: The Effect of Changes in Foreign Exchange Rates IAS 23: Borrowing Costs IAS 24: Related Party Disclosure IAS 26: Retirement Benefit Plans IAS 27: Consolidated and Separate Financial Assets IAS 28: Investment in Associates IAS 31: Investment in Joint Ventures IAS 32: Financial Instruments Presentation IAS 33: Earnings Per Share IAS 34: Interim Financial Reporting

33 37 40 45 49 52 55 58 63 67 72 77 81 85 88 92 94 98 102 107 112 117

IAS 36: Impairment of Assets 120 IAS 37: Provisions, Contingent Liabilities and Contingent Assets 125 IAS 38: Intangible Assets 129 IAS 39: Financial Instruments: Measurement and Recognition 136 IAS 40: Investment Property 142 IAS 41: Agriculture 145 IFRS 1: First Time Adoption of International Financial Reporting Standards 148 IFRS 2: Share—Based Payment 151 IFRS 3: Business Combinations 154 IFRS 5: Non-current Assets Held for Sale 158 IFRS 7: Financial Instruments—Disclosure 161 IFRS 8: Segment Reporting 162

CHAPTER 4

CHAPTER 5 CHAPTER 6 CHAPTER 7 CHAPTER 8 CHAPTER 9 CHAPTER 10 CHAPTER 11 CHAPTER 12 CHAPTER 13 CHAPTER 14 Glossary

DIFFERENCES BETWEEN IFRS/GAAP AND ACCOUNTING STANDARDS

PRESENTATION OF FINANCIAL STATEMENTS �IAS 1� INVENTORIES �IAS 2� CASH FLOW STATEMENT �IAS 7� ACCOUNTING POLICY, CHANGES IN ACCOU� NTING ESTIMATES AND ERRORS �IAS 8� EVENTS AFTER BALANCE SHEET DATE �IAS 10� CONSTRUCTION CONTRACTS �IAS 11� PROPERTY, PLANT AND EQUIPMENT �IAS 16� REVENUE RECOGNITION �IAS 18� PROVISIONS, CONTINGENT ASSETS AND CONTINGENT LIABILITIES �IAS 37� INTANGIBLE ASSETS �IAS 38�

165

185 207 223 251 267 283 297 331 349 367 386

1. AS

Accounting Standards

2. ASB

Accounting Standards Board

3. EU

European Union

4. GAAP Generally Accepted Accounting Principles 5. IAS

International Accounting Standards

6. IASB

International Accounting Standards Board

7. IASC

International Accounting Standards Committee

8. ICAI

Institute of Chartered Accountants of India

9. IFAC

International Federation of Accountants

10. IFRS

International Financial Reporting Standards

11. IFRIC International Financial Reporting Interpretation Committee 12. IOSCO International Organization of Securities Commissioners 13. NACAS National Advisory Committee on Accounting Standards 14. SAC

Standards Advisory Council

15. SEBI

Securities and Exchange Board of India

16. SIC

Standard Interpretation Committee

17. SME

Small and Medium Enterprises

PART - I GENERAL OVERVIEW

CHAPTER 1 INTRODUCTION TO IFRS 'Whether Indian companies like it or not, the new era of global accounting appears unstoppable...'

CHAPTER 1 Accounting has been developed in response to the need to keep a record of transactions between the organization and various parties. But, for many years the practice of financial accounting lacked a generally accepted theory that could clearly enunciate the objective of financial reporting, the required qualitative characteristics of financial information or provided clear guidance as to when and how to recognize and measure the various elements of accounting. Over the years, a set of rules were developed as generalizations of existing practices. But, in absence of an accounting theory, accounting standards were evolved in an ad-hoc manner with numerous inconsistencies among them.

Framework of Accounting If the practice of financial reporting is to be developed logically and consistently (important for creating public confidence in the practice of accounting), its important to: q Develop consensus on issue like meaning and scope of financial reporting q Objective of financial reporting q Qualitative characteristics that financial information should possess q Elements of financial reporting q Measurement rules to be employed in relation to various elements of accounting

There should be an agreement on the above fundamental issues, else accounting standards will be developed in an ad-hoc or piecemeal manner. Keeping all the parameters under consideration, accounting framework was created not only to make sure the right formulations of various accounting standards but also their right implementation and regulation. The broad accounting framework consists of four pillars: q The Conceptual framework q The Legal framework q The Regulatory framework q The Institutional framework

Let us try to understand these frameworks briefly. THE CONCEPTUAL FRAMEWORK The conceptual framework is a coherent system of interrelated objectives and fundamentals that is expected to lead to consistent standards. It provides a theory of accounting which is structured in nature. It is based on the normative theory and prescribes the nature, function and limits of financial accounting and reporting. It helps in removing the inconsistencies and differences between the various standards. THE LEGAL AND THE REGULATORY FRAMEWORK The legal framework is the requirements as per law w.r.t the maintenance of books, records and system of internal controls to be maintained by the companies. And the regulatory framework oversees all the requirements and disclosures as demanded by the authorities in preparing and presenting the financial statements. These include directives under Companies Act 1956, Income tax Act 1969, SEBI Guidelines, Reserve Bank of India rules. The various regulatory authorities are NACAS, ASB, ICAI, MCA etc THE INSTITUTIONAL FRAMEWORK This refers to the apex body that develops standards keeping in mind the conceptual A PRACTICAL APPROACH TO IFRS

O Pg. 5

framework which at present is International Accounting Standards Board (IASB) in London. IASB is committed to 'A single set of high quality global accounting standards resulting in transparent and comparable information for one global capital market.' These standards are known as INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS). The main constituents are: q International

Financial Reporting Standards (IFRS): 1 - 9

q International

Accounting Standards (IAS): Till 41

q International

Financial Reporting Interpretations Committee (IFRIC) - 16 Interpretations

q Standing

Interpretations Committee (SIC) - 11 Interpretations

IFRS refers to the above entire body of pronouncements including interpretations.

IFRS – A Broad Framework Every Standard under IFRS has following sections to facilitate reading, interpretation and application – Introduction : a brief highlight – Standards : the main content – Basis of Conclusion (BC) : the reasons of conclusions – Implementation Guidelines (IG) : the rules and guidelines – Illustrative Examples (IE) : examples to illustrate implementation Dissenting Opinions of board members, if any

IFRS – Process of Standard Setting Every standard before being finalized has to pass through the following six stages: Stage I : On the very onset, its required to identify the various important accounting issues that need a standard for its proper regulation. This is known as the agenda setting stage. Stage II : The second stage is that of Project planning. It includes taking into account the various important elements relating to the selected agenda. Stage III : After earmarking the various elements to be considered, the next step by the members is to develop and publish a discussion paper. A discussion paper highlights the broad framework of the standard and the issues and their conclusions undertaken for discussion. Stage IV : The next stage is to prepare an Exposure draft and make it open to the general public for comments on it. Stage V : After incorporating the valid comments on the exposure draft, the next stage is to develop and publish the standard. Stage VI : Once the standard has been published, the final stage is of reviewing it.

International Financial Reporting Interpretations Committee (IFRIC) Apart from the basic standards, IFRS also includes interpretations issued by IFRIC. These are interpretations of the reporting standards (IASs and IFRSs) and developed by the IFRS Interpretations Committee*. The Interpretations Committee replaced the former Standing Interpretations Committee (SIC) in March 2002. The Interpretations Committee's mission (from the IASCF Constitution) is "to interpret the application of International Accounting A PRACTICAL APPROACH TO IFRS

O Pg. 6

Standards (IASs) and International Financial Reporting Standards (IFRSs) and provide timely guidance on financial reporting issues not specifically addressed in IASs and IFRSs, in the context of the IASB Framework, and undertake other tasks at the request of the IASB". There are at present 16 IFRICs. These interpretations tend to deal with reporting issues where unsatisfactory practice has arisen or where the Standards lack guidance in particular business circumstances. *At their meeting in January 2010, the IASCF Trustees voted to rename the International Financial Reporting Interpretations Committee (IFRIC) to the IFRS Interpretations Committee. The name change is being implemented as of 31 March 2010.

Striking Features of IFRS IFRS are principle- based standards as compared to the rule-based GAAP. This means that they have an distinct advantage that transactions cannot be manipulated easily.

l

IFRS lays down treatments based on the economic substance of various events and transactions rather than their legal form. l Under the IFRS, the 'historical cost' concept has been abandoned and replaced by a 'current cost' system for a more accurate financial reporting. The concept of 'fair value' accounting has taken over 'historical cost' accounting in financial reporting to improve the relevance of the information contained in financial reports and getting the balance sheet right. This has the following impact: (a) Fair value increases the transparency of the impact of market forces on financial information by taking the current valuations into account. (b) The fair value balance sheet restates the financial statements on its fair market value as on the balance sheet date. It refocuses on the BALANCE SHEET as the PRIMARY tool in decision making. (c) Fair valuation of assets and liabilities result in unrealized gains and losses from one accounting period to another leading to distortion in the income statement. (d) One person's fair value may be different from another's fair value which might lead to distortion of financial statements. (e) Fair value system is characterized by matching the assets with the liabilities which makes it more difficult to match the revenues and the expenses when compared to the financial statements based on the historical cost. l

Presentation of Financial Statements (IAS 1) is significantly different from IGAAP which follows the Schedule VI of the Companies Act, 1956. For example:

l

IFRS requires clean segregation of Assets and Liabilities into 'Current' and 'Non-Current' groups. At present the liquidity basis is preferred as per the Companies Act.

o

IFRS also requires preparation of Statement of Other Comprehensive Income (SoCI) and Statement of Changes in Equity (SoCE) apart from P&L Account and Balance Sheet.

o

Functional grouping of expenses is generally preferred such as production expenses, administrative expenses, selling & distribution expenses in IFRS. o Under IFRS there is no concept of extraordinary or exceptional items' as in AS 5. All events/transactions are considered as normal course of business. Material items may be disclosed separately but cannot be termed as extraordinary or exceptional. o

A PRACTICAL APPROACH TO IFRS

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IFRS requires stringent disclosure of: Critical judgment of management in applying accounting policies u Key sources of estimation uncertainty that have significant risks u Information that enables users to evaluate entity's objectives, policies and process of managing capital.

o

u

Indian Entities prepare Financial Statements in Indian rupees. Under IFRS, an entity measures its assets, liabilities, revenues & expenses in its functional currency. Functional currency is the currency of the primary environment in which the entity operates which may be different from the local currency of a country.

l

IFRS requires annual reassessment of useful life of assets. Earlier depreciation was stopped once asset is retired from active use. But under IFRS, depreciation is to be allowed till the time of actual de-recognition of asset from the books.

l

IFRS mandates Component Accounting. Under this approach, each major part of an item of equipment with a cost that is significant in relation to the total cost of an item has to be maintained and depreciated separately.

l

Genesis of IFRS Initially, all multinational and global companies were required to prepare separate financial statements for each country in which they did business, in accordance with each country's GAAP evolved from International Accounting Standards (IAS) issued by International Accounting Standards Committee (IASC) from 1973 to 2001. During this period, a series of Accounting Standards (AS) were released which were numbered numerically starting from IAS 1 and concluded with IAS 41 in December 2000.

l

IASC lasted for 27 years till the year 2001 when it was restructured to become International Accounting Standards Board (IASB). At the time of establishment of IASB, they agreed to adopt the revised set of standards issued by IASC, i.e., IAS 1-41, but any standards to be published after that would follow a series known as IFRS.

l

Earlier: Accounting standards issued by ICAI in accordance with IAS l Pronouncements of companies ACT, 1956 l SEBI guidelines l

Formulated IASC

Present:

Evolved IAS

}

IFRS used as national standards with explanatory material added Adopted by Specific l IFRS used as national Indian Co. as Formulated standards plus national standard for topics not IASB IFRS covered by IFRS l IFRS modified for national conditions l National standards 'similar to' based on or 'converged with' IFRS l

A PRACTICAL APPROACH TO IFRS

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INDIAN GAAP

}

Harmonization of INDIAN GAAP with IFRS

In 2002, the European Union (EU) adopted legislation that requires listed companies in Europe to apply IFRS in their consolidated financial statements w.e.f. 2005. This applied to more than 8000 companies in 30 countries

l

Outside Europe, many other countries have also been adopting IFRS. It has become mandatory in Africa, Asia and Latin America. In addition, countries such as Australia, Hong Kong, New Zealand, Philippines, Singapore etc. have adopted national accounting standards that mirror IFRS. The table below provides a snapshot of IFRS acceptability globally:

l

DOMESTIC LISTED ENTITIES

No. of Countries

•

IFRS required for all domestic listed companies

85

•

IFRS permitted for all domestic listed companies

24

•

IFRS required for some domestic listed companies

4 113

IFRS are increasingly becoming the set of globally accepted accounting standards that meet the needs of the world's increasingly integrated global capital markets. The adoption of standards that require high-quality, transparent, and comparable information is welcomed by investors, creditors, financial analysts and other users of financial statements. This enables comparability of financial information prepared by entities located in different parts of the world. A use of a single set of accounting standards facilitates investments and other economic decisions across borders, increases market efficiency and reduces the cost of raising capital.

l

Journey of IAS to IFRS International Accounting Standards started in mid-1960s precisely 1966 with an initial proposal to enact institution and organization like ICAEW for England and Wales; AICPA for the United States; CICA for Canada to evolve accounting standards. Consequently, Accounts International Study Group (AISG) was founded in 1967 which aggressively championed for a single international body for evolving accounting standards. As a result in 1973, an agreement was reached to establish an international body with the sole purpose of writing accounting standards to be used internationally.

l

In mid-1973, IASC was established as an agreement between the professional accounting bodies in nine countries for releasing new international standards that would be rapidly accepted and implemented worldwide. The objectives, as stated in its constitution, were to:

l

-

Formulate and publish in public interest accounting standards to be observed in the presentation of financial statement and to promote their worldwide acceptance and observance.

-

Work generally for the harmonization of important regulation, accounting standards and procedures relating to the presentation of financial statement.

Since 1982, members of ISAC consisted of all those professional accountancy bodies that were members of International Federation Of Accountants (IFAC) i.e. professional accountancy bodies in more than 100 countries.

l

A PRACTICAL APPROACH TO IFRS

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The members of IASC delegated the responsibility for all IASC activities, including standard-setting activities to IASC board, which consisted of 13 country delegations representing members of ISAC and upto four other organizations appointed by the board.

l

In 2000, the IASC received support from the International Organization of Securities Commissioners (IOSCO), the primary forum for International Corporation among securities regulator. The IOSCO recommended its members (181 Organizations including USSEC and committee of European Securities Regulators) to permit multinational companies (MNC's) to use IASC standards along with reconciliation to national GAAP.

l

IASC issued 41 numbered standards, known as International Accounting Standards (IAS) as well as framework for the preparation and presentation. A few of these standards have been withdrawn and many are still in force. In addition, some of the interpretations issued by the IASC's interpretive body (SIC) are still in force.

l

List of IAS still in force for 2009 Financial Statements IAS 1

:

Presentation of Financial Statements

IAS 2

:

Inventories

IAS 7

:

Cash Flow Statements

IAS 8

:

Accounting Policies, Changes in Accounting Estimates and Errors

IAS 10

:

Events After the Reporting Period

IAS 11

:

Construction Contracts

IAS 12

:

Accounting Treatment for Income Taxes

IAS 16

:

Property, Plant and Equipment

IAS 17

:

Accounting for Leases

IAS 18

:

Revenue

IAS 19

:

Employee Benefits

IAS 20

:

Accounting for Government Grants

IAS 21

:

The Effects of Changes in Foreign Exchange Rates

IAS 23

:

Accounting for Borrowing Costs

IAS 24

:

Related Party Disclosure

IAS 26

:

Accounting & Reporting by Retirement Benefit Plans

IAS 27

:

Consolidated and Separate Financial Statements

IAS 28

:

Investment in Associates

IAS 31

:

Investment in Joint Ventures

IAS 32

:

Financial Instruments- Presentation

IAS 33

:

Earning Per Share

IAS 34

:

Interim Financial Reporting

IAS 36

:

Impairment of Assets

IAS 37

:

Provisions, Contingent Liabilities and Contingent Assets

IAS 38

:

Intangible Assets

IAS 39

:

Financial Instruments- Measurement & Recognition

IAS 40

:

Investment Property

IAS 41

:

Agriculture

A PRACTICAL APPROACH TO IFRS

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In 2001, fundamental changes were made to strengthen the independence and quality of the international accounting standard-setting process. And so, International Accounting Standard Committee (IASC) was replaced by the International Accounting Standards Board (IASB) as the body in charge of setting the international standards. The interpretive body of the IASC i.e. Standards Interpretation Committee (SIC) has been replaced by International Financial Reporting Interpretation Committee (IFRIC).

l

List of IFRS IFRS 1

: First time Adoption of International Financial Reporting Standards

IFRS 2

: Share Based Payment

IFRS 3

: Business Combinations

IFRS 4

: Insurance Contacts

IFRS 5

: Non-Current Assets held for Sale and Discontinued Operations.

IFRS 6

: Explanation & Evaluation of Mineral Resources

IFRS 7

: Financial Instruments; Disclosure

IFRS 8

: Operating Segments

Final Interpretations Issued by the IFRS Interpretations Committee q IFRIC

1

Changes in Existing Decommissioning, Restoration and Similar Liabilities

q IFRIC 2

Members' Shares in Co-operative Entities and Similar Instruments

q IFRIC 3

Emission Rights

q IFRIC 4

Determining Whether an Arrangement Contains a Lease

q IFRIC

5

Rights to Interests Arising from Decommissioning, Restoration and Environmental Rehabilitation Funds

q IFRIC

6

Liabilities Arising from Participating in a Specific Market - Waste Electrical and Electronic Equipment

Withdrawn June 2005

q IFRIC 7

Applying the Restatement Approach under IAS 29 Financial Reporting in Hyperinflationary Economies

q IFRIC 8

Scope of IFRS 2

q | IFRIC 9

Reassessment of Embedded Derivatives

q IFRIC 10

Interim Financial Reporting and Impairment

q IFRIC

Withdrawn effective 1 January 2010

11 IFRS 2: Group and Treasury Share Transactions Withdrawn effective 1 January 2010

A PRACTICAL APPROACH TO IFRS

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q IFRIC 12

Service Concession Arrangements

q IFRIC 13

Customer Loyalty Programs

q IFRIC

14 IAS 19 – The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction

q IFRIC 15

Agreements for the Construction of Real Estate

q IFRIC 16

Hedges of a Net Investment in a Foreign Operation

q IFRIC 17

Distributions of Non-cash Assets to Owners

q IFRIC 18

Transfers of Assets from Customers

q IFRIC 19

Extinguishing Financial Liabilities with Equity Instruments

Final Interpretations Issued by the Standing Interpretations Committee q SIC 7

Introduction of the Euro

q SIC 10

Government Assistance – No Specific Relation to Operating Activities

q SIC 12

Consolidation – Special Purpose Entities

q SIC 13

Jointly Controlled Entities – Non-Monetary Contributions by Venturers

q SIC 15

Operating Leases – Incentives

q SIC 21

Income Taxes – Recovery of Revalued Non-Depreciable Assets

q SIC 25

Income Taxes – Changes in the Tax Status of an Enterprise or its Shareholders

q SIC 27

Evaluating the Substance of Transactions in the Legal Form of a Lease

q SIC 29

Disclosure – Service Concession Arrangements

q SIC 31

Revenue – Barter Transactions Involving Advertising Services

q SIC 32

Intangible Assets – Web Site Costs

The organization that comprises both IASB and its trustees is the international accounting standards committee foundation ('the IASC foundation'). The objectives of this foundation as stated in its constitution are:-

l

-

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 financial statements and other financial reporting to help participants in the various capital markets of the world and other users of the information to make economic decisions.

-

To promote the use and rigorous application of those standards and,

-

In fulfilling the above objectives, to take account of, as appropriate the special needs of small and medium-sized entities and emerging economies; and

-

To bring about the convergence of national accounting standards and international financial reporting standards to high-quality solutions. A PRACTICAL APPROACH TO IFRS

O Pg. 12

PROCESS OF EVOLUTION OF IFRS

Monitoring Board

Approves and Monitors Trusted

IASC Foundation

Reports to

Informs

for

ms

Reviews Effectiveness

In

Ap

po int s

Monitors

Appoints Funds

Technically Advice SAC

IFRIC

IASB

IFRS- High quality, enforceable and global standards for publicly accountable entities

IFRS for SMEs simplified IFRS, designed for small and medium sized entities.

In 2001, IASB adopted all IAS issued by IASC as its own standards after some revision. All these standards and further new standards issued by IASB are known as IFRS.

l

Structure & Governance of IASC Foundations The governance of IASB rests with the trustees of IASC foundation. These trustees are only responsible for board strategic issues, budget, operating procedures and appointing members of IASB.

l

The board is responsible for all standard – setting activities, including development and adoption of IFRS. The board has 14 members from around the world selected by the trustees based on technical skills and market experience. It meets once a month and has 12 full – time and 2 part – time members.

l

A PRACTICAL APPROACH TO IFRS

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IASB STRUCTURE IASC foundation : 22 Trustees appointed to oversee raising of funds

Board 12 full-time and 2 part-time members to set technical agenda, approve standards, expose drafts and interpretations

IFRIC 14 members

Standard Advisory Council : Approx 40 members

Appoints Reports to Advises

Working groups for major agenda projects IFRS

29 existing IAS (1 to 41) from 1973-2000 issued by IASC + IFRS 1-8 + Interpretations

IASB is advised by Standards Advisory Council (SAC). It has about 40 members appointed by the trustees and provides a forum for organization and individuals with an interest in international financial reporting to provide advice on IASB agenda decisions and priorities.

l

IASB's interpretive body, IFRIC, is in charge of developing interpretive guidance issues that are not specifically dealt within IFRS or are likely to receive divergent or unacceptable interpretation in absence of any authoritative guidance. IFRS at present has 12 members appointed by the Trustees.

l

As a part process of developing new or revised standards, the board publishes an exposure draft of the proposed standard for public comment to obtain views of all interested parties. It also publishes a 'Basis for Conclusions' to exposure drafts and standards to explain how it reached its conclusions and to give background information if one or more board members disagree with a standard, the board publishes those dissenting opinions with the standard and forms advisory committee, groups, hold public hearings, conduct field tests to obtain advice.

l

What is IFRS? Its meaning IFRS are a set of international accounting standards, stating how particular types of transaction and other events should be reported in the financial statements. They are the guidelines and rules set by IASB which the company and organisation can follow while compiling financial statements. The creation of international standards allows investors, organization and government to compare the IFRS supported financial statements with greater ease.

l

The term IFRS has both a narrow and a broad meaning. Narrowly, IFRS refers to the new numbered series of pronouncements that IASB is issuing as distinct from the IAS series

l

A PRACTICAL APPROACH TO IFRS

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issued by its predecessor IASC. More broadly, IFRS refers to the entire body of IASB pronouncements, including standards and interpretations approved by IASB, IFRIC, IASC and SIC. IFRS is principle based, drafted lucidly and is easy to understand and apply. However, the application of IFRS require an increased use of fair values for measurement of assets and liabilities. The focus of IFRS is on getting the balance sheet right and hence can bring significant volatility to the income statement.

l

29

+ 11

+8

+ 16

IAS (revised)

SICs

IFRS

IFRICs

IFRS

FROM IAS to IFRS (Old Wine In New Bottle) 1973

2001

International Accounting Standards Committee (IASC)

International Accounting Standards Board (IASB)

2000

Future

International Accounting Standards (IAS)

IFRS Series Standards

SIC Interpretation

IAS

IAS

IFRIC interpretation

International Financial Reporting Standards (IFRS)

Advantages of Adopting IFRS 1. Common Basis of Comparison Most of the countries of the European Union have switched over to IFRS. If companies in India also switched over to IFRS, it would make transactions and dealings with companies of other countries who operate under IFRS much easier. It would also give stock holders and other interested parties a common basis of comparability. Adopting a global financial reporting basis will enable the company to be understood in the global market place. It allows company to be perceived as an international player. 2. Clarity & Productivity Under IFRS, financial makers use their own professional judgment as to how to handle a specific transaction. This will lead to less time being spent trying to follow all rules/ complications that are coupled with rule based accounting. It will also allow preparers of financial information to keep statement on a simplistic and understandable forms for investors and other companies interested in the said company's financial statements. A PRACTICAL APPROACH TO IFRS

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3. Consistent Financial Reporting Basis A consistent financial reporting basis would allow a multinational company to apply common accounting standards with its subsidiaries worldwide, which would improve internal communications, quality of reporting and group decision-making. Improved Management Information Access to International Capital Markets

Streamlining Reporting Processes

IFRS Conversion

Harmonization of Internal and External Reporting

Benchmarking with Global Peers Better Information to Investors

4. Improved Access to International Capital Markets Many Indian entities are expending and making significant acquisition in the global arena for which large amount of capital is to be required. The majority of the stock exchanges require financial information prepared under IFRS. Migration to IFRS will enable Indian entities to have access to international capital markets, reducing the risk premium that is added to those reporting under Indian GAAP. 5. Lower Cost of Capital Migration to IFRS will lower the cost of raising funds, as it will eliminate the need for preparing dual sets of financial statements. It will also reduce accountant's fees, abolish risk premiums and will enable access to all major capital markets as IFRS is globally acceptable. 6. Escape Multiple Reporting Convergence to IFRS by all group entities will enable company managements to view all components of the group on one financial reporting platform. This will eliminate the need for multiple reports and significant adjustments for preparing consolidated financial statements or filing financial statements in different stock exchange. 7. Reflect True Value of Acquisition In Indian GAAP, business combinations (with few exceptions) are recorded at carrying values rather than fair value of net assets in the acquirers book is usually not reflected separately in the financial statements, instead the amount gets added to the goodwill. Hence, the true value of the business combination is not reflected in the financial statements. IFRS will overcome this flow as it mandates accounting of net assets taken over in a business combination at fair value. It also requires recognition of intangible assets, even if they have not been recorded in the acquirer's financial statements. 8. Benchmarking with Global Peers Adoption of IFRS will enable companies to gain a broader and deeper understanding of A PRACTICAL APPROACH TO IFRS

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the entity's relative standing by looking beyond country and regional milestones. Further, adoption of IFRS will facilitate companies to set targets and milestones based on global business environment, rather than merely local ones.

Challenges of Adopting of IFRS 1. Wide Gap IFRS is very much different from the present accounting policies being followed. There are big differences expected in accounting for financial instruments, deferred taxes, business combinations and employee benefits. 2.

Increased Responsibility The change to IFRS opens up certain choices a company will have in flow to account for some items. This carries with it the responsibility of explaining to investors the reasons for the choices and the impact on financial statements. A communication strategy should be developed to prepare the market and stakeholders for potential impacts of IFRS on key performance measures.

3. Tax Implications IFRS convergence will have a significant impact on the financial statements and consequently tax liabilities. Tax authorities should ensure that there is clarity on the tax treatment of items arising from convergence to IFRS, e.g. Will government authorities tax unrealized gains arising out of the accounting required by the standard on financial instruments? From an entity's point of view, a thorough review of the existing tax planning strategies is essential to test their alignment with changes created by IFRS. 4. Distributable Profits IFRS is fair value driven, which often results in unrealized gains and losses. Whether this can be considered for the purpose of computing distributable profit, is still to be debated, in order to ensure that distribution of unrealized profits will not eventually lead to reduction of share capital.

Current Perspective in India a) Present Status of Indian Accounting Standard The Accounting Standards Board (ASB) of the Institute of Chartered Accountants of India (ICAI) formulates Accounting Standards (AS) based on the IFRS keeping in view the local conditions including legal and economic environment, which have recently been notified by the central government under the companies Act 1956.

l

Accordingly, the ASB departs from the corresponding IFRSs to maintain consistency with legal, regulatory and economic environment and keeping in view the level of preparation of the industry and the accounting professionals.

l

In some cases, departures are made on account of conceptual differences with the treatments prescribed in the IFRSs.

l

b) Indian Convergence to IFRS In line with the global trend, the Institute of Chartered Accountants of India (ICAI) has proposed a plan for convergence with IFRS w.e.f. April 1, 2011.

l

In India, the institute of chartered accountants of India (ICAI) has issued a document entitled 'Concept Paper Of Convergence With IFRS In India' to evaluate the need

l

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for Indian GAAP to change to IFRS. In this paper, the ICAI specifies that with globalization it has become imperative for India to make a formal strategy for convergence with IFRS with the objective of harmonizing with globally accepted accounting standards. The paper recognizes the advantages arising from convergence to various stakeholders, i.e. the economy, industry, investors and accounting professionals. It also highlights that convergence would require some fundamental changes to the corporate laws and regulations currently guiding the accounting and reporting space in India. Keeping all this in view ICAI in its 269th meeting held on 2.4.2006 decided to converge with IFRS. It has given deadline of 1.4.2011 for adoption of IFRS by publicinterest entities such as listed companies, banks, insurance companies and large-size entities.

l

c) Meaning of Convergence with IFRS Convergence means to achieve harmony with IFRS. It can be considered to design and maintain national accounting standards in a way that financial statements prepared in accordance with national accounting standards draw unreserved statement of compliance with IFRS, i.e., National Accounting Standards comply with all the requirement of IFRS.

l

Convergence doesn't mean that IFRS should be adopted word by word. e.g. replacing the term 'true & fair for present fairly' in IAS 1 does not lead to nonconvergence.

l

The IASB accepts in its Statement of best practice: working relationships between the IASB and other accounting standards setters that 'adding disclosure requirements or removing optional treatments do not create non-compliance with IFRS'. But, such changes should be made clear so that the users are aware of them.

l

d) IFRS Reporting in India Reporting under IFRS, as proposed IFRS, as proposed by ICAI, would be applicable for accounting periods beginning on or after April 1, 2011.

l

The first set of IFRS financial statements for the year ending March 31, 2012 would require preparation of:

l

" Opening balance sheet as on April 1, 2010. " Comparative financial statements for Year ending March 31, 2011. " Reporting

enterprises would need to ensure preparation for IFRS reporting as early as April'2010.

Date of Transition Reporting Date IFRS Opening Balance Sheet

First IFRS Financial Statements

Comparative Period April, 2010

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e) Entities Covered Under Convergence Strategy In India Keeping in view the complex nature of IFRSs and the extent of differences between the existing accounting standards and the corresponding IFRSs, the ICAI is of the view that IFRSs, should be adopted for public interest entities from the accounting periods beginning on, or after 1st April'2011 e.g. listed entities, banking, insurance companies.

l

Whose equity or debt securities are listed or are in the process of listing on any stock exchange, whether in India or outside India Which is a bank (including a cooperative bank), financial institution, a mutual fund or an insurance entity.

Whose turnover (excluding other income) exceeds `100 crore in the immediately proceeding accounting year

PUBLIC INTEREST ENTITY Which has public deposits and borrowings from banks & financial institutions in excess of `25 crore at any time during the immediately preceeding accounting year.

Which is a holding or a subsidiary of an entity mentioned earlier?

Format of IFRS in India The format of IFRS to be adopted for public interest entities should be the same as that of IFRSs, including their numbers.

l

The numbers of the existing accounting standards may be given in brackets for the purpose of easier identification.

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Wherever required, a section maybe at the end of the adopted IFRS indicating the Indian legal and regulatory position.

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The IFRSs when adopted will take into account the interpretation issued by IASB.

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IFRS for Small and Medium-sized Entities (SMEs) SMEs need not adopt all the IFRS as it will be too voluminous for them.

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A separate standard for SMEs will be formulated based on the IFRS for SMEs which is still in exposure draft stage.

l

The proposed standard represents a simplified set of standards for SME s with recognition and measurement simplified and not relevant to SME's eliminated.

l

Compliance with IFRS for SME's is not necessary to make India IFRS- compliant .

l

Role of Accounting Standard Board in Post Convergence Scenario

Determine whether each, IFRS meets specified criteria set out in local legistation/regulation

Endorse the IFRS, in the form of IFRS - equivalent Indian Accounting Standards for the local regulatory framwork with changes such as removing optional treatments and adding disclosure requirements, where appropriate

Present the Indian Accounting Standards so developed for approval of National Advisory Committee on Accounting Standards (NACAS) for the purpose of Government notification

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Categorization of IFRS by ICAI ICAI has categorized IFRS in five categories based on the extent of changes and support required from the legal and regulatory authorities.

Categories of IFRS

Category I

Category IA

Category II

Category IB

Category III

Category IIIA

Category IV

Category V

Category IIIB

Category I IFRS Category I A

Category I B

IFRSs which do not have any differences with the corresponding Indian Accounting Standards

IFRSs which have minor differences with the corresponding Indian Accounting Standards

* IAS 11, Construction Contract * IAS 23, Borrowing Cost

* IAS 2, Inventories * IAS 7, Cash Flow Statements * IAS 20, Accounting for Government Grants and Disclosure of Government Assistance * IAS 33, Earnings Per Share * IAS 36, Impairment of Assets * IAS 36, Intangible Assets

Category II IFRS IFRS which may require some time to reach a level of preparedness by industry and professionals in view of existing economic environment and other factors.

IAS 18, Revenue

IAS 40, IAS 26, IAS 21, Accounting Investment The Property and Effects of Changes in Reporting (Correspond ing IAS by Foreign is under Exchange retirement preparation) benefit Rates plans

IFRS 2, Share based Payment (Correspond ing IAS is under preparation)

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IFRS 5, Non-current assets held for sale and discontinued operations (corresponding IAS is under preparation)

Category III IFRS Category III A

Category III B

IFRS, having major differences with corresponding Indian Accounting Standards that should be taken up with IASB

IFRS, having major differences with corresponding Indian Accounting Standards and need to be examined to determine whether these should be taken with IASB or should be removed by ICAI itself

* IAS 17, Leases * IAS 19, Employee Benefits * IAS 27, Consolidates and Separate Financial Statement * IAS 28, Investment is Associates * IAS 31, Interest in Joint Ventures * IAS 37, Provision, Contingent Liabilities and Contingent Assets

* IAS 12, Income Taxes * IAS 24, Related Party Disclosures * IAS 41, Agriculture (Corresponding IAS is Under Preparation) * IFRS 3, Business Combinations * IFRS 6, Exploration for and Evaluation of Mineral Resource * IFRS 8, Operating Segments

Category IV IFRS IFRS, the adoption of which would require changes in laws/regulation because compliance with them is not possible until regulation/laws are amended.

* IAS 1 * IAS 8 * IAS 10 * IAS 16 * IAS 32 * IAS 34 * IAS 39 * IFRS 1 * IFRS 4 * IFRS 7

Presentation of Financial Statements Accounting Polices Events After the Reporting Period Property, Plant and Equipment Financial Instruments- Presentation Interim Financial Reporting Financial Instruments- Measurement & Recognition First time Adoption of International Financial Reporting Standards Insurance Contacts Financial Instruments; Disclosure

Category V IFRS, corresponding to which no Indian Accounting Standards is required for the time being; IAS 29, Financial Reporting in Hyper-Inflationary Economies.

Stage-wise Adoption Vs Immediate Implementation All At Once l The ICAI

examined whether a stage-wise approach to convergence should be followed by adopting some of the IFRS immediately of category I and II and the balance as and when the rules and regulation are changed.

l But, ICAI has adopted an approach whereby all IFRS should be adopted for defined entities

for the accounting periods commencing on or after 1/4/2011. This is because of the interrelationship between many accounting standards and their application complexity. F F F A PRACTICAL APPROACH TO IFRS

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CHAPTER 2 FRAMEWORK 'Our role is to maintain and monitor a framework in which fair competition can flourish.'

CHAPTER 2

Introduction To The Framework o The

Framework for the Preparation and Presentation of Financial Statements (the 'Framework') sets out the concepts that underlie the preparation and presentation of financial statements. They focus on the:

objectives, assumptions, characteristics, definitions, and criteria that govern financial reporting. It is also referred to as the 'conceptual framework'. o This

framework was approved in1989 by IASC and adopted by IASB in 2001. It is not an International Accounting Reporting Standard. Instead, its purpose include, first, to assist and guide the International Accounting Standards Board (IASB) as it develops new or revised Standards and, second, to assist preparers of financial statements in applying Standards and in dealing with topics that are not addressed by a Standard. Thus, in case of a conflict between the Framework and a specific Standard, the Standard prevails over the Framework.

o In the absence of a standard or an interpretation that specifically applies to a transaction,

IAS 8 requires that an entity must use its judgement in developing and applying an accounting policy that results in information that is relevant and reliable. In making that judgement, IAS 8.11 requires management to consider the definitions, recognition criteria and measurement concepts for assets, liabilities, income, and expenses in the Framework.

Objectives Of The Framework o Defines the objective of general purpose financial statements. The objective is to provide

information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions. o States

the underlying assumptions for preparation and presentation of financial statements.

o Identifies

the qualitative characteristics that make information in financial statements useful. The Framework identifies four principal qualitative characteristics: understandability, relevance, reliability and comparability.

o Defines the basic

elements of financial statements and the concepts for recognising and measuring them in financial statements. Elements directly related to financial position are assets, liabilities and equity. Elements directly related to performance are income.

o Explains the concept of capital and capital maintenance.

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Objective of General Purpose Financial Statements: Framework states that 'the objective of financial statements is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions.' The users of Financial Statements are : Present and Potential Investors Suppliers Employees Lenders Creditors Government The information needs of investors are deemed to be a paramount concern, and if financial statements meet their needs, it is presumed, and likely, that other users' needs would generally also be satisfied. The Framework holds that financial statement users need to evaluate the reporting entity's ability to generate cash as well as the timing and certainty of its generation. The financial position is affected by the economic resources controlled by the entity, its financial structure, its liquidity and solvency, and its capacity to adapt to changes in the environment in which it operates.

The Underlying Assumptions Normally, two assumptions underlying the preparation and presentation of financial statements are the accrual basis and going concern.

Accrual Basis When financial statements are prepared on the accrual basis of accounting, the effects of transactions and other events are recognized when they occur (and not as and when cash or its equivalent is received or paid), and they are recorded in the accounting records and reported in the financial statements of the periods to which they relate. The accrual basis assumption is also addressed in IAS 1, Presentation of Financial Statements, which clarifies that when the accrual basis of accounting is used, items are recognized as assets, liabilities, equity, income, and expenses (the elements of financial statements) when they satisfy the definitions and recognition criteria for those elements in the Framework.

EXAMPLE In December, some goods are sold on credit. Cash is received from the client in February. The transaction is recorded as sale in December, not when the cash is received. In December the office rent is paid for January to March. The rent cost is spread over these three months, not just expensed in full in the month that it was paid. This is the accrual basis of accounting. A PRACTICAL APPROACH TO IFRS

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Going Concern When financial statements are prepared on a going concern basis, it is assumed that the entity has neither the intention nor the need to liquidate or curtail materially the scale of its operations, but will continue it operations for the foreseeable future. If this assumption is not valid the financial statements may need to be prepared on a different basis and, if so, the basis used is disclosed. The going concern assumption is also addressed in IAS 1, which requires management to make an assessment of an entity's ability to continue as a going concern when preparing financial statements.

EXAMPLE Banks provide loans under specific conditions, including the financial performance of clients. A breach of these conditions may enable the bank to liquidate the client. In these circumstances, unless the client can secure an alternative source of finance, financial statements should not be prepared on a going concern basis.

Qualitative Characteristics of Financial Statements Qualitative characteristics are the attributes that make the information provided in the financial statements useful to users. According to the Framework, the four principal qualitative characteristics are: (1) Understandability (2) Relevance (3) Reliability (4) Comparability (1) Understandability 'Understandability' refers to information being readily understandable by users who have a reasonable knowledge of accounting, business and economic activities and a willingness to study the information with reasonable diligence. (2) Relevance 'Relevance' refers to information being relevant to the decision-making needs of users. Information has the quality of relevance when it influences the economic decisions of users by helping them evaluate past, present, or future events or confirming, or correcting, their past evaluations. The concept of relevance is closely related to the concept of materiality. The Framework describes materiality as a threshold or cut-off point for information whose omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements. The concept of materiality is further addressed in IAS 1, which specifies that each material class of A PRACTICAL APPROACH TO IFRS

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similar items shall be presented separately in the financial statements and that items of a dissimilar nature or function shall be presented separately unless they are immaterial. Under the concept of materiality, a specific disclosure requirement in a Standard or an Interpretation need not be met if the information is not material. (3) Reliability Reliability comprises representational faithfulness, substance over form, completeness, neutrality, and prudence. It suggests that these are subject to a cost/benefit constraint and that, in practice, there will often be a trade-off between characteristics. The Framework does not specifically include a 'true and fair' requirement, but says that application of the specified qualitative characteristics should result in statements that presented fairly or are true and fair. IAS 1, Presentation of Financial Statements, states that financial statements are to present fairly the financial position, financial performance, and cash flows of the reporting entity and that the achievement of a fair presentation requires the faithful representation of the effects of the reporting entity's transactions, other events and conditions. 'Reliability' refers to information being free from material error and bias and can be depended on by users to represent faithfully that it either purports to represent or could reasonably be expected to represent. According to the Framework, to be reliable, information must u Be free from material error u Be neutral, that is, free from bias u Represent faithfully the transactions and other events it either purports to represent

or could reasonably be expected to represent (representational faithfulness). If information is to represent faithfully the transactions and other events that it purports to represent, the Framework specifies that they need to be accounted for and presented in accordance with their substance and economic reality even if their legal form is different (substance over form). (4) Comparability 'Comparability' refers to information being comparable through time and across entities. To achieve comparability, like transactions and events should be accounted for similarly by an entity throughout an entity, over time for that entity, and by different entities. Consistency of presentation is also addressed in IAS 1. It specifies that the presentation and classification of items in the financial statements, as a general rule, shall be retained from one period to the next, with specified exceptions.

Elements of Financial Statements The elements of financial statements are: u Assets. An asset is a resource controlled by the entity as a result of past events and from

which future economic benefits are expected to flow to the entity. u Liabilities.

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settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. u Equity.

Equity is the residual interest in the assets of the entity after deducting all its liabilities.

u Income.

Income is increase in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.

u Expenses. Expense is decrease in economic benefits during the accounting period in the

form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.

Concepts of Capital and Capital Maintenance The Framework distinguishes between a financial concept of capital and a physical concept of capital. Most entities use a financial concept of capital, under which capital is defined in monetary terms as the net assets or equity of the entity. Under a physical concept of capital, capital is instead defined in terms of physical productive capacity of an entity. Under the financial capital maintenance concept, a profit is earned if the financial amount of the net assets at the end of the period exceeds the financial amount of net assets at the beginning of the period, after excluding any distributions to, and contributions from, owners during the period. Under the physical capital maintenance concept, a profit is instead earned if the physical productive capacity (or operating capability) of the entity (or the resources or funds needed to achieve that capacity) at the end of the period exceeds the physical productive capacity at the beginning of the period, after excluding any distributions to, and contributions from, owners during the period.

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INSIGHT While there are many similarities (e.g. objectives of financial statements) between the Framework and the conceptual framework established by FASB in the six Statements of Financial Accounting Concepts, there are differences as well. The greatest difference lies in the concepts of capital and capital maintenance, which include measurement methods to be used in recognizing elements of the financial statements. While US GAAP relies primarily on historical cost (with the exception of certain financial instruments which are carried at fair value), IFRS lists several options – historical cost, current cost, realizable value, and present value – without providing guidance on which method to implement. An additional difference is found in the elements of financial statements. While the definitions are similar for the two organizations, there are differences in the details – e.g. the line between liabilities and equity as applied to convertible debt. A minor difference is also found in the qualitative characteristics identified in each framework. The IASB Framework focuses on understandability, relevance, reliability, and comparability. US GAAP also includes these characteristics, but adds a focus on consistency – the ability to compare the financial statements of an entity at two different points in time.

RECENT DEVELOPMENTS FASB and IASB currently are revisiting their respective conceptual frameworks, the objective of which is to refine and update them and develop them into a common framework that both can use in developing accounting standards. With concurrent IASB and FASB deliberations and a single integrated staff team, this is truly an international project. A joint discussion paper on certain of these matters was issued in mid-2006, stressing the qualitative characteristics of financial statement information. Other aspects of the multiphase conceptual framework project have since been addressed. An Exposure Draft of the first phase is promised for late 2007, with earlystage exposure literature addressing subsequent parts of this project. The existing Framework is used by IASB members and staff in their debate, and they expect that those commenting on exposure drafts will articulate their arguments in terms of the Framework. However, it is not intended that the Framework can be used directly by preparers and auditors in determining all of their accounting methods.

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CHAPTER 3 A BRIEF OVERVIEW OF ACCOUNTING STANDARDS 'The Global Financial and Economic crises, by many accounts the worst since the great depression, only illustrates the urgent need for universal accounting and oversight.'

CHAPTER 3 IAS 1

PRESENTATION OF FINANCIAL STATEMENT

OBJECTIVE This Standard prescribes the basis for presentation of general purpose financial statements to ensure comparability both with the entity's financial statements of previous periods and with the financial statements of other entities. It sets out overall requirements for the presentation of financial statements, guidelines for their structure and minimum requirements for their content.

KEY NOTES OF THE STANDARD According to this standard, a complete set of financial statements comprises: (a) a statement of financial position as at the end of the period; (b) a statement of 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; and (f) a statement of financial position as at the beginning of the earliest comparative period when an entity applies an accounting policy retrospectively or makes a retrospective restatement of items in its financial statements, or when it reclassifies items in its financial statements. An entity whose financial statements comply with IFRSs shall make an explicit and unreserved statement of such compliance in the notes. An entity shall not describe financial statements as complying with IFRSs unless they comply with all the requirements of IFRSs. The application of IFRSs, with additional disclosure when necessary, is presumed to result in financial statements that achieve a fair presentation.

Certain Important Definition GOING CONCERN When preparing financial statements, management shall make an assessment of an entity's ability to continue as a going concern. An entity shall prepare financial statements on a going concern basis unless management either intends to liquidate the entity or to cease trading, or has no realistic alternative but to do so. When management is aware, in making its A PRACTICAL APPROACH TO IFRS

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assessment, of material uncertainties related to events or conditions that may cast significant doubt upon the entity's ability to continue as a going concern, the entity shall disclose those uncertainties. Materiality An entity shall present separately each material class of similar items. An entity shall present separately items of a dissimilar nature or function unless they are immaterial. Such disclosures maybe on the face of income statement or in the notes to the financial statements. Offsetting An entity shall not offset assets and liabilities or income and expenses, unless required or permitted by an IFRS. Time Period An entity shall present a complete set of financial statements (including comparative information) at least annually. Except when IFRSs permit or require otherwise, an entity shall disclose comparative information in respect of the previous period for all amounts reported in the current period's financial statements. An entity shall include comparative information for narrative and descriptive information when it is relevant to an understanding of the current period's financial statements. New Requirements IAS 1 requires an entity to present, in a statement of changes in equity, all owner changes in equity. All non-owner changes in equity are required to be presented in one statement of comprehensive income or in two statements (a separate income statement and a statement of comprehensive income). Components of comprehensive income are not permitted to be presented in the statement of changes in equity. An entity shall recognise all items of income and expense in a period in profit or loss unless an IFRS requires or permits otherwise.

When the entity changes the presentation or classification of items in its financial statements, the entity shall reclassify comparative amounts unless reclassification is impracticable. An entity shall clearly identify the financial statements and distinguish them from other information in the same published document.

The Notes Shall: (a) present information about the basis of preparation of the financial statements and the specific accounting policies used; (b) disclose the information required by IFRSs that is not presented elsewhere in the financial statements; and (c) provide information that is not presented elsewhere in the financial statements, but is relevant to an understanding of any of them. * Also refer to IFRIC 17 - Distributions of Non-Cash Assets to Owners.

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Disclosures q An entity

shall disclose in the summary of significant accounting policies or other notes, the judgements, apart from those involving estimations, that management has made in the process of applying the entity's accounting policies and that have the most significant effect on the amounts recognised in the financial statements.

q An entity shall disclose information about the assumptions it makes about the future, and

other major sources of estimation uncertainty at the end of the reporting period, that have a significant risk of resulting in a material adjustment to the carrying amounts of assets and liabilities within the next financial year. q An entity

shall disclose information that enables users of its financial statements to evaluate the entity's objectives, policies and processes for managing capital.

Q.1

Can you write out the format for the income statement? 2009 (`)

2008 (`)

x

x

Cost of Sales

(x)

(x)

Gross Profit

x

x

Distribution costs

(x)

(x)

Administrative expenses

(x)

(x)

x

x

(x)

(x)

x

x

(x)

(x)

x

x

Revenue

Profit from operations Investment income Fiance cost Profit before tax

Tax expense Profit after tax

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Q.2

What about the statement of financial position (balance sheet*)?

XYZ-Statement of Financial Position (balance sheet*) as at 31st December 2009 (in thousands of currency units)

2009(`) 2009(`) 2008(`) 2008(`) Asset Non-current Assets Current Assets Total Assets

x

x

x

x

Equity and Liabilities Equity attributable to the holders of the parent Share capital Retained earnings Non-current Liabilities Current Liabilities Total Equity and Liabilities

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IAS 2

INVENTORIES

OBJECTIVE The objective of this Standard is to prescribe the accounting treatment for inventories. A primary issue in accounting for inventories is the amount of cost to be recognised as an asset and carried forward until the related revenues are recognised. This Standard provides guidance on the determination of cost and its subsequent recognition as an expense including any written-down amount to net realisable value. It also provides guidance on the cost formulas that are used to assign costs to inventories.

Scope and Application IAS 2 applies to all inventories, except: K work in progress arising under construction contracts financial instruments K biological assets related to agricultural activity and agricultural produce at the point of

harvest IAS 2 measurement principles do not apply to the inventories held by: K producers of agricultural and forest products, agricultural produce after harvest, and

minerals and mineral products, to the extent that they are measured at net realisable value in accordance with well-established practices in those industries K commodity broker-traders who measure their inventories at fair value less costs to sell

Valuation of Inventories Inventories shall be measured at the lower of cost and net realisable value.

But what is meant by Cost and Net Realisable Value? Net realisable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. The cost of inventories shall comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. The cost of inventories shall be assigned by using the first-in, first-out (FIFO) or weighted average cost formula. An entity shall use the same cost formula for all inventories having a similar nature and use to the entity. For inventories with a A PRACTICAL APPROACH TO IFRS

Inventory cost should not include: (a) Abnormal waste (b) storage cost (c) Administrative overheads unrelated to production (d) Selling costs (e) Foreign exchange differences (f) Interest costs.

The LIFO method which had been allowed prior to 2003 revision of IAS 2 is no longer allowed.

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different nature or use, different cost formulas may be justified. However, the cost of inventories of items that are not ordinarily interchangeable and goods or services produced and segregated for specific projects shall be assigned by using specific identification of their individual costs.

Recognition of Expense When inventories are sold, the carrying amount of those inventories shall be recognised as an expense in the period in which the related revenue is recognised. The amount of inventories written down to net realisable value and all losses of inventories shall be recognised as an expense in the period in which the inventories are written down or loss has incurred. The amount of any reversal in case of written-down inventories, arising from an increase in net realisable value, shall be recognised as a reduction in the amount of inventories recognised as an expense in the period in which the reversal occurs.

Disclosures The following disclosures are required by this statement: (a) Accounting policy for inventories. (b) Carrying amount of inventories carried at fair value less costs to sell. (c) Amount of inventories written down and recognized as an expense. (d) Amount of reversal of written down values to net realisable values and the circumstances that led to such reversal. (e) Inventories pledged as securities for liabilities.

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Q.1

What is Inventory?

...or materials to be used in production (raw materials) Goods held for sale (finished goods)

... Or goods in process of production (work in progress)

WHAT IS INVENTORY?

Q.2

How is inventory valued ?

Inventories should be valued at total of the lower of cost (all costs incurred in bringing to present location and condition) and net realisable value of separate items of stock, or of groups of similar items.

A PRACTICAL APPROACH TO IFRS

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IAS 7

CASH FLOW STATEMENTS

OBJECTIVE The objective of this Standard is to require the provision of information about the historical changes in cash and cash equivalents of an entity by means of a cash flow statement that classifies cash flows during the period from operating, investing and financing activities.

What are Cash Flows? Cash flows are inflows and outflows of cash and cash equivalents. Cash comprises of cash-on-hand and demand deposits. Cash equivalents are shortterm, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value. The cash flow statement shall report cash flows during the period classified as operating, investing and financing activities.

Information about the cash flows of an entity is useful in providing users of financial statements with a basis to assess the ability of the entity to generate cash and cash equivalents and the needs of the entity to utilise those cash flows. The economic decisions that are taken by users require an evaluation of the ability of an entity to generate cash and cash equivalents and the timing and certainty of their generation.

Operating Activities Operating activities are the principal revenue-producing activities of an entity and other activities that are not investing or financing 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 and 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 financing. An entity shall report cash flows from operating activities using either: (a) the direct method, whereby major classes of gross cash receipts and gross cash payments are disclosed; or A PRACTICAL APPROACH TO IFRS

Cash flows arising from taxes on income are normally classified as operating, unless they can specifically be identified with financing or investing activities.

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(b) the indirect method, whereby 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. For operating cash flows, the direct method of presentation is encouraged but indirect method is also acceptable. The direct method shows each class of gross cash receipts and gross cash payments. The operating cash flow section of the statement of cash flows section of the cash flow statement under the direct method is as follows: Cash Receipts from Customers

xxxxxxxxx

Cash paid to Suppliers

xxxxxxxxx

Cash paid to Employees

xxxxxxxxx

Cash paid for other operating expenses

xxxxxxxxx

Interest paid

xxxxxxxxx

Income-Taxes paid

xxxxxxxxx

Net cash from operating activities

xxxxxxxxx

The indirect method adjusts accrual basis net profit or loss for the effects of non-cash transactions. The operating cash flow section of the cash flow statement under indirect method is as follows: Profit before interest and income-taxes

xxxxxxx

ADD: Non-cash and non-operating expenses

xxxxxxx

LESS: Non-operating incomes

xxxxxxx

ADD: Decrease in Assets and Increase in Liabilities

xxxxxxx

LESS: Increase in Assets and Decrease in Liabilities

xxxxxxx

LESS: Income-Taxes paid

xxxxxxx

Net cash from operating activities

xxxxxxx

Investing Activities Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents. The separate disclosure of cash flows arising from investing activities is important because the cash flows represent the extent to which expenditures have been made for resources intended to generate future income and cash flows. The aggregate cash flows arising from acquisitions and from disposals of subsidiaries or other business units shall be presented separately and classified as investing activities.

Investing and financing transactions that do not require the use of cash or cash equivalents shall be excluded from a cash flow statement. Such transactions shall be disclosed elsewhere in the financial statements in a way that provides all the relevant information about these investing and financing activities.

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Financing Activities Financing activities are activities that result in changes in the size and composition of the contributed equity and borrowings of the entity. The separate disclosure of cash flows arising from financing activities is important because it is useful in predicting claims on future cash flows by providers of capital to the entity. An entity shall report separately major classes of gross cash receipts and gross cash payments, arising from investing and financing activities. Investing and financing transactions that do not require the use of cash or cash equivalents shall be excluded from a cash flow statement. Such transactions shall be disclosed elsewhere in the financial statements in a way that provides all the relevant information about these investing and financing activities.

Foreign Currency Cash Flows Cash flows arising from transactions in a foreign currency shall be recorded in an entity's functional currency by applying to the foreign currency amount, the exchange rate between the functional currency and the foreign currency at the date of the cash flow.

Cash Flows related to extraordinary items should be classified as operating, financing or investing and disclosed separately.

The cash flows of a foreign subsidiary shall be translated at the exchange rates between the functional currency and the foreign currency at the dates of the cash flows. Unrealised gains and losses arising from changes in foreign currency exchange rates are not cash flows. However, the effect of exchange rate changes on cash and cash equivalents held or due in a foreign currency is reported in the cash flow statement in order to reconcile cash and cash equivalents at the beginning and the end of the period.

Cash and Cash Equivalents An entity shall disclose the components of cash and cash equivalents and shall present a reconciliation of the amounts in its cash flow statement with the equivalent items reported in the balance sheet. An entity shall disclose, together with a note by management, the amount of significant cash and cash equivalent balances held by the entity that are not available for use by the group.

Q.1

What are the three headings required by IAS 7?

Operating Activities

Investing Activities

A PRACTICAL APPROACH TO IFRS

Financing Activities

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Q. 2

Can you remember the format for cashflow from operating activities ?

Cash flows from operating activities Profit from operations

x

Adjustments for: Depreciation

x

Disposal of property, plant and equipment (gain)/loss

(x)/x

Operating cash flows before working capital changes

x

Inventories increase/decrease

(x)/x

Receivables increase/decrease

(x)/x

Payables decrease/increase

(x)/x

Cash generated from operations

Q.3

xx

Can you remember how to work out the tax paid figure in a cash flow statement? (note-primary working)

(Working 2)

Tax Account Cash paid in year

x

(for the cash flow statement) Bal c/fwd - Current tax

x

Balance c/fwd - Deferred tax

x

Bal c/fwd - Current tax

x

Balance c/fwd - Deferred tax

x

Income Statement tax for the year

x

x

A PRACTICAL APPROACH TO IFRS

x

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Can you remember how to work out the cashflow from purchase of property, plant and equipment? (Note: a primary working)

Q.4 (Working 4)

Non-current Assets/Property, Plant and Equipment Bal b/fwd (from opening

Depreciation

x x

balance sheet*

x

NBV of asset sold

= Additions in period

xx

Bal c/fwd (from closing balance sheet)*

Q. 5

x

What about the proceeds from disposal?

(Working 3)

Proceeds from Disposal of Equipment NBV of asset sold

Add: Profit made on disposal

(what you expected to get)

x

= Proceeds from sale (figure for cash flow statement)

xx

(taken to income statement) i.e. you got more than expected x

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IAS 8

ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS

OBJECTIVE The objective of this Standard is to prescribe the criteria for selecting and changing accounting policies, together with the accounting treatment and disclosure of changes in accounting policies, changes in accounting estimates and corrections of errors. The Standard is intended to enhance the relevance and reliability of an entity's financial statements, and the comparability of those financial statements over time and with the financial statements of other entities.

Accounting Policies Accounting policies are the specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements. When a Standard or an Interpretation specifically applies to a transaction, event or condition, the accounting policy or policies applied to that item shall be determined by applying the standard or interpretation and considering any relevant Implementation Guidance issued by the IASB for the standard or interpretation. In the absence of a Standard or an Interpretation that specifically applies to a transaction, other event or condition, management shall use its judgement in developing and applying an accounting policy that results in information that is relevant and reliable. In making the judgement, management shall refer to and consider the applicability of, the following sources in descending order: (a) the requirements and guidance in Standards and Interpretations dealing with similar and related issues; and (b) the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Framework.

Consistency of Accounting Policies An entity shall select and apply its accounting policies consistently for similar transactions, other events and conditions, unless a standard or an interpretation specifically requires or permits categorisation of items for which different policies may be appropriate. If a standard or an interpretation requires or permits such categorisation,

A PRACTICAL APPROACH TO IFRS

Change in accounting policies do not include applying an accounting policy to a kind of transaction or event that did not exist in the past.

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an appropriate accounting policy shall be selected and applied consistently to each category. An entity shall change an accounting policy only if the change: (a) is required by a Standard or an Interpretation; or (b) 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. An entity shall account for a change in accounting policy resulting from the initial application of a Standard or an Interpretation in accordance with the specific transitional provisions, if any, in that Standard or Interpretation. When an entity changes an accounting policy upon initial application of a Standard or an Interpretation that does not include specific transitional provisions applying to that change, or changes an accounting policy voluntarily, it shall apply the change retrospectively. However, a change in accounting policy shall be applied retrospectively except to the extent that it is impracticable to determine either the periodspecific effects or the cumulative effect of the change.

Change in Accounting Estimate The use of reasonable estimates is an essential part of the preparation of financial statements and does not undermine their reliability. A change in accounting estimate is an adjustment of the carrying amount of an asset or a liability, or the amount of the periodic consumption of an asset, that results from the assessment of the present status of, and expected future benefits and obligations associated with, assets and liabilities. The effect of a change in an accounting estimate, shall be recognised prospectively by including it in profit or loss in:

Changes in accounting estimates result from new information or new developments and, accordingly, are not corrections of errors.

(a) the period of the change, if the change affects that period only; or (b) the period of the change and future periods, if the change affects both.

Prior Period Errors Prior period errors are 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 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. Such errors include the effects of mathematical mistakes, mistakes in applying accounting policies, oversights or misinterpretations of facts, and fraud. Except to the extent that it is impracticable to determine either the period-specific effects or the cumulative effect of the error, an entity shall correct material prior period errors retrospectively in the first set of financial statements authorised for issue after their discovery by: (a) restating the comparative amounts for the prior period(s) presented in which the error occurred; or A PRACTICAL APPROACH TO IFRS

O Pg. 46

(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. Omissions or misstatements of items are material if they could, individually or collectively, influence the economic decisions of users taken on the basis of the financial statements.

Q. 1

What is difference between a change in accounting policy and a change in accounting estimate?

A change is accounting policy

A change in the specific principles, bases, conventions, rules and practices applied by an entity

Q. 2

A change is accounting estimate

An adjustment of the carrying amount of an asset or a liability, or the amount of periodic consumption of an asset. A change in an accounting estimate is not a change in policy or correction of errors

Give five examples of changes in accounting policy.

A

-

Asset measurement changed from depreciated historic cost to revaluation

R

-

Revenue recognition policy is changed

E

-

Expenses reclassified from cost of sales to admin

A

-

A new accounting standard forces change

L

-

Legislation changes

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Q. 3

Give three examples of changes in accounting estimate.

A

-

Provisions for warranty obligations

B

-

Useful lives of property, plant and equipment

C

-

Bad debts

Q. 4

If a company has made a material change to an accounting policy in preparing its current financial statements, what disclosures are required?

The reasons for the change.

The amount of the adjustment in the current period and in comparative information for prior periods.

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IAS 10

EVENTS AFTER THE REPORTING PERIOD

OBJECTIVE The objective of this Standard is to prescribe: (a) when an entity should adjust its financial statements for events after the balance sheet date; and (b) the disclosures that an entity should give about the date when the financial statements were authorised for issue and about events after the balance sheet date. The Standard also requires that an entity should not prepare its financial statements on a going concern basis if events after the balance sheet date indicate that the going concern assumption is not appropriate.

Events After the Reporting Period Events after the balance sheet date are those events, favourable and unfavourable, that occur between the balance sheet date and the date when the financial statements are authorised for issue. Two types of events can be identified: (a) those that provide evidence of conditions that existed at the balance sheet date (adjusting events after the balance sheet date); and (b) those that are indicative of conditions that arose after the balance sheet date (non-adjusting events after the balance sheet date).

If an enterprise declares a dividend after the reporting period, the enterprise shall not recognize those dividends as liability at the end of the reporting period. It is a Non-adjusting event.

An entity shall adjust the amounts recognised in its financial statements to reflect adjusting events after the balance sheet date. An entity shall not adjust the amounts recognised in its financial statements to reflect nonadjusting events after the balance sheet date.

Disclosures If non-adjusting events after the balance sheet date 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 balance sheet date: A PRACTICAL APPROACH TO IFRS

O Pg. 49

(a) the nature of the event; and (b) an estimate of its financial effect, or a statement that such an estimate cannot be made. If an entity receives information after the balance sheet date about conditions that existed at the balance sheet date, it shall update disclosures that relate to those conditions, in the light of the new information.

Q. 1

What are 'events after the reporting period'?

They are events, both favourable and unfavourable, that occur between the balance sheet* date and the date of approval of the accounts.

Q. 2

This is not a difficult standard but it is important right from your earliest accounting exams and therefore a cloud diagram works well.

What are the two types of event ?

Two types of event

Adjusting

A PRACTICAL APPROACH TO IFRS

NonAdjusting

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Q. 3

How do you distinguish and account for them?

Two types of event NonAdjusting

Adjusting

Those events that provide evidence of conditions that actually existed at the end of reporting period, albeit they were not known at that time.

Those post-balance sheet events that are indicative of conditions that arose after the end of reporting period.

Adjust the accounts!

A PRACTICAL APPROACH TO IFRS

Disclose in the notes

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IAS 11

CONSTRUCTION CONTRACTS

OBJECTIVE The objective of IAS 11, Construction Contracts, is to prescribe the criteria for the accounting of revenue and costs in relation to construction contracts. Due to the nature of such contracts, the commencement and completion dates are usually well separated, often crossing over an accounting period. This Standard focuses on the allocation of revenue and costs to those accounting periods in which the construction contract is executed.

Scope The Standard shall be applied in accounting for construction contracts in the financial statements of contractors. Construction contracts also include contracts for services that are directly related to the construction of an asset, such as project management or design.

Construction Contract A construction contract is a contract made for the construction of one or more assets that are closelyrelated or interdependent in their design, technology, and function or their purpose or use.

What Is Included in Contract Revenue and Costs?

If a contract covers two or more assets, the construction should be accounted for separately if: (a) separate proposals were submitted for each asset. (b) portions of the contract relating to each asset were negotiated separately, and (c) costs and revenues of each asset can be measured.

Contract revenue should include the amount agreed in the initial contract, plus revenue from alterations in the original contract work, plus claims and incentive payments that (a) are expected to be collected and (b) that can be measured reliably.

Contract costs should include costs that relate directly to the specific contract plus costs that are attributable to the contractor's general contracting activity to the extent that they can be reasonably allocated to the contract, plus such other costs that can be specifically charged to the customer under the terms of the contract.

Accounting Principles If the outcome of a construction contract can be estimated reliably, revenue and costs should be recognised in proportion to the stage of completion of contract activity. This is known as the percentage of completion method of accounting. A PRACTICAL APPROACH TO IFRS

An expected loss on a construction contract should be recognised as an expense as soon as such loss is probable.

O Pg. 52

To be able to estimate the outcome of a contract reliably, the entity must be able to make a reliable estimate of total contract revenue, the stage of completion, and the costs to complete the contract. If the outcome cannot be estimated reliably, no profit should be recognised. Instead, contract revenue should be recognised only to the extent that contract costs incurred are expected to be recoverable and contract costs should be expensed as incurred. The stage of completion of a contract can be determined in a variety of ways – including the proportion that contract costs incurred for work performed to date bear to the estimated total contract costs, surveys of work performed, or completion of a physical proportion of the contract work.

Disclosure o Amount of contract revenue recognised; o Method used to determine revenue; o Method

used to determine stage of completion; and for contracts in progress at balance sheet date: G aggregate costs incurred and recognised profit G amount of advances received G amount of retentions

Presentation The gross amount due from customers for contract work should be shown as an asset. The gross amount due to customers for contract work should be shown as a liability.

Q. 1

What is a construction contract ?

A construction contract is a contract specifically negotiated for the construction of an assets or a combination of assets that are closely interrelated or interdependent in terms of their design, technology and function or their ultimate purpose or use.

Q. 2

What are the two methods of calculating completion percentage on a project? The percentage completion can be calculated by : Work certified method =

Work certified to date Contract price

Invent a project you have quoted a price to build. Imagine it 3/4 build. Now think of the money you are do to get under the contract, that is one way of measuring the degree of completion. The work certified method conjures positive imagery-abuilding nears completion/loads of money to earned.

A PRACTICAL APPROACH TO IFRS

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Cost method =

Cost to date Total contract costs

The cost method creates more negative imagery cash going out of your bank whilst you undertake the project and under the line even more cash yet to be paid out-a sad face.

Revenue and costs on contracts should be recognised over the period of the contract. Profit should also be recognised over the period of the contract as long as it can be assessed with reasonable certainty.

Q. 3

How are losses recognised ?

Losses on contracts must be recognised in full as soon as they are foreseen.

* Also refer to IFRIC 15 - Agreement for the construction of real state. * Also refer to IFRIC 12 - Service concession arrangements.

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IAS 12

ACCOUNTING TREATMENT FOR INCOME TAXES

OBJECTIVE The objective of this Standard is to prescribe the accounting treatment for income taxes. For the purposes of this Standard, income taxes include all domestic and foreign taxes, which are based on taxable profits. Income taxes also include taxes, such as withholding taxes which are payable by a subsidiary, associate or joint venture on distributions to the reporting entity.

The principal issue in accounting for income taxes is how to account for the current and future tax consequences of: (a) the future recovery (settlement) of the carrying amount of assets (liabilities) that are recognised in an entity's balance sheet; and (b) transactions and other events of the current period that are recognised in an entity's financial statements.

Recognition Current tax for current and prior periods shall, to the extent unpaid, be recognised as a liability. If the amount already paid in respect of current and prior periods exceeds the amount due for those periods, the excess shall be recognised as an asset. Current tax liabilities (assets) for the current and prior periods shall be measured at the amount expected to be paid to (recovered from) the taxation authorities, using the tax rates (and tax laws) that have been enacted or substantively enacted by the balance sheet date. It is inherent in the recognition of an asset or liability that the reporting entity expects to recover or settle the carrying amount of that asset or liability. If it is probable that recovery or settlement of that carrying amount will make future tax payments larger (smaller) than they would be if such recovery or settlement were to have no tax consequences, this Standard requires an entity to recognise a deferred tax liability (deferred tax asset), with certain limited exceptions. A deferred tax asset shall be recognised for the carryforward of unused tax losses and unused tax credits to the extent that it is probable that future taxable profit will be available against which the unused tax losses and unused tax credits can be utilised.

Measurement Deferred tax assets and liabilities shall be measured at the tax rates that are expected to apply to the period when the asset is realised or the liability is settled, based on tax rates (and tax laws) that have been enacted or substantively enacted by the balance sheet date. A PRACTICAL APPROACH TO IFRS

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The measurement of deferred tax liabilities and deferred tax assets shall reflect the tax consequences that would follow from the manner in which the entity expects, at the balance sheet date, to recover or settle the carrying amount of its assets and liabilities. Deferred tax assets and liabilities shall not be discounted. The carrying amount of a deferred tax asset shall be reviewed at each balance sheet date. An entity shall reduce the carrying amount of a deferred tax asset to the extent that it is no longer probable that sufficient taxable profit will be available to allow the benefit of part or all of that deferred tax asset to be utilised. Any such reduction shall be reversed to the extent that it becomes probable that sufficient taxable profit will be available.

Allocation This Standard requires an entity to account for the tax consequences of transactions and other events in the same way that it accounts for the transactions and other events themselves. Thus, for transactions and other events recognised in profit or loss, any related tax effects are also recognised in profit or loss. For transactions and other events recognised directly in equity, any related tax effects are also recognised directly in equity. Similarly, the recognition of deferred tax assets and liabilities in a business combination affects the amount of goodwill arising in that business combination or the amount of any excess of the acquirer's interest in the net fair value of the acquiree's identifiable assets, liabilities and contingent liabilities over the cost of the combination.

Q. 1

How does deferred tax arise?

Deferred tax is provided in full on all temporary differences (a balance sheet calculation approach), except for any amount relating to non-deductible goodwill and assets purchased that are ineligible for capital allowances.

Q. 2

We h ave a ' te m p o ra r y difference' if the figure on the balance sheet - the Net Book Value (NBV) - is different to its 'tax base', i.e. its tax written down value (WDV) the amount that can be set against future tax bills.

Can you set out the temporary difference working which is key for all deferred tax questions?

Deferred tax is provision required for balance sheet Cost-depreciation (NBV) Tax value (WDV) Temporary difference

xx

Closing deferred tax liability (xx x tax rate) A PRACTICAL APPROACH TO IFRS

2008 `000 x x

O Pg. 56

x

Q. 3

What are the accounting entries ?

To achieve this we Dr Income statement - transfer to deferred tax Cr Balance sheet - provision for deferred tax

Q. 4

Unless we are reducing an existing pro-vision for deferred tax, we Dr Balance sheet - provision for deferred tax Cr income statement - transfer from deferred tax

Can a deferred tax asset arise and should it go on the balance sheet?

Deferred tax assets can be created (mainly for tax losses) provided it is probable that the asset will be recovered.

Q. 5

How is deferred tax measured ?

Deferred tax must not be discounted to present value.

Q. 6

The tax rate used should be the one when the difference reverse, however, based on legislation enacted or substantially enacted by the balance sheet date.

Where does it go in the format ?

Deferred tax is always presented as a non-current item on the balance sheet. If the item giving rise to the deferred tax is in reserves (for example, a revaluation of an asset), them the deferred tax should be recognised in reserves.

* Also refer to SIC 21 - Income Taxes - Recovery of Revalue non depreciable assets * Also refer to IFRIC 25 - Income Taxes - Changes in the Tax Status of an enterprise or its shareholder.

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IAS 16

PROPERTY, PLANT AND PROPERTY

OBJECTIVE The objective of this Standard is to prescribe the accounting treatment for property, plant and equipment so that users of the financial statements can discern information about an entity's investment in its property, plant and equipment and the changes in such investment. The principal issues in accounting for property, plant and equipment are the recognition of the assets, the determination of their carrying amounts and the depreciation charges and impairment losses to be recognised in relation to them.

Property, Plant and Equipment Property, plant and equipment are tangible items that: (a) are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and (b) are expected to be used during more than one period.

Recognition An item of property, plant, and equipment should be recognized as an asset if and only if: (a) it is probable that future economic benefits associated with the asset will flow to the entity and (b) the cost of the item can be measured reliably. For many years the issue of replacement of part of an asset ('subsequent costs'), often involving significant expenditure, was a difficult matter to address; merely adding the cost of the replacement part to the cost of the original asset posed certain logical flaws vis-à-vis the preexisting, and the replaced, part. The current standard states that incase of any replacements or major inspections, the carrying amount of the item of PPE replaced should be de-recognised and the cost of the new replacement be added.

Measurement at Recognition An item of property, plant and equipment that qualifies for recognition as an asset shall be measured at its cost. The cost of an item of property, plant and equipment is the cash price equivalent at the recognition date including cost of site preparation, delivery and handling, installation fees, professional fees etc. If payment is deferred beyond normal credit terms, the difference between the cash price equivalent and the total payment is recognised as interest over the period of credit. The cost of an item of property, plant and equipment comprises: (a) its purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates. A PRACTICAL APPROACH TO IFRS

O Pg. 58

(b) any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management. (c) the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located, the obligation for which an entity incurs either when the item is acquired or as a consequence of having used the item during a particular period for purposes other than to produce inventories during that period.

Measurement after Recognition An entity shall choose either the cost model or the revaluation model as its accounting policy and shall apply that policy to an entire class of property, plant and equipment.

Cost Model After recognition as an asset, an item of property, plant and equipment shall be carried at its cost less any accumulated depreciation and any accumulated impairment losses.

Revaluation Model After recognition as an asset, an item of property, plant and equipment whose fair value can be measured reliably shall be carried at a revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses. Revaluations shall be made with sufficient regularity to ensure that the carrying amount does not differ materially from that which would be determined using fair value at the balance sheet date.

Depreciation Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life. Depreciable amount is the cost of an asset, or other amount substituted for cost, less its residual value. Each part of an item of property, plant and equipment with a cost that is significant in relation to the total cost of the item shall be depreciated separately. The depreciation charge for each period shall be recognised in profit or loss unless it is included in the carrying amount of another asset. The depreciation method used shall reflect the pattern in which the asset's future economic benefits are expected to be consumed by the entity. The method of depreciation should be reviewed annually and if the pattern of consumption of benefits has changed, the method of depreciation should be changed prospectively as a change in estimate under IAS 8. The residual value of an asset is the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life. To determine whether an item of property, plant and equipment is impaired, an entity applies IAS 36 Impairment of Assets. The carrying amount of an item of property, plant and equipment shall be derecognised: (a) on disposal; or (b) when no future economic benefits are expected from its use or disposal. A PRACTICAL APPROACH TO IFRS

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Disclosure Disclosures with respect to each class of property, plant and equipment are extensive and comprise Measurement bases for determining gross carrying amounts

n

Depreciation methods

n

Useful lives or depreciation rates used

n

Gross carrying amount and accumulated depreciation (aggregated with accumulated impairment losses) at the beginning and end of the period

n

Additions

n

Assets classified as held for sale

n

Acquisitions through business combinations

n

Increases and decreases arising from revaluations and from impairment losses and reversals thereof

n

Depreciation

n

Net exchange differences recognized under IAS 21

n

Other changes

n

Existence and amounts of restrictions on ownership title

n

Assets pledged as security for liabilities

n

Assets in the course of construction

n

Contractual commitments for the acquisition of property, plant, and equipment

n

Compensation for assets impaired, lost, or given up

n

If property, plant and equipment are stated at revalued amounts, these items must be specified:

If an asset's carrying amount is increased as a result of a revaluation, the increase shall be credited directly to equity under the heading of revaluation surplus. However, the increase shall be recognised in profit or loss to the extent that it reverses a revaluation decrease of the same asset previously recognised in profit or loss. If an asset's carrying amount is decreased as a result of a revaluation, the decrease shall be recognised in profit or loss. However, the decrease shall be debited directly to equity under the heading of revaluation surplus to the extent of any credit balance existing in the revaluation surplus in respect of that asset.

The effective date of the valuation

n

Whether an independent valuer was involved

n

Methods and significant assumptions used in assessing fair values

n

The extent to which fair values were measured by reference to observable prices in an active market, recent market transactions on an arm's-length basis, or were estimated using other techniques

n

For each class of asset revalued, the carrying amount that would have been recognized if the class had not been revalued

n

The residual value and the useful life of an asset should be reviewed annually and if expectations differ from previous estimates, any change should be accounted prospectively as a change in estimate under IAS 8.

The revaluation surplus, indicating the change for the period and any restrictions on distributions to shareholders.

n

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Q. 1

Which assets are covered by IAS 16?

Property, Plant and Equipment are hell for use in the production or supply of goods and services, for

l

rental to others or for administrative purposes; and are expected to be used during more than one period.

l

Q. 2

What is deprecation ?

Depreciation is the systematic allocation of the depreciable amount (cost or valuation less residual value) of an asset over its useful economic life.

Q. 3

What is meant by 'fair value' ?

Fair value is the amount for which an asset could be exchanged between knowledgeable, willing parties in an arms length transaction.

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Q. 4

Owned assets - how are they accounted for ?

Capitalised at cost (include any directly attributable costs incurred in bringing the asset into working condition)

Owned assets how are they accounted for?

Land - no depreciation

Note - you are allowed to revalue the assets to current value (optional)

Other property, plant and equipment items - depreciate

A PRACTICAL APPROACH TO IFRS

Cost - Residual value Expected useful life

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IAS 17

LEASES

OBJECTIVE The objective of this Standard is to prescribe, for lessees and lessors, the appropriate accounting policies and disclosure to apply in relation to leases.

Scope The Standard shall be applied in accounting for leases other than (a) Leases to explore for or use non-regenerative resources such as oil, natural gas and so forth (b) Licensing arrangements for motion pictures, video recordings, music, and so on The Standard shall not be applied in the measurement of q Property

held by lessees that is an investment property (see IAS 40)

q Investment

property provided by lessors under operating leases (see IAS 40)

q Biological assets held by lessees under finance leases

(see IAS 41) q Biological

assets provided by lessors under operating leases (see IAS 41)

Classifications of leases are to be made at the inception of the lease. The inception of a lease is the earlier of the agreement date and the date of the commitment by the parties to the principal provisions of the lease.

Classification of Leases The classification of leases adopted in this Standard is based on the extent to which risks and rewards incidental to ownership of a leased asset lie with the lessor or the lessee. A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership. A lease is classified as an operating lease if it does not transfer substantially all the risks and rewards incidental to ownership.

Leases in the Financial Statements of Lessees Operating Leases Lease payments under an operating lease shall be recognised as an expense on a straight-line basis over the lease term unless another systematic basis is more representative of the time pattern of the user's benefit. Finance Leases At the commencement of the lease term, lessees shall recognise finance leases as assets and liabilities in their balance sheets at amounts equal to the fair value of the leased property or, if lower, the present value of the minimum lease payments, each determined at the inception of A PRACTICAL APPROACH TO IFRS

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the lease. The discount rate to be used in calculating the present value of the minimum lease payments is the interest rate implicit in the lease, if this is practicable to determine; if not, the lessee's incremental borrowing rate shall be used. Any initial direct costs of the lessee are added to the amount recognised as an asset. Minimum lease payments shall be apportioned between the finance charge and the reduction of the outstanding liability. The finance charge shall be allocated to each period during the lease term so as to produce a constant periodic rate of interest on the remaining balance of the liability. Contingent rents shall be charged as expenses in the periods in which they are incurred. A finance lease gives rise to depreciation expense for depreciable assets as well as finance expense for each accounting period. The depreciation policy for depreciable leased assets shall be consistent with that for depreciable assets that are owned, and the depreciation recognised shall be calculated in accordance with IAS 16 Property, Plant and Equipment and IAS 38 Intangible Assets. If there is no reasonable certainty that the lessee will obtain ownership by the end of the lease term, the asset shall be fully depreciated over the shorter of the lease term and its useful life.

Leases in the Financial Statements of Lessors Operating Leases Lessors shall present assets subject to operating leases in their balance sheets according to the nature of the asset. The depreciation policy for depreciable leased assets shall be consistent with the lessor's normal depreciation policy for similar assets, and depreciation shall be calculated in accordance with IAS 16 and IAS 38. Lease income from operating leases shall be recognised in income on a straight-line basis over the lease term, unless another systematic basis is more representative of the time pattern in which the benefit derived from the leased asset is diminished. Finance Leases Lessors shall recognise assets held under a finance lease in their balance sheets and present them as a receivable at an amount equal to the net investment in the lease. The recognition of finance income shall be based on a pattern reflecting a constant periodic rate of return on the lessor's net investment in the finance lease. Manufacturer or dealer lessors shall recognise selling profit or loss in the period, in accordance with the policy followed by the entity for outright sales. If artificially low rates of interest are quoted, selling profit shall be restricted to that which would apply if a market rate of interest were charged. Costs incurred by manufacturer or dealer lessors in connection with negotiating and arranging a lease shall be recognised as an expense when the selling profit is recognised. Sale and Leaseback Transactions A sale and leaseback transaction involves the sale of an asset and the leasing back of the same asset. The lease payment and the sale price are usually interdependent because they are negotiated as a package. The accounting treatment of a sale and leaseback transaction depends upon the type of lease involved. A PRACTICAL APPROACH TO IFRS

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Q. 1

Which assets are covered by IAS 16?

Finance lease

Q. 2

Operating lease

Can you define them both ?

A finance lease is a lease that substantially transfers the risks and rewards of ownership to the lessee. An operating lease is a lease other than a finance lease.

Q. 3

How do you decide if it is a finance lease or an operating lease ?

Land leases are operating leases unless legal title passes at the end of the lease term. Leases of land and buildings must be treated as two lease

The present value of guaranteed minimum lease payments is substantially all of the fair value of the asset at the start of the lease What are the indicators of whether the risks and rewards of ownership have passed to the leasee?

The lessee has the use of the asset for the substantial majority of its economic life

A PRACTICAL APPROACH TO IFRS

The lease transfers legal title at the end or there is a bargain purchase option for the lesses

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Q. 4

How do you account for a finance lease?

Finance lease assets are capitalised (brought on balance sheet) at their fair value, or the present value of the guaranteed minimum lease payments if lower than fair value, and a lease creditor is set up for the same amount. The non-current asset should be depreciated over the shorter of the useful economic life of the asset and the lease term. Interest is allocated to the lease creditor and charged to the income statement using either the interest rate implicit in the lease or, occasionally, the sum-of-digits method. As the rental payments are made the lease creditor falls. In numeric questions we use a leasing table to sort the numbers for us. You will need to first of all ascertain whether the lease payments are made in advance or in arrears. This is vital as it will change the calculations.

Q. 5

Can you draw a leasing table for an in arrears lease ?

Balance b/fwd

Q. 6

Balance c/fwd

Cash paid

Can you draw a leasing table for an in advance lease ?

Balance b/fwd

Q. 7

Interest

Cash paid

Capital Outstanding

Interest

Balance c/fwd

How are operating leases accounted ?

The rentals are charged to the income statement on a straight-line basis over the lease term (unless another systematic basis is more appropriate.)

No asset or liability arises except for normal accruals and prepayments.

* Also refer to IFRIC 12 - Service concession arrangements. * Also refer to SIC 15 - Operating Leases - Incentives. * Also refer to SIC 27 - Evaluating the substance of transaction in the legal form of a lease. A PRACTICAL APPROACH TO IFRS

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IAS 18

REVENUE RECOGNITION

OBJECTIVE The primary issue in accounting for revenue is determining when to recognise revenue. Revenue is recognised when it is probable that future economic benefits will flow to the entity and these benefits can be measured reliably. This Standard identifies the circumstances in which these criteria will be met and, therefore, revenue will be recognised. It also provides the accounting treatment for revenue arising from sales of goods, rendering of services and from interest, royalties and dividends.

Scope The requirements of IAS 18 are to be applied in accounting for revenue arising from: Sale of goods

n

Rendering of services

n

The use by others of the entity's assets thus yielding interest, royalties, or dividends

n

The Standard does not deal with revenue arising from the following items, as they are dealt with by other Standards: Leases (IAS 17)

n

Dividends from investments accounted under the equity method (IAS 28)

n

Insurance contracts (IFRS 4)

n

Changes in fair values of financial instruments (IAS 39)

n

Changes in the values of current assets

n

Initial recognition and changes in value of biological assets (IAS 41)

n

Initial recognition of agricultural produce (IAS 41)

n

Extraction of minerals

n

Revenue Revenue is the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an entity when those inflows result in increases in equity, other than increases relating to contributions from equity participants. This Standard shall be applied in accounting for revenue arising from the following transactions and events: (a) the sale of goods;

'Revenue' should be distinguished from 'gains.' Revenue arises from an entity's ordinary activities. Gains, however, include such items as the profit on disposal of non-current assets, or on re-translating balances in foreign currencies, or fair value adjustments to financial and non-financial assets.

(b) the rendering of services; and A PRACTICAL APPROACH TO IFRS

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(c) the use by others of entity assets yielding interest, royalties and dividends.

Recognition The recognition criteria in this Standard are usually applied separately to each transaction. However, in certain circumstances, it is necessary to apply the recognition criteria to the separately identifiable components of a single transaction in order to reflect the substance of the transaction. For example, when the selling price of a product includes The principal issue in the an identifiable amount for subsequent servicing, that recognition of revenue is its amount is deferred and recognised as revenue over the timing—at what point is it period during which the service is performed. probable that future economic Conversely, the recognition criteria are applied to two or benefit will flow to the entity more transactions together when they are linked in such and can the benefit be a way that the commercial effect cannot be understood measured reliably. without reference to the series of transactions as a whole. For example, an entity may sell goods and, at the same time, enter into a separate agreement to repurchase the goods at a later date, thus negating the substantive effect of the transaction; in such a case, the two transactions are dealt with together.

Measurement Revenue shall be measured at the fair value of the consideration received or receivable. Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction. The amount of revenue arising on a transaction is usually determined by agreement between the entity and the buyer or user of the asset. It is measured at the fair value of the consideration received or receivable taking into account the amount of any trade discounts and volume rebates allowed by the entity.

Sale of Goods Revenue from the sale of goods shall be recognised when all the following conditions have been satisfied: (a) the entity has transferred to the buyer the significant risks and rewards of ownership of the goods; (b) the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold; (c) the amount of revenue can be measured reliably; (d) it is probable that the economic benefits associated with the transaction will flow to the entity; and (e) the costs incurred or to be incurred in respect of the transaction can be measured reliably. A PRACTICAL APPROACH TO IFRS

In the case of retail sales, wherein customers have a right to return the goods or right to seek a refund, the retention of risks and rewards is not considered that 'significant' that revenue from the sale of goods is not recognized at the point when goods are sold to the customers. The risk not transferred is the risk of goods sold b eing returned by customers or the risk of customers seeking refunds. Revenue in such a situation is recognized at the time of sale provided the seller can reliably estimate future returns (based on some rational basis, such as past experience and other pertinent factors) and recognize a provision under IAS 37. O Pg. 68

Rendering of Services When the outcome of a transaction involving the rendering of services can be estimated reliably, revenue associated with the transaction shall be recognised by reference to the stage of completion of the transaction at the balance sheet date. The outcome of a transaction can be estimated reliably when all the following conditions are satisfied: (a) the amount of revenue can be measured reliably; (b) it is probable that the economic benefits associated with the transaction will flow to the entity; (c) the stage of completion of the transaction at the balance sheet date can be measured reliably; and (d) the costs incurred for the transaction and the costs to complete the transaction can be measured reliably. The recognition of revenue by reference to the stage of completion of a transaction is often referred to as the percentage of completion method. Under this method, revenue is recognised in the accounting periods in which the services are rendered. The recognition of revenue on this basis provides useful information on the extent of service activity and performance during a period. When the outcome of the transaction involving the rendering of services cannot be estimated reliably, revenue shall be recognised only to the extent of the expenses recognised that are recoverable.

Interest, Royalties and Dividends Revenue shall be recognised on the following bases: (a) interest shall be recognised using the effective interest method as set out in IAS 39. (b) royalties shall be recognised on an accrual basis in accordance with the substance of the relevant agreement; and (c) dividends shall be recognised when the shareholder's right to receive payment is established.

Disclosures The Standard requires the following disclosures: The accounting policies adopted for the recognition of revenue, including the methods for determining stage of completion for the rendering of services

n

The amount of each significant category of revenue recognized during the period, including

n

Sale of goods

l

Rendering of services

l

Interest

l

Royalties

l

Dividends

l

The amount of revenue recognized from the exchange of goods or services included in each category.

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Q. 1

How is revenue measured ?

Revenue should be measured at the fair value of the consideration received or receivable.

If revenue is deferred it should be measured at present value.

Q. 2

In a barter transaction the revenue should be the fair value of the goods received and, only if unreliable, the fair value of the goods given up.

When should revenue be recognised for sale of goods?

No retained involvement or control over the goods

Risks and rewards transferred to buyer

Measured reliably

When should revenue be recognised for sale of goods?

Probable economic benefits will flow

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Costs incurred can be measured reliably

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Q. 3

When should revenue be recognised from services ?

It is probable economic benefits will flow

Measured reliably

When should revenue be recognised from services ?

The stage of completion can be measured reliably at the balnce sheet date

The costs to complete the transaction can be measured reliably

* Also refer to IFRIC 18 - Transfer of Assets from Customers. * Also refer to IFRIC 15 - Arrangement for the Construction of Real Estate. * Also refer to IFRIC 13 - Customer Loyalty Programmes. * Also refer to IFRIC 12 - Service Concession Arrangments. * Also refer to SIC 27 - Evaluating the Substance of Transaction in the legal form of a lease. * Also refer to SIC 31 - Revenue - Barter Transaction Involving Advertising Services.

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IAS 19

EMPLOYEE BENEFITS

OBJECTIVE Employee benefits are all forms of consideration given by an entity in exchange for service rendered by employees. The objective of this Standard is to prescribe the accounting and disclosure for employee benefits. The Standard requires an entity to recognise: (a) a liability when an employee has provided service in exchange for employee benefits to be paid in the future; and (b) an expense when the entity consumes the economic benefit arising from service provided by an employee in exchange for employee benefits. The cost of providing employee benefits should be recognized in the period in which the benefit is earned by the employee rather than when it is paid or payable.

Scope This Standard shall be applied by an employer in accounting for all employee benefits, except those to which IFRS 2 Share-based Payment applies.

Short-term Employee Benefits Short-term employee benefits are employee benefits (other than termination benefits) which fall due wholly within twelve months after the end of the period in which the employees render the related service. When an employee has rendered service to an entity during an accounting period, the entity shall recognise the undiscounted amount of short-term employee benefits expected to be paid in exchange for that service: (a) as a liability (accrued expense), after deducting any amount already paid. If the amount already paid exceeds the undiscounted amount of the benefits, an entity shall recognise that excess as an asset (prepaid expense) to the extent that the prepayment will lead to, for example, a reduction in future payments or a cash refund; and (b) as an expense, unless another Standard requires or permits the inclusion of the benefits in the cost of an asset (see, for example, IAS 2 Inventories and IAS 16 Property, Plant and Equipment).

Post-employment Benefits Post-employment benefits are employee benefits (other than termination benefits) which are payable after the completion of employment. Post-employment benefit plans (PBPs) are formal or informal arrangements under which an entity provides these benefits for one or more employees. PBPs are classified as either defined contribution plans or defined benefit plans, depending on the economic substance of the plan as derived from its principal terms and conditions. A PRACTICAL APPROACH TO IFRS

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Post-employment Benefits: Defined Contribution Plans Defined contribution plans are post-employment benefit plans under which an entity pays fixed contributions into a separate fund and will have no legal or constructive obligation to pay further contributions if the fund does not hold sufficient assets to pay all employee benefits relating to employee service in the current and prior periods. Under defined contribution plans: (a) the entity's legal or constructive obligation is limited to the amount that it agrees to contribute to the fund. Thus, the amount of the post-employment benefits received by the employee is determined by the amount of contributions paid by an entity (and perhaps also the employee) to a post-employment benefit plan or to an insurance company, together with investment returns arising from the contributions; and (b) in consequence, actuarial risk (that benefits will be less than expected) and investment risk (that assets invested will be insufficient to meet expected benefits) fall on the employee. When an employee has rendered service to an entity during a period, the entity shall recognise the contribution payable to a defined contribution plan in exchange for that service: (a) as a liability (accrued expense), after deducting any contribution already paid. If the contribution already paid exceeds the contribution due for service before the balance sheet date, an entity shall recognise that excess as an asset (prepaid expense) to the extent that the prepayment will lead to, for example, a reduction in future payments or a cash refund; and (b) as an expense, unless another Standard requires or permits the inclusion of the contribution in the cost of an asset (see, for example, IAS 2 Inventories and IAS 16 Property, Plant and Equipment).

Post-employment Benefits: Defined Benefit Plans Defined benefit plans are post-employment benefit plans other than defined contribution plans. Under defined benefit plans: (a) the entity's obligation is to provide the agreed benefits to current and former employees; and (b) actuarial risk (that benefits will cost more than expected) and investment risk fall, in substance, on the entity. If actuarial or investment experience are worse than expected, the entity's obligation may be increased. Accounting by an entity for defined benefit plans involves the following steps: (a) using actuarial techniques to make a reliable estimate of the amount of benefit that employees have earned in return for their service in the current and prior periods. This requires an entity to determine how much benefit is attributable to the current and prior periods and to make estimates (actuarial assumptions) about demographic variables (such as employee turnover and A PRACTICAL APPROACH TO IFRS

Corridor Approach T h e s t a n d a rd s p e c i f i e s that if the accumulated unrecognized actuarial gains and losses exceed 10% of the defined benefit obligation or the fair value of plan assets whichever is greater, a portion of the net gain or loss is required to be recognized immediately as income or expense. Actuarial gains and losses that do not breach the 10% limits need not be recognized, although the enterprise may choose to do so.

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mortality) and financial variables (such as future increases in salaries and medical costs) that will influence the cost of the benefit. (b) discounting that benefit using the Projected Unit Credit Method in order to determine the present value of the defined benefit obligation and the current service cost. Such valuation should be carried out with sufficient regularity so that the amount recognized in the financial statements do not differ materially from those that would be determined from the balance sheet date. (c) determining the fair value of any plan assets (see paragraphs 102–104); DIFFERENTIATING DEFINED BENEFIT AND DEFINED CONTRIBUTION Under the defined benefits scheme, the benefits payable to the employees are not based solely on the amount of the contributions, as in a defined contribution scheme; rather, they are determined by the terms of the defined benefit plan. (b) This means that the risks remain with the employer, and the employer's obligation is to provide the agreed amount of benefits to current and former employees. The benefits normally are based on such factors as age, length of service, and compensation. (c) The employer retains the investment and actual risks of the plan. The accounting for defined benefit plans is more complex than defined contributions plans. (d) determining the total amount of actuarial gains and losses and the amount of those actuarial gains and losses to be recognised . (e) where a plan has been introduced or changed, determining the resulting past service cost and (f) where a plan has been curtailed or settled, determining the resulting gain or loss. Where an entity has more than one defined benefit plan, the entity applies these procedures for each material plan separately.

Other Long-term Employee Benefits Other long-term employee benefits are employee benefits (other than post-employment benefits and termination benefits) which do not fall due wholly within twelve months after the end of the period in which the employees render the related service. The Standard requires a simpler method of accounting for other long-term employee benefits than for post-employment benefits: actuarial gains and losses and past service cost are recognized immediately.

Termination Benefits Termination benefits are employee benefits payable as a result of either: (a) an entity's decision to terminate an employee's employment before the normal retirement date; or (b) an employee's decision to accept voluntary redundancy in exchange for those benefits. An entity shall recognise termination benefits as a liability and an expense when, and only when, the entity is demonstrably committed to either: (a) terminate the employment of an employee or group of employees before the normal retirement date; or (b) provide termination benefits as a result of an offer made in order to encourage voluntary redundancy. A PRACTICAL APPROACH TO IFRS

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Where termination benefits fall due more than 12 months after the balance sheet date, they shall be discounted. In the case of an offer made to encourage voluntary redundancy, the measurement of termination benefits shall be based on the number of employees expected to accept the offer.

Q. 1

What are the two types of pension scheme and how are they accounted for ?

Defined Contribution Schemes

Defined Benefit Schemes

Fixed Contribution - Variable Benefit

Recognised a cost in the income statement equal to the contributions payable to the scheme for the period. A debit in the income statement and a credit to cash with an accrual if anything is outstanding at the end of the reporting period.

Q. 2

Variable Contribution - Fixed Benefit

The scheme assets are valued at fair value (usually market value). The scheme liabilities are measured at present value.

What goes in the statement of financial position (balance sheet) on a defined benefit scheme ?

The statement of financial position (balance sheet) recognised the total of : Market value of scheme assets

x

Less the present value of the cobliagations of the fund

(x)

Balance sheet asset (liability), i.e. only the surplus/deficit

x(x)

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Q. 3

Can you draw the T accounts for the movement in the assets and liabilities ?

Pension Fund Assets Bal b/fwd Expected return on the assets Contributions Actuarial gain on assets Bal b/fwd

Note it could be actuarial losses not gains

x x x xx x

Benefits paid out

Bal c/fwd

x

x xx

Pension Fund Liability Benefits paid out Actuarial gain on assets Bal c/fwd

x x x xx

Bal b/fwd Current service cost Interest cost (1000 x 10%) Bal b/fwd

* Also refer to IFRIC 14 - The Limit on a Define Benefit Asset, Minimum Funding Requirements and their Interaction.

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x x x x x

IAS 20

ACCOUNTING FOR GOVERNMENT GRANTS AND DISCLOSURE OF GOVERNMENT ASSISTANCE

OBJECTIVE This Standard prescribes the accounting for, and in the disclosure of, government grants and in the disclosure of other forms of government assistance.

Scope IAS 20 deals with the accounting treatment and disclosure requirements of grants received by entities from government. It also mandates disclosure requirements of other forms of government assistance. The Standard provides four exclusions: (1) Special problems arising in reflecting the effects of changing prices on financial statements or similar supplementary information. (2) Government assistance provided in the form of tax benefits (including income tax holidays, investment tax credits, accelerated depreciation allowances, and concessions in tax rates). (3) Government participation in the ownership of the entity. (4) Government grants covered by IAS 41.

Government Grants Government grants are 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 that cannot reasonably have a value placed upon them and transactions with government, which cannot be distinguished from the normal trading transactions of the entity.

Government Assistance Government assistance is action by government designed to provide an economic benefit specific to an entity or range of entities qualifying under certain criteria. Government assistance for the purpose of this Standard does not include benefits provided only indirectly through action affecting general trading conditions, such as the provision of infrastructure in development areas or the imposition of trading constraints on competitors. In this Standard, government assistance does not include the provision of infrastructure by improvement to the general transport and communication network and the supply of improved facilities such as irrigation or water reticulation which is available on an ongoing A PRACTICAL APPROACH TO IFRS

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indeterminate basis for the benefit of an entire local community. A government grant may take the form of a transfer of a non-monetary asset, such as land or other resources, for the use of the entity. In these circumstances it is usual to assess the fair value of the non-monetary asset and to account for both grant and asset at that fair value.

Recognition Government grants, including non-monetary grants at fair value, shall not be recognised until there is reasonable assurance that: (a) the entity will comply with the conditions attaching to them; and (b) the grants will be received. Government grants shall be recognised as income over the periods necessary to match them with the related costs which they are intended to compensate, on a systematic basis. A government grant that becomes receivable as compensation for expenses or losses already incurred or for the purpose of giving immediate financial support to the entity with no future related costs shall be recognised as income of the period in which it becomes receivable. Grants related to assets are government grants whose primary condition is that an entity qualifying for them should purchase, construct or otherwise acquire long-term 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. Government grants related to assets, including non-monetary grants at fair value, shall be presented in the balance sheet either by setting up the grant as deferred income or by deducting the grant in arriving at the carrying amount of the asset. Grants related to income are government grants other than those related to assets. Grants related to income are sometimes presented as a credit in the income statement, either separately or under a general heading such as 'Other income'; alternatively, they are deducted in reporting the related expense.

The Standard discusses two broad approaches with respect to the accounting treatment of government grants—the 'capital approach' and the 'income approach.' IAS 20 is not in favor of the capital approach, which requires a government grant to be directly credited to the shareholders' equity. Supporting the income approach, the Standard sets out this rule for recognition of government grants: 'Government grants should be recognized as income, on a systematic and rational basis, over the periods necessary to match them with the related costs.'

A government grant that becomes repayable shall be accounted for as a revision to an accounting estimate (see IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors). Repayment of a grant related to income shall be applied first against any unamortised deferred credit set up in respect of the grant. To the extent that the repayment exceeds any such deferred credit, or where no deferred credit exists, the repayment shall be recognised immediately as an expense. Repayment of a grant related to an asset shall be recorded by increasing the carrying amount of the asset or reducing the deferred income balance by the amount repayable. The cumulative additional depreciation that would have been recognised to date as an expense in the absence of the grant shall be recognised immediately as an expense. A PRACTICAL APPROACH TO IFRS

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Disclosures The following matters shall be disclosed: (a) the accounting policy adopted for government grants, including the methods of presentation adopted in the financial statements; (b) the nature and extent of government grants recognised in the financial statements and an indication of other forms of government assistance from which the entity has directly benefited; and (c) unfulfilled conditions and other contingencies attaching to government assistance that has been recognised.

Q. 1

How are government grants accounted for, if they relate to current or future costs ?

Government grants should be recognised in the income statement to match them against the expenditure to which they contribute.

For current/future costs - in the period that the costs are recognised.

Q. 2

Grants towards future expenditure will be treated as deferred income when they are received and credited to income statement to match against the expenditure.

How are government grants accounted for, if they relate to past costs ?

For past costs incurred - immediately in the income statement.

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Q. 3

What are the two methods of recording non-current assets ?

Non-current Asset Grants

Deducted from the cost of the asset - depreciate the net amount

Treated as deferred income (a liability) in the balance sheet and released to the income statement over the useful economic life. This is matched against depreciation

Grants can only be recognised when the conditions for their receipt have been complied with. Provision must be made for the repayment of grants if this is likely to happen.

* Also refer to SIC 10 - Government Assistance - No Specific Relation to Operating Activities.

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IAS 21

THE EFFECT OF CHANGES IN FOREIGN EXCHANGE RATES

OBJECTIVE An entity may carry on foreign activities in two ways. It may have transactions in foreign currencies or it may have foreign operations. In addition, an entity may present its financial statements in a foreign currency. The objective of this Standard is to prescribe how to include foreign currency transactions and foreign operations in the financial statements of an entity and how to translate financial statements into a presentation currency. The principal issues are which exchange rate(s) to use and how to report the effects of changes in exchange rates in the financial statements.

Scope This Standard does not apply to hedge accounting for foreign currency items, including the hedging of a net investment in a foreign operation. IAS 39 applies to hedge accounting. This Standard does not apply to the presentation in a cash flow statement of cash flows arising from transactions in a foreign currency, or to the translation of cash flows of a foreign operation (see IAS 7 Cash Flow Statements).

Functional Currency Functional currency is the currency of the primary economic environment in which the entity operates. The primary economic environment in which an entity operates is normally the one in which it primarily generates and expends cash. An entity considers the following factors in determining its functional currency: (a) the currency: (i) that mainly influences sales prices for goods and services (this will often be 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 (this will often be the currency in which such costs are denominated and settled).

Reporting Foreign Currency Transactions in the Functional Currency Foreign currency is a currency other than the functional currency of the entity. Spot exchange rate is the exchange A PRACTICAL APPROACH TO IFRS

A foreign currency transaction shall be recorded, on initial recognition in the functional currency, by applying to the foreign currency amount the spot exchange rate between the functional currency and the foreign currency at the date of the transaction.

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rate for immediate delivery. Exchange difference is the difference resulting from translating a given number of units of one currency into another currency at different exchange rates. Net investment in a foreign operation is the amount of the reporting entity's interest in the net assets of that operation.

Recording Foreign Currency Transactions At each balance sheet date: (a) foreign currency monetary items shall be translated using the closing rate; (b) non-monetary items that are measured in terms of historical cost in a foreign currency shall be translated using the exchange rate at the date of the transaction; and (c) non-monetary items that are measured at fair value in a foreign currency shall be translated using the exchange rates at the date when the fair value was determined. Exchange differences arising on the settlement of monetary items or on translating monetary items at rates different from those at which they were translated on initial recognition during the period or in previous financial statements shall be recognised in profit or loss in the period in which they arise. However, exchange differences arising on a monetary item that forms part of a reporting entity's net investment in a foreign operation shall be recognised in profit or loss in the separate financial statements of the reporting entity or the individual financial statements of the foreign operation, as appropriate. In the financial statements that include the foreign operation and the reporting entity (e.g. consolidated financial statements when the foreign operation is a subsidiary), such exchange differences shall be recognised initially in a separate component of equity and recognised in profit or loss on disposal of the net investment. Furthermore, when a gain or loss on a non-monetary item is recognised directly in equity, any exchange component of that gain or loss shall be recognised directly in equity. Conversely, when a gain or loss on a non-monetary item is recognised in profit or loss, any exchange component of that gain or loss shall be recognised in profit or loss.

Translation to the Presentation Currency/Translation of a Foreign Operation The Standard permits an entity to present its financial statements in any currency (or currencies). For this purpose, an entity could be a standalone entity, a parent preparing consolidated financial statements or a parent, an investor or a venturer preparing separate financial Any goodwill arising on the statements in accordance with IAS 27 Consolidated and acquisition of a foreign operation and any fair value Separate Financial Statements. If the presentation adjustments to the carrying currency differs from the entity's functional currency, it amounts of assets and translates its results and financial position into the liabilities arising on the presentation currency. For example, when a group acquisition of that foreign contains individual entities with different functional operation shall be treated as currencies, the results and financial position of each assets and liabilities of the foreign operation. entity are expressed in a common currency so that consolidated financial statements may be presented. A PRACTICAL APPROACH TO IFRS

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An entity is required to translate its results and financial position from its functional currency into a presentation currency (or currencies) using the method required for translating a foreign operation for inclusion in the reporting entity's financial statements. The results and financial position of an entity whose functional currency is not the currency of a hyper-inflationary economy shall be translated into a different presentation currency using the following procedures: (a) assets and liabilities for each balance sheet presented (i.e. including comparatives) shall be translated at the closing rate at the date of that balance sheet; (b) income and expenses for each income statement (i.e. including comparatives) shall be translated at exchange rates at the dates of the transactions; and (c) all resulting exchange differences shall be recognised as a separate component of equity.

Translation of a Foreign Operation Foreign operation is an entity that is a subsidiary, associate, joint venture or branch of a reporting entity, the activities of which are based or conducted in a country or currency other than those of the reporting entity. On the disposal of a foreign operation, the cumulative amount of the exchange differences deferred in the separate component of equity relating to that foreign operation shall be recognised in profit or loss when the gain or loss on disposal is recognised.

Change in Functional Currency When there is a change in an entity's functional currency, the entity shall apply the translation procedures applicable to the new functional currency prospectively from the date of the change. If the functional currency is the currency of a hyper-inflationary economy, the entity's financial statements are restated in accordance with IAS 29 Financial Reporting in Hyperinflationary Economies. The results and financial position of an entity whose functional currency is the currency of a hyper-inflationary economy shall be translated into a different presentation currency using the following procedures: (a) all amounts (i.e. assets, liabilities, equity items, income and expenses, including comparatives) shall be translated at the closing rate at the date of the most recent balance sheet, except that (b) when amounts are translated into the currency of a non-hyperinflationary economy, comparative amounts shall be those that were presented as current year amounts in the relevant prior year financial statements (i.e. not adjusted for subsequent changes in the price level or subsequent changes in exchange rates).

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Q. 1

Have you learnt the rules for translation of individual company transactions/balances ?

Translation of individual company transactions into functional currency Translation Rules

Exchange Difference Treatment

(1) All transactions in the period should be translated at the rate in force on the date of the transaction (actual rate).

(1) All exchange differences are to be recognised in the income statement.

(2) At the year-end closing balances should be translated: G monetary items at closing rate G non-monetary items at historic rate. (3) It is not acceptable to use forward contract rates.

Note Actual rate can also be referred to as a 'spot rate'

Q. 2

Note Monetary items - Cash - Payables - Bank - Loans - Receivables

Note Non-Monetary items - Property, Plant and Equipment - Inventory - Investments

What are the rules for foreign subsidiaries ?

Foreign Operations The following rules apply to foreign operations with a different functional and presentation currency. Translation Rules (1) All net assets should be translated at the closing rate.

(2) Goodwill and fair value adjustments must be made in the local currency.

Exchange Difference Treatment (1) Arise on the restatement of opening net assets from opening to closing rate, and retained profit from average rate to closing rate. (2) The parent's percentage of the total exchange difference is shown as a movement in a separate item in equity (exchange difference reserve)

(3) The income statement must be translated at average rate.

Note The closing rate is the rate of exchange as at the balance sheet date * Also refer to IFRIC 16 - Hedge of a Net Investment in a Foreign Operation. A PRACTICAL APPROACH TO IFRS

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IAS 23

BORROWING COSTS

OBJECTIVE The objective of this Standard is to prescribe the accounting treatment for borrowing costs. It highlights the criteria for determining whether borrowing costs can be capitalised as part of the cost of acquiring, constructing, or producing a 'qualifying asset.'

Borrowing Costs Borrowing costs are interest and other costs incurred by an entity in connection with the borrowing of funds. Interest includes amortization of discount/premium on debt. Other costs include amortization of debt issue costs and certain foreign exchange differences that are regarded as an adjustment of interest cost.

Borrowing costs does not include actual or imputed cost of equity capital, including any preferred capital.

Qualifying Asset An asset that necessarily takes a substantial period of time to get ready for its intended use or sale. It could be property, plant and equipment, investment property during the construction period, intangible assets during development period or made to order inventories.

Accounting Treatment The Standard prescribes two alternative treatments for recognizing borrowing costs. The capitalization of borrowing costs into the cost of a qualifying asset is an 'allowed alternative treatment' under the Standard, while the 'benchmark treatment' prescribed by the Standard is to expense borrowing costs when incurred. Under Benchmark treatment the borrowing costs shall be recognised as an expense in the period in which they are incurred. Under Allowed alternative treatment the borrowing costs shall be recognised as an expense in the period in which they are incurred, except to the extent that they are capitalized.

Which costs should be capitalized? Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset shall be capitalised as part of the cost of that asset. Capitalization of borrowing costs that are directly attributable to the acquisition, construction, or production of a qualifying asset as part of the cost of the asset is possible only if both these conditions are met: It is probable that they will result in future economic benefits to the entity. The costs can be measured reliably. (If borrowing costs do not meet these criteria, then they are expensed). The amount of A PRACTICAL APPROACH TO IFRS

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borrowing costs eligible for capitalisation shall be determined in accordance with this Standard. A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale. To the extent that funds are borrowed specifically for the purpose of obtaining a qualifying asset, the amount of borrowing costs eligible for capitalisation on that asset shall be determined as the actual borrowing costs incurred on that borrowing during the period less any investment income on the temporary investment of those borrowings.

When borrowings are taken s p e c i f i c a l ly t o a c q u i r e , construct, or produce an asset, the borrowing costs that relate to that particular qualifying asset are readily identifiable. In such circumstances, it is easy to quantify the borrowing costs t h a t wo u l d n e e d to b e capitalized by using the process of elimination, that is, capitalizing the borrowing costs that would have been avoided had the expenditure on the qualifying asset not been made.

To the extent that funds are borrowed generally and used for the purpose of obtaining a qualifying asset, the amount of borrowing costs eligible for capitalisation shall be determined by applying a capitalisation rate to the expenditures on that asset. The capitalisation rate shall be the weighted average of the borrowing costs applicable to the borrowings of the entity that are outstanding during the period, other than borrowings made specifically for the purpose of obtaining a qualifying asset. The amount of When funds borrowed borrowing costs capitalised during a period shall not specifically to finance a exceed the amount of borrowing costs incurred during qualifying asset are not that period. utilized immediately, and The capitalisation of borrowing costs as part of the cost instead the idle funds are of a qualifying asset shall commence when: invested temporarily until (a) expenditures for the asset are being incurred; required, the borrowing costs (b) borrowing costs are being incurred; and that are capitalized should be reduced by any investment (c) activities that are necessary to prepare the asset for income resulting from the its intended use or sale are in progress. investment of idle funds. Capitalisation of borrowing costs shall be suspended during extended periods in which active development is interrupted. Capitalisation of borrowing costs shall cease when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete.

Borrowing costs capitalized in a period cannot exceed the amount of borrowing costs incurred by the entity during that period.

Disclosures The financial statements shall disclose: (a) the accounting policy adopted for borrowing costs; (b) the amount of borrowing costs capitalised during the period; and (c) the capitalisation rate used to determine the amount of borrowing costs eligible for capitalisation.

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Q. 1

What are the two possible accounting treatments for borrowing costs ?

Borrowing Costs ?

Benchmark treatment is that borrowing costs should be recognised as an expense in the period they are incurred

Q. 2

Borrowing costs directly attributable to the purchase, construction or production of a qualifying asset are capitalised

What is a qualifying asset ?

An asset that necessarily takes a substantial period of time to get ready for its intended use of sale.

Q. 3

What are the rules attached to the alternative treatment?

Financial costs must be capitalised for the period of construction, and must cease when all activities necessary to get the asset to its intended use have been completed. Capitalisation must also cease during periods when construction is suspended.

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IAS 24

RELATED PARTY DISCLOSURES

OBJECTIVE The objective of this Standard is to ensure that an entity's This is a disclosure financial statements contain the disclosures necessary to Standard and does not draw attention to the possibility that its financial position deal with recognition or and profit or loss may have been affected by the existence of measurement issues, all related parties and by transactions and outstanding of which are dealt with balances with such parties. The purpose of the Standard is to b y o t h e r r e l e v a n t make the reader of financial statements aware of the Standards. existence of related party relationships and the extent to which an entity's financial position, profitability, or cash flows may have been affected by transactions with such parties.

Related Parties A party is related to an entity if: (a) directly, or indirectly through one or more intermediaries, the party: (i) controls, is controlled by, or is under common control with, the entity (this includes parents, subsidiaries and fellow subsidiaries); (ii) has an interest in the entity that gives it significant influence over the entity; or (iii) has joint control over the entity; (b) the party is an associate (as defined in IAS 28 Investments in Associates) of the entity; (c) the party is a joint venture in which the entity is a venturer (see IAS 31 Interests in Joint Ventures); (d) the party is a member of the key management personnel of the entity or its parent; (e) the party is a close member of the family of any individual referred to in (a) or (d); (f) the party is an entity that is controlled, jointly controlled or significantly influenced by, or for which significant voting power in such entity resides with, directly or indirectly, any individual referred to in (d) or (e); or (g) the party is a post-employment benefit plan for the benefit of employees of the entity, or of any entity that is a related party of the entity.

Related Party Transaction A related party transaction is a transfer of resources, services or obligations between related parties, regardless of whether a price is charged.

Members of the Family Close members of the family of an individual are those family members who may be expected to influence, or be influenced by, that individual in their dealings with the entity. They may include: A PRACTICAL APPROACH TO IFRS

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(a) the individual's domestic partner and children; (b) children of the individual's domestic partner; and (c) dependants of the individual or the individual's domestic partner. Relationships between parents and subsidiaries shall be disclosed irrespective of whether there have been transactions between those related parties. An entity shall disclose the name of the entity's parent and, if different, the ultimate controlling party. If neither the entity's parent nor the ultimate controlling party produces financial statements available for public use, the name of the next most senior parent that does so shall also be disclosed.

The following are deemed not to be related: (a) Two enterprises because they have a director in common. (b) Two venturers who share joint control over a joint venture. (c) Providers of finance, trade unions, public utilities, government departments and agencies in course of their normal dealings with an enterprise. (d) A single customer, supplier, franchiser or distributorwith whom an enterprise transacts a significant volume of business.

Compensation An entity shall disclose key management personnel compensation in total and for each of the following categories: (a) short-term employee benefits; (b) post-employment benefits; (c) other long-term benefits; (d) termination benefits; and (e) share-based payment.

Disclosures If there have been transactions between related parties, an entity shall disclose the nature of the related party relationship as well as information about the transactions and outstanding balances necessary for an understanding of the potential effect of the relationship on the financial statements. These disclosure requirements are in addition to the requirements to disclose key management personnel compensation. At a minimum, disclosures shall include: (a) the amount of the transactions; (b) the amount of outstanding balances and: (i) their terms and conditions, including whether they are secured, and the nature of the consideration to be provided in settlement; and (ii) details of any guarantees given or received; (c) provisions for doubtful debts related to the amount of outstanding balances; and (d) the expense recognised during the period in respect of bad or doubtful debts due from related parties. The disclosures shall be made separately for each of the following categories: (a) the parent;

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(b) entities with joint control or significant influence over the entity; (c) subsidiaries; (d) associates; (e) joint ventures in which the entity is a venturer; (f) key management personnel of the entity or its parent; and (g) other related parties. Items of a similar nature may be disclosed in aggregate except when separate disclosure is necessary for an understanding of the effects of related party transactions on the financial statements of the entity.

Q. 1

Who are related parties ?

Under common control, e.g. two subsidiaries An entity having significant influence, e.g. associate

A controlled entity, e.g. subsidiary

Who are related parties ?

A jointly controlled entity, e.g. joint venture

Postemployment plan

Close family member

Key management personnel

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Q. 2

Who are the disclosures ?

If a related party transaction has been entered into the following disclosures should be made : a description of the relationship

G

a description of the transactions

G

the amounts involved

G

other elements of the transactions necessary for an understanding of the financial statements

G

balances with related parties at the balance sheet date (and any provision for doubtful debts from related parties)

G

amounts written off in the period on debts due to or from related parties.

G

No disclosure is required of the name of the related party.

No disclosure of related party transaction is required in 100% owned subsidiary company individual company accounts.

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IAS 26

RETIREMENT BENEFIT PLANS

OBJECTIVE This Standard shall be applied in the financial statements of retirement benefit plans where such financial statements are prepared. IAS 26 deals with accounting and reporting to all participants of a retirement benefit plan as a group, and not with reports that might be made to individuals about their particular retirement benefits. The Standard sets out the form and content of the general-purpose financial reports of retirement benefit plans. The Standard applies to: Defined contribution plans : Where benefits are determined by contributions to the plan together with investment earnings thereon. Defined benefit plans : Where benefits are determined by a formula based on employees' earnings and/or years of service.

Retirement Benefit Plans Retirement benefit plans are arrangements whereby an entity provides benefits for employees on or after termination of service (either in the form of an annual income or as a lump sum) when such benefits, or the contributions towards them, can be determined or estimated in advance of retirement from the provisions of a document or from the entity's practices.

Accounting Policy The financial statements of a defined contribution plan shall contain a statement of net assets available for benefits and a description of the funding policy. The financial statements of a defined benefit plan shall contain either: (a) a statement that shows: (i) the net assets available for benefits; (ii) the actuarial present value of promised retirement benefits, distinguishing between vested benefits and non-vested benefits; and

IAS 26 is sometimes confused with IAS 19, because both Standards address employee benefits. But there is a difference: while IAS 26 addresses the financial reporting considerations for the benefit plan itself, as the reporting entity, IAS 19 deals with employers' accounting for the cost of such benefits as they are earned by the employees. These Standards are thus somewhat related, but there will not be any direct interrelationship between amounts reported in benefit plan financial statements and amounts reported under IAS 19 by employers.

(iii) the resulting excess or deficit; or (b) a statement of net assets available for benefits including either: (i) a note disclosing the actuarial present value of promised retirement benefits, distinguishing between vested benefits and non-vested benefits; or (ii) a reference to this information in an accompanying actuarial report. A PRACTICAL APPROACH TO IFRS

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Disclosures If an actuarial valuation has not been prepared at the date of the financial statements, the most recent valuation shall be used as a base and the date of the valuation disclosed. The actuarial present value of promised retirement benefits shall be based on the benefits promised under the terms of the plan on service rendered to date using either current salary levels or projected salary levels with disclosure of the basis used. The effect of any changes in actuarial assumptions that have had a significant effect on the actuarial present value of promised retirement benefits shall also be disclosed.

Actuarial present value of promised retirement benefits. The present value of the expected future payments by a retirement benefit plan to existing and past employees, attributable to the service already rendered.

The financial statements shall explain the relationship between the actuarial present value of promised retirement benefits and the net assets available for benefits, and the policy for the funding of promised benefits. Retirement benefit plan investments shall be carried at fair value. In the case of marketable securities fair value is market value. Where plan investments are held for which an estimate of fair value is not possible disclosure shall be made of the reason why fair value is not used. The financial statements of a retirement benefit plan, whether defined benefit or defined contribution, shall also contain the following information: (a) a statement of changes in net assets available for benefits; (b) a summary of significant accounting policies; and (c) a description of the plan and the effect of any changes in the plan during the period.

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IAS 27

CONSOLIDATED AND SEPARATE FINANCIAL ASSETS

OBJECTIVE This Standard shall be applied in the preparation and presentation of consolidated financial statements for a group of entities under the control of a parent company and in accounting for investments in subsidiaries, jointly controlled entities and associates when an enterprise elects or is required by the local regulations to present separate (non-consolidated) financial statements.

KEY DEFINITIONS Consolidated financial statements are the financial statements of a group presented as those of a single economic entity. Control is the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities. A group is a parent and all its subsidiaries. A parent is an entity that has one or more subsidiaries. A subsidiary is an entity, including an unincorporated entity such as a partnership, that is controlled by another entity.

Presentation of Consolidated Accounts A parent shall present consolidated financial statements in which it consolidates its investments in subsidiaries in accordance with this Standard. A parent need not present consolidated financial statements if and only if: (a) the parent is itself a wholly-owned subsidiary, or is a partially-owned subsidiary of another entity and its other owners, including those not otherwise entitled to vote, have been A sub si dia r y cannot be informed about, and do not object to, the parent excluded from consolidation not present ing consolidated fina ncial b e c a u s e i t s b u s i n es s i s statements; dissimilar from that of the (b) the parent's debt or equity instruments are not other entities within the traded in a public market (a domestic or foreign group. stock exchange or an over-the-counter market, A PRACTICAL APPROACH TO IFRS

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including local and regional markets); (c) the parent did not file, nor is it in the process of filing, its financial statements with a securities commission or other regulatory organisation for the purpose of issuing any class of instruments in a public market; and (d) the ultimate or any intermediate parent of the parent produces consolidated financial statements available for public use that comply with International Financial Reporting Standards.

The Standard does not require the consolidation of a subsidiary where the control is intended to be temporary. There should be evidence that the subsidiary has been acquired with the intention to dispose of it within 12 months and that management is actively seeking a buyer.

Consolidated financial statements shall include all subsidiaries of the parent.

Consolidation procedures Consolidated financial statements shall be prepared using uniform accounting policies for like transactions and other events in similar circumstances. In preparing consolidated financial statements, an entity combines the financial statements of the parent and its subsidiaries line by line by adding together like items of assets, liabilities, equity, income and expenses. In order that the consolidated financial statements present financial information about the group as that of a single economic entity, the following steps are then taken:

Minority interest is that portion of the profit or loss and net assets of a subsidiary attributable to equity interests that are not owned, directly or indirectly through subsidiaries, by the parent.

(a) the carrying amount of the parent's investment in each subsidiary and the parent's portion of equity of each subsidiary are eliminated (see IFRS 3, which describes the treatment of any resultant goodwill); (b) minority interests in the profit or loss of consolidated subsidiaries for the reporting period are identified; and (c) minority interests in the net assets of consolidated subsidiaries are identified separately from the parent shareholders' equity in them. Minority interests in the net assets consist of: (i) the amount of those minority interests at the date of the original combination calculated in accordance with IFRS 3; and (ii) the minority's share of changes in equity since the date of the combination. Intragroup balances, transactions, income and expenses shall be eliminated in full. Minority interests shall be presented in the consolidated balance sheet within equity, separately from the parent shareholders' equity. Minority interests in the profit or loss of the group shall also be separately disclosed. Accounting for investments in subsidiaries, jointly controlled entities and associates in separate financial statements This Standard shall also be applied in accounting for investments in subsidiaries, jointly controlled entities and associates when an entity elects, or is required by local regulations, to A PRACTICAL APPROACH TO IFRS

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present separate financial statements. Separate financial statements are those presented by a parent, an investor in an associate or a venturer in a jointly controlled entity, in which the investments are accounted for on the basis of the direct equity interest rather than on the basis of the reported results and net assets of the investees. When separate financial statements are prepared, investments in subsidiaries, jointly controlled entities and associates that are not classified as held for sale (or included in a disposal group that is classified as held for sale) in accordance with IFRS 5 shall be accounted for either: (a) at cost, or (b) in accordance with IAS 39. The same accounting shall be applied for each category of investments. Investments in subsidiaries, jointly controlled entities and associates that are classified as held for sale (or included in a disposal group that is classified as held for sale) in accordance with IFRS 5 shall be accounted for in accordance with that IFRS. Investments in jointly controlled entities and associates that are accounted for in accordance with IAS 39 in the consolidated financial statements shall be accounted for in the same way in the investor's separate financial statements.

Q. 1

What is a subsidiary?

An entity that is controlled by another entity.

Q. 2

What do we mean by control?

Control is the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities.

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Q. 3

When does control exist?

Note : five examples when you have a parent/ subsidiary undertaking. 2. Right to exercise dominant influence

1.

3. Controls voting rights (could be in agreement with other investors)

Majority votes (51%) (the standard one!!)

Parent undertaking 5.

4.

Appoint/ remove directors (assuming control of the entity is by that board)

Managed on a unified basis

Think of your parents - are they ? Dominant Controlling G Always having the majority vote G Managing G Making key decisions (appointing/removing!!) G

G

Q. 4

Who has to prepare consolidated accounts ?

A parent shall present consolidated accounts subject to some limited exemptions mainly for unlisted parents that are themselves wholly owned subsidiaries. * Also refer to IFRIC 17 - Distribution of Non Cash Assets to owners. * Also refer to SIC 12 - Consolidation - Special Purpose Entity. A PRACTICAL APPROACH TO IFRS

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IAS 28

INVESTMENTS IN ASSOCIATES

OBJECTIVE This Standard shall be applied in accounting for investments in associates. However, it does not apply to investments in associates held by: (a) venture capital organisations, or (b) mutual funds, unit trusts and similar entities including investment-linked insurance funds that upon initial recognition are designated as at fair value through profit or loss or are classified as held for trading and accounted for in accordance with IAS 39 Financial Instruments: Recognition and Measurement. Such investments shall be measured at fair value in accordance with IAS 39, with changes in fair value recognised in profit or loss in the period of the change.

KEY DEFINITIONS An Associate entity in which an investor has significant influence but which is neither a subsidiary nor an interest in a joint venture. 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. For example, if an investor holds, directly or indirectly (e.g. through subsidiaries), 20 percent or more of the voting power of the investee, it is presumed that the investor has significant influence, unless it can be clearly demonstrated that this is not the case. Conversely, if the investor holds, directly or indirectly (through subsidiaries), less than 20 per cent of the voting power of the investee, it is presumed that the investor does not have significant influence, unless such influence can be clearly demonstrated. A substantial or majority ownership by another investor does not necessarily preclude an investor from having significant influence.

Equity Method Under the equity method, the investment in an associate is initially recognised at cost and the carrying amount is increased or decreased to recognise the investor's share of the profit or loss of the investee after the date of acquisition. The investor's share of the profit or loss of the investee is recognised in the investor's profit or loss. Distributions received from an investee reduce the carrying amount of the investment. Adjustments to the carrying amount may also be necessary for changes in the investor's proportionate interest in the investee arising from A PRACTICAL APPROACH TO IFRS

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changes in the investee's equity that have not been recognised in the investee's profit or loss. Such changes include those arising from the revaluation of property, plant and equipment and from foreign exchange translation differences. The investor's share of those changes is recognised directly in equity of the investor. The investor's financial statements shall be prepared using uniform accounting policies for like transactions and events in similar circumstances. After application of the equity method, including recognising the associate's losses, the investor applies the requirements of IAS 39 to determine whether it is necessary to recognise any additional impairment loss with respect to the investor's net investment in the associate.

Acquisition of an Associate and the Accounting Treatment q When

Significant influence is normally created in one of these ways: l Representation on the board of directors l Participation in the policy-making process l Material transactions occurring between the two entities l The changing over of management l T h e p rov i s i o n o f e s s e n t i a l technical information

Significant influence is lost when the investor loses the power to participate in the financial and operating policy decisions of the investee. This can occur without the loss of voting power or without a change in the ownership levels. It could occur, for example, where the associate is subject to government control or regulation as the result of a contractual agreement.

an investment in an associate is acquired, any difference between the cost of the investment and the investor's share of the net fair value of the associate's net assets and contingent liabilities is accounted for in accordance with IFRS 3. Thus, any goodwill relating to the associate will be included in the carrying value of the investment.

q IAS 28 do not allow amortization of that goodwill. Negative goodwill is excluded from the

carrying amount of the investment. This amount should be included as income in determining the investor's share of the associate's profit or loss for the period in which the investmentwas acquired. q After acquisition,

adjustments will be made to the investor's share of the associates' profits or losses for such events as impairment losses incurred by the associate.

q In determining

the investor's share of profits or losses, the most recently available financial statements of the associate are used. If the reporting dates of the investor and the associate are different, both should prepare financial statements as of the date as

An investment in an associate should be accounted for using the equity method exc e p t i n t h e s e t h re e e xc e p t i o n a l circumstances: (1) Where the investment is classified as held for sale in accordance with IFRS 5 (2) Where a parent does not have to present consolidated financial statements because of the exemption in IAS 27 (3) The investor need not use the equity method if all of these criteria apply: (a) The investor is a wholly owned subsidiary or is a partially owned subsidiary of another entity and its owners have been informed about and do not object to the investor not applying the equity method. The

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those of the investor unless it is impracticable to do so. q If financial statements are prepared to

a different reporting date, then adjustments should be made for any significant transactions or events that occurred between the date of the associate's financial statements and the date of the investor's financial statements. The difference between the reporting dates should not be more than three months. q If the

associate uses accounting policies that are different from those of the investor, the associate's financial statements should be adjusted and the investor's accounting policies should be used.

owners in this case are all of those entitled to vote. (b) The investor's debt or equity instruments are not traded in a public market. (c) The investor did not file, nor is it in the process of filing, its financial statements with a securities commission or other regulatory body for the purpose of issuing any class of financial instrument in a public market. (d) The ultimate or any intermediate parent of the investor produces consolidated financial statements that are available for public use and that comply with IFRS.

q If the investor's

share of losses of an associate equals or exceeds its interest in the associate, then the investor should not recognize its share of any further losses.

q The interest

in the associate is essentially the carrying amount of the investment using the equity method together with any other long-term interests that are essentially part of the investor's net investment in the associate. An example is a long-term loan from the investor to the associate. Long-term interests in this context do not include trade receivables or payables or any secured long-term receivables. Losses recognized in excess of the investor's investment in ordinary shares should be applied to the other elements of the investor's interest in the associate in the order of their priority in liquidation.

q When the investor's interest is reduced to zero, any additional losses are provided for and

liabilities recognized only to the extent that the investor has a legal or constructive obligation or has made payments on behalf of the associate. When the associate reports profits, the investor can recognize its share of those profits only after its share of the profits equals the share of the losses not yet recognized.

Separate Financial Statements When separate financial statements are prepared, investments in subsidiaries, jointly controlled entities and associates that are not classified as held for sale (or included in a disposal group that is classified as held for sale) in accordance with IFRS 5 shall be accounted for either: (a) at cost, or (b) in accordance with IAS 39. The same accounting shall be applied for each category of investments. Investments in subsidiaries, jointly controlled entities and associates that are classified as held for sale (or included in a disposal group that is classified as held for sale) in accordance with IFRS 5 shall be accounted for in accordance with that IFRS. A PRACTICAL APPROACH TO IFRS

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Investments in jointly controlled entities and associates that are accounted for in accordance with IAS 39 in the consolidated financial statements shall be accounted for in the same way in the investor's separate financial statements.

Q. 1

What is an associate ?

An associate is an entity, including an unincorporated entity such as a partnership, over which the investor has significant influence and that is neither a subsidiary nor an interest in a joint venture.

Q. 2

What do we mean by 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.

Q. 3

What method of accounting do we use for associates ?

If aparent company has significant influence, it must use the equity method of accounting for its interest in the associate, in the consolidated accounts unless the investment is held exclusively for resale.

Q. 4

What do we mean by equity accounting ? Calculate goodwill on associate and add it in

Equity method

One line entryour share of net assets of associate

A PRACTICAL APPROACH TO IFRS

This can also be calculated by adding together the cost of the investment and any postacquisition profits

O Pg. 101

IAS 31

INVESTMENT IN JOINT VENTURES

OBJECTIVE This Standard shall be applied in accounting for interests in joint ventures and the reporting of joint venture assets, liabilities, income and expenses in the financial statements of venturers and investors, regardless of the structures or forms under which the joint venture activities take place. However, it does not apply to venturers' interests in jointly controlled entities held by: (a) venture capital organisations, or (b) mutual funds, unit trusts and similar entities including investment-linked insurance funds that upon initial recognition are designated as at fair value through profit or loss or are classified as held for trading and accounted for in accordance with IAS 39 Financial Instruments: Recognition and Measurement.

KEY DEFINITIONS A joint venture is a contractual arrangement whereby two or more parties undertake an economic activity that is subject to joint control. Joint control is the contractually agreed sharing of control over an economic activity, and exists only when the strategic financial and operating decisions relating to the activity require the unanimous consent of the parties sharing control (the venturers). Control is the power to govern the financial and operating policies of an economic activity so as to obtain benefits from it. A venturer is a party to a joint venture and has joint control over that joint venture. Joint ventures take many different forms and structures. This Standard identifies three broad types—jointly controlled operations, jointly controlled assets and jointly controlled entities—that are commonly described as, and meet the definition of, joint ventures.

Jointly Controlled Operations The operation of some joint ventures involves the use of the assets and other resources of the venturers rather than the establishment of a corporation, partnership or other entity, or a financial structure that is separate from the venturers themselves. Each venturer uses its own property, plant and equipment and carries its own inventories. It also incurs its own expenses and liabilities and raises its own finance, which represent its own obligations. In respect of its interests in jointly controlled operations, a venturer shall recognise in its financial statements: (a) the assets that it controls and the liabilities that it incurs; and A PRACTICAL APPROACH TO IFRS

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(b) the expenses that it incurs and its share of the income that it earns from the sale of goods or services by the joint venture.

Jointly Controlled Assets Some joint ventures involve the joint control, and often the joint ownership, by the venturers of one or more assets contributed to, or acquired for the purpose of, the joint venture and dedicated to the purposes of the joint venture. The assets are used to obtain benefits for the venturers. Each venturer may take a share of the output from the assets and each bears an agreed share of the expenses incurred. In respect of its interest in jointly controlled assets, a venturer shall recognise in its financial statements: (a) its share of the jointly controlled assets, classified according to the nature of the assets; (b) any liabilities that it has incurred; (c) its share of any liabilities incurred jointly with the other venturers in relation to the joint venture; (d) any income from the sale or use of its share of the output of the joint venture, together with its share of any expenses incurred by the joint venture; and (e) any expenses that it has incurred in respect of its interest in the joint venture.

Jointly Controlled Entities A jointly controlled entity is a joint venture that involves the establishment of a corporation, partnership or other entity in which each venturer has an interest. The entity operates in the same way as other entities, except that a contractual arrangement between the venturers establishes joint control over the economic activity of the entity. A venturer shall recognise its interest in a jointly controlled entity using

An example Joint controlled operations agreement may be where two entities agree to develop and manufacture a high-speed train where, for example, the engine may be developed by one venture and the carriages by another. Each venturer would pay the costs and take a share of the revenue from the sale of the trains according to the agreement. Here each venturer will show in its financial statements the assets that it controls, the liabilities that it incurs, together with the expenses that it incurs and its share of the income from the sale of goods or services.

An example of this type of venture is in the oil industry, where a number of oil companie jointly own a pipeline. The pipeline will be used to transport the oil, and each venturer agrees to bear part of the expenses of operating the pipeline. The financial statements of each venturer will show its share of the joint assets, any liabilities it has incurred directly, and its share of any joint liabilities together with any income from the sale or usage of its share of the output of the joint venture. Additionally any share of the expenses incurred by the joint venturer or expenses incurred directly will be shown in the financial statements.

Exceptions to the use of Equity and Proportionate consolidation method l If the

jointly controlled entity becomes classified as held for sale under IFRS 5, it has to be accounted for using that Standard. Similarly if the jointly controlled entity becomes a subsidiary or an associate, then the respective standards should be used.

l In the separate

financial statements of the venturer, any interest in a jointly controlled entity should be accounted for either at cost or under IAS 39.

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proportionate consolidation or the equity method. Proportionate consolidation is a method of accounting whereby a venturer's share of each of the assets, liabilities, income and expenses of a jointly controlled entity is combined line by line with similar items in the venturer's financial statements or reported as separate line items in the venturer's financial statements. The equity method is a method of accounting whereby an interest in a jointly controlled entity is initially recorded at cost and adjusted thereafter for the postacquisition change in the venturer's share of net assets of the jointly controlled entity. The profit or loss of the venturer includes the venturer's share of the profit or loss of the jointly controlled entity.

l If an asset

is contributed or sold to the jointly controlled entity and the asset is still retained by the joint venture, then the venturer should recognize only that portion of the gain that is attributable to the other venturers (assuming that the risks and rewards of ownership have passed).

l However,

the venturer should recognize the full amount of any loss incurred when this sale provides evidence of a reduction in the net realizable value of current assets or an impairment loss.

l When the venturer purchases assets from a

jointly controlled entity, it should not recognize its share of the gain until it resells the asset to a third party

Transactions between a Venturer and a Joint Venture When a venturer contributes or sells assets to a joint venture, recognition of any portion of a gain or loss from the transaction shall reflect the substance of the transaction. While the assets are retained by the joint venture, and provided the venturer has transferred the significant risks and rewards of ownership, the venturer shall recognise only that portion of the gain or loss that is attributable to the interests of the other venturers. The venturer shall recognise the full amount of any loss when the contribution or sale provides evidence of a reduction in the net realisable value of current assets or an impairment loss. When a venturer purchases assets from a joint venture, the venturer shall not recognise its share of the profits of the joint venture from the transaction until it resells the assets to an independent party. A venturer shall recognise its share of the losses resulting from these transactions in the same way as profits except that losses shall be recognised immediately when they represent a reduction in the net realisable value of current assets or an impairment loss.

Separate Financial Statements of a Venturer When separate financial statements are prepared, investments in subsidiaries, jointly controlled entities and associates that are not classified as held for sale (or included in a disposal group that is classified as held for sale) in accordance with IFRS 5 shall be accounted for either: (a) at cost, or (b) in accordance with IAS 39. The same accounting shall be applied for each category of investments. Investments in subsidiaries, jointly controlled entities and associates that are classified as held for sale (or A PRACTICAL APPROACH TO IFRS

O Pg. 104

included in a disposal group that is classified as held for sale) in accordance with IFRS 5 shall be accounted for in accordance with that IFRS. Investments in jointly controlled entities and associates that are accounted for in accordance with IAS 39 in the consolidated financial statements shall be accounted for in the same way in the investor's separate financial statements.

Q. 1

What is joint venture ? A joint venture is a contractual arrangement whereby two or more parties undertake an economic activity that is subject to joint control.

Q. 2

How do you account for a jointly controlled entity ?

Benchmark (preferred) Allowed alternative

Proportionate consolidation Equity accounting

What is a joint venture ?

A jointly controlled activity

Proportional consolidation

A PRACTICAL APPROACH TO IFRS

Equity method

O Pg. 105

Q. 3

What is proportional consolidation ?

When we add our share (percentage) into the accounts on a 'line-by-line' basis

Liabilities

Revenues

Assets

Costs

Q. 4

Equity accounting - for what other type of entity do we use equity accounting ?

Equity method is the same as we use for an associate.

Q. 5

What is equity accounting ?

Equity Method

One line entry our share of net assets of associate

Calculate goodwill on associate and add it in

* Also refer to SIC 13 - Jointly Controlled Entities - Non Monetary Contribution by Venturer. A PRACTICAL APPROACH TO IFRS

O Pg. 106

IAS 32

FINANCIAL INSTRUMENTS PRESENTATION

OBJECTIVE The objective of this Standard is to establish principles for presenting financial instruments as liabilities or equity and for offsetting financial assets and financial liabilities. It applies to the classification of financial instruments, from the perspective of the issuer, into financial assets, financial liabilities and equity instruments; the classification of related interest, dividends, losses and gains; and the circumstances in which financial assets and financial liabilities should be offset. The principles in this Standard complement the principles for recognising and measuring financial assets and financial liabilities in IAS 39 Financial Instruments: Recognition and Measurement, and for disclosing information about them in IFRS 7 Financial Instruments: Disclosures. The issuer of a financial instrument shall classify the instrument, or its component parts, on initial recognition as a financial liability, a financial asset or an equity instrument in accordance with the substance of the contractual arrangement and the definitions of a financial liability, a financial asset and an equity instrument. The issuer of a non-derivative financial instrument shall evaluate the terms of the financial instrument to determine whether it contains both a liability and an equity component. Such components shall be classified separately as financial liabilities, financial assets or equity instruments.

KEY DEFINITIONS A financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity. A financial asset is any asset that is: (a) cash; (b) an equity instrument of another entity; (c) a contractual right: (i) to receive cash or another financial asset from another entity; or (ii) to exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity; or (d) a contract that will or may be settled in the entity's own equity instruments and is: (i) a non-derivative for which the entity is or may be obliged to receive a variable number of the entity's own equity instruments; or (ii) a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity's own equity instruments. For this purpose the entity's own equity instruments do not include instruments that are themselves contracts for the future receipt or delivery of the entity's own equity instruments. A PRACTICAL APPROACH TO IFRS

O Pg. 107

A financial liability is any liability that is: (a) a contractual obligation: (i) to deliver cash or another financial asset to another entity; or (ii) to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity; or (b) a contract that will or may be settled in the entity's own equity instruments and is: (i) a non-derivative for which the entity is or may be obliged to deliver a variable number of the entity's own equity instruments; or (ii) a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity's own equity instruments. For this purpose the entity's own equity instruments do not include instruments that are themselves contracts for the future receipt or delivery of the entity's own equity instruments. An equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.

Classification as Liability or Equity A key issue addressed by IAS 32 is how an issuer of a financial instrument determines whether the instrument should be classified as an equity instrument or a financial liability (or, in Examples of assets that meet the a few cases, a financial asset). IAS 32 provides definition of a financial asset are l Cash, this principle: l Investment in shares or other equity q The issuer of a financial instrument shall instrument issued by other entities, classify the instrument, or its component l Receivables, parts, on initial recognition as a financial l Loans to other entities, liability, a financial asset, or an equity l Investments in bonds and other debt instrument in accordance with the instruments issued by other entities, substance of the contractual arrangement l Derivative financial assets and the definitions of a financial liability, a financial asset, and an equity instrument. q This principle highlights the need to consider not only the legal form of an instrument but

also the substance of the contractual arrangement associated with the instrument when determining whether an instrument should be classified and presented as Examples of liabilities that meet the liabilities or equity. When substance and definition of financial liabilities are legal form of an instrument are different, l Payables (e.g., trade payables), substance governs the classification and l Loans from other entities, presentation. l Issued bonds and other debt q A critical feature in differentiating a instruments issued by the entity, financial liability from an equity l Derivative financial liabilities, instrument is the existence of a l Obligations to deliver own shares contractual obligation that meets the worth a fixed amount of cash, definition of a financial liability. If there is l Some derivatives on own equity. an obligation to deliver cash or another A PRACTICAL APPROACH TO IFRS

O Pg. 108

financial asset, the instrument usually meets the definition of a financial liability, even though its form may be that of an equity instrument. It does not matter whether the obligation is conditional on the counterparty exercising a right to require payment. An obligation to deliver cash or another financial asset usually is a financial liability even though the obligation may be contingent upon the holder exercising a right to require the delivery of cash or another financial asset.

Examples of equity instruments include l Ordinary shares (that cannot be put back to the issuer by the holder) l Preference shares (that cannot be redeemed by the holder or provide for nondiscretionary dividends) l Warrants or written call options (that allow the holder to subscribe for—or purchase—a fixed number of nonputtable ordinary shares in exchange for a fixed amount of cash or another financial asset)

Compound Financial Instruments S o m e t i m e s n o n - d e r iva t ive f i n a n c i a l instruments contain both liability and equity elements. In other words, one component of the instrument meets the definition of a financial liability and another component of the instrument meets the definition of an equity instrument. Such instruments are referred to as compound instruments. The approach to accounting for compound instruments is to apply split accounting, that is, to present the liability and equity elements separately. IAS 32 provides this principle: The issuer of a nonderivative financial instrument shall evaluate the terms of the financial instrument to determine whether it contains both a liability and an equity component. Such components shall be classified separately as financial liabilities, financial assets, or equity instruments.

Treasury Shares Treasury shares are shares that are not currently outstanding. When an entity reacquires an outstanding share or other equity instrument, the consideration paid is deducted from equity. No gain or loss is recognized in profit or loss even if the reacquisition price differs from the amount at which the equity instrument was originally issued. Similarly, if the entity subsequently resells the treasury share, no gain or loss is recognized in profit or loss even if the proceeds at reissuance differ from the consideration paid when the treasury shares were reacquired previously. The amount of treasury shares is disclosed separately either in the notes or on the face of the balance sheet.

Offsetting A financial asset and a financial liability shall be offset and the net amount presented in the balance sheet when, and only when, an entity: (a) currently has a legally enforceable right to set off the recognised amounts; and (b) intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously.

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Q. 1

What is a financial instrument ?

Any contract that gives rise to both a financial asset of one enterprise and a financial liability or equity instrument of another enterprise.

Q. 2

What is a financial asset ? An equity instrument of another enterprise (e.g. an investment inshares)

Revenues

A financial asset

A contractual right to receive cash or another financial asset from another enterprise (e.g. receivables!)

Q. 3

A contractual right to exchange financial instrument with another enterprise under conditions that are potentially favourable (e.g. a forward contract when the market has moved favourably)

What is a financial asset ?

A liability that is a contractual obligation

To deliver cash or another financial asset to another enterprise (e.g. payables/loans)

The exchange financial instruments with another enterprise under conditions that are potentially unfavourable (e.g. forward contract where the market has moved against the contract)

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O Pg. 110

Q. 4

What is an equity instrument ?

Any contract that evidences a residual interest in the assets of an enterprise after deducting all of its liabilities.

Q. 5

How do we present financial instruments ?

Equity and liabilities should be presented on the balance sheet following the substance of the instruments. If an instrument contains an obligation to pay out cash it is a financial liability. Preference shares are therefore often financial liabilities.

Compound instruments issued (those with both debt and equity elements) such as convertible debentures are 'split' accounted. This means the proceeds are recognised as debt and a separate equity option. The debt is measured by discounted cash flows and the equity is the residual of the proceeds.

Interest, dividends, gains and losses treatment follow the presentation on the balances sheet. If a preference share is treated as a debt instrument, any dividends paid on that share are treated as interest charges.

* Also refer to IFRIC 2 - Members Shares in Co-operative Entity and Similar Instruments A PRACTICAL APPROACH TO IFRS

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IAS 33

EARNINGS PER SHARE

OBJECTIVE The objective of this Standard is to prescribe principles for the determination and presentation of earnings per share, so as to improve performance comparisons between different entities in the same reporting period and between different reporting periods for the same entity. The focus of this Standard is on the denominator of the earnings per share calculation.

Scope This Standard shall be applied by entities whose ordinary shares or potential ordinary shares are publicly traded and by entities that are in the process of issuing ordinary shares or potential ordinary shares in public markets. An entity that discloses earnings per share shall calculate and disclose earnings per share in accordance with this Standard.

KEY DEFINITIONS An ordinary share is an equity instrument that is subordinate to all other classes of equity instruments. These are also known as common share or common stock. A potential ordinary share is a financial instrument or other contract that may entitle its holder to ordinary shares. Examples are options, warrants, and financial liabilities or equity instruments that are convertible into ordinary shares. Dilution is the reduction in earnings per share or increase in the loss per share resulting from the assumption that potential ordinary shares will materialize. Antidilution is an increase in earnings per share or a reduction in loss per share resulting from the assumption that potential ordinary shares will materialize.

Presentation of Earnings Per Share An entity shall present on the face of the income statement basic and diluted earnings per share for profit or loss from continuing operations attributable to the ordinary equity holders of the parent entity and for profit or loss attributable to the ordinary equity holders of the parent entity for the period for each class of ordinary shares that has a different right to share in profit for the period. An entity shall present basic and diluted earnings per share with equal prominence for all periods presented. An entity that reports a discontinued operation shall disclose the basic and diluted amounts per share for the discontinued operation either on the face of the income statement or in the notes. A PRACTICAL APPROACH TO IFRS

O Pg. 112

Basic Earnings Per Share Basic earnings per share shall be calculated by dividing profit or loss attributable to ordinary equity holders of the parent entity (the numerator) by the weighted average number of ordinary shares outstanding (the denominator) during the period. For the purpose of calculating basic earnings per share, the amounts attributable to ordinary equity holders of the parent entity in respect of: (a) profit or loss from continuing operations attributable to the parent entity; and (b) profit or loss attributable to the parent entity shall be the amounts in (a) and (b) adjusted for the after-tax amounts of preference dividends, differences arising on the settlement of preference shares, and other similar effects of preference shares classified as equity.

Basic earnings per share =

Net profit or loss attributable to ordinary equity holder Weighted-average number of ordinary shares outstanding during the period

For the purpose of calculating basic earnings per share, the number of ordinary shares shall be the weighted average number of ordinary shares outstanding during the period. The weighted average number of ordinary shares outstanding during the period and for all periods presented shall be adjusted for events, other than the conversion of potential ordinary shares, that have changed the number of ordinary shares outstanding without a corresponding change in resources.

Diluted Earnings Per Share For the purpose of calculating diluted earnings per share, an entity shall adjust profit or loss attributable to ordinary equity holders of the parent entity, and the weighted average number of shares outstanding, for the effects of all dilutive potential ordinary shares. Dilution is 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.

Diluted earnings per share is an important statistic for analysts and potential investors as it shows the effect on earnings per share of all dilutive potential ordinary shares that were outstandingduring the year. Potential ordinary shares include preference shares convertible into ordinary shares, share warrants and options, shares that may be issued to employees as part of their remuneration or as part of other share purchase plans, and contingently issuable shares, say on the purchase of an enterprise.

For the purpose of calculating diluted earnings per share, the number of ordinary shares shall be the weighted average number of ordinary shares plus the weighted average number of ordinary shares that would be issued on the conversion of all the dilutive potential ordinary shares into ordinary shares. Potential ordinary shares shall be treated as dilutive when, and only when, their conversion to ordinary shares would decrease earnings per share or increase loss per share from continuing operations.

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An entity uses profit or loss from continuing operations attributable to the parent entity as the control number to establish whether potential ordinary shares are dilutive or antidilutive. In determining whether potential ordinary shares are dilutive or antidilutive, each issue or series of potential ordinary shares is considered separately rather than in aggregate.

Retrospective Adjustments If the number of ordinary or potential ordinary shares outstanding increases as a result of a capitalisation, bonus issue or share split, or decreases as a result of a reverse share split, the calculation of basic and diluted earnings per share for all periods presented shall be adjusted retrospectively. Basic and Diluted EPS are also adjusted for the effects of Errors and adjustments resulting from changes in accounting policies retrospectively.

Q. 1

How do you calculate earnings per share ?

The basic EPS calculation is simply

Earnings Shares

Q. 2

What do we mean by 'earnings'?

Profit available to the ordinary shareholders... profit after tax - minority interests preference dividend.

Q. 3

What do we mean by 'shares' ?

Actually under the line is a 'weighted average number of shares'

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Q. 4

Can you calculate a weighted average number of shares ? - you must learn this.

Actually under the line is a 'weighted average number of shares' Date

Actual number of

Fraction of year

Total

1 January 20 x 4

8,280,000

6/12

4,140,000

30 June 20 x 4

11,529,000

6/12

5,796,000

Number of shares in EPS calculation

9,936,000

(dates and number for illustrative purposes only)

Q. 5

What do you do if it's a rights issue of shares ?

When a rights issue takes place shares are issued at less than full market price. We treat this as a combination of a bonus issue and an issue at full market price. We will therefore need to calculate the rights issue bonus fraction by using share prices.

Q. 6

What is the rights issue bonus fraction ?

Rights issue bonus fraction = Actual cum rights price

Actual cum rights price

Theoretical ex rights price = Price of share with rights attached immediately before rights issue.

Theoretical ex rights price = Expected share price immediately after rights issue (weighted average of actual cum rights price and exercise price of rights issue shares) 10.20/6 = `1.70

Rights issue bonus fraction (number for illustration) ` 5 shares at 1.60 1 share at 1.20

` 9.00 1.20

6 shares

10.20

Therefore rights `1.80 issue bonus fraction = `1.70

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O Pg. 115

Use a table for full computation of the number of shares, as follows Date

Actual number of shares

Fraction of year

1 January 20 x 4

8,280,000

9/12

1 October 20 x 4

9,936,000 (W1)

3/12

Rights issue bonus traction `1.80 `1.70

Total 4,140,000 2,484,000

Number of shares to be used in EPS calculation

9,059,294

This is the basic weighted average table with an additional column - you must learn this tool (again dates and numbers given for illustration)

Q. 7

What circumstances give rise to a 'diluted' calculation?

Shares not yet ranking for dividend. Convertible debt or preference shares in issue. l Options granted to subscribe for new shares. l l

Q. 8

What is the formula for diluted EPS ? Earnings + Notional earnings Number of shares + Notional extra shares

For convertible instruments

By adding the maximum number of shares to be issued in the future.

For options

By adding the number of effectively 'free' shares to be issued when the options are exercised.

Q. 9

What are the required disclosures ?

The disclosures are required are: Basic and diluted EPS are presented on the face of the P&L account l The numerators for each calculation should be disclosed and reconciled to the net profit or loss for the period l The denominators should be disclosed and reconciled to each other l Any alternative measures of EPS (other than basic or diluted) must only be disclosed in the notes to the financial statements. l

l

A PRACTICAL APPROACH TO IFRS

O Pg. 116

IAS 34

INTERIM FINANCIAL REPORTING

OBJECTIVE The objective of this Standard is to prescribe the minimum content of an interim financial report and to prescribe the principles for recognition and measurement in complete or condensed financial statements for an interim period. Timely and reliable interim financial reporting improves the ability of investors, creditors, and others to understand an entity's capacity to generate earnings and cash flows and its financial condition and liquidity. This Standard applies if an entity is required or elects to publish an interim financial report in accordance with International Financial Reporting Standards.

IAS 34 does not detail which entities should publish interim financial reports, how frequently they should be published, or how soon they should be published after the end of the interim period. The Standard applies where an entity is required or elects to publish an interim financial report. The International Accounting Standards Board (IASB) encourages publicly traded entities to provide such reports at least at the end of the half year, and such reports are to be made available not later than 60 days after the end of the interim period.

Interim Financial Report Interim financial report means a financial report containing either a complete set of financial statements (as described in IAS 1 Presentation of Financial Statements) or a set of condensed financial statements (as described in this Standard) for an interim period. Interim period is a financial reporting period shorter than a full financial year. In the interest of timeliness and cost considerations and to avoid repetition of information previously reported, an entity may be required to or may elect to provide less information at interim dates as compared with its annual financial statements. This Standard defines the minimum content of an interim financial report as including condensed financial statements and selected explanatory notes. The interim financial report is intended to provide an update on the latest complete set of annual financial statements. Accordingly, it focuses on new activities, events, and circumstances and does not duplicate information previously reported.

Periods to be presented in the Interim Financial Statement IAS 34 requires this information to be presented: q Balance sheet as at the end of the current interim period and a comparative balance sheet

as at the end of the preceding financial year. q Income

statements for the current interim period and for the current financial year to date, with comparative income statements for the comparable interim periods (current and year-to-date) of the preceding financial year. A PRACTICAL APPROACH TO IFRS

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q Statement

showing changes in equity for the current financial year to date, with a comparative statement for the comparable year-to-date period of the preceding financial year

q Cash flow

statement for the current financial year to date, with a comparative statement for the comparable year-todate period of the preceding financial year

IAS 34 recognizes the usefulness of additional information if the business is seasonal by encouraging for those businesses the disclosure of financial information for the l a t e s t 1 2 m o n t h s , a n d c o m p a ra t ive information for the prior 12-month period, in addition to the interim period financial statements.

If the entity publishes interim financial statements that are condensed, then they should include, as a minimum, the headings and subtotals included in the most recent annual financial statements and the explanatory notes as required by IAS 34. Additional line items or notes should be included if omitting them would make the interim financial statements misleading. Basic and diluted earnings per share should be presented on the face of the income statement

Minimum Contents of an Interim Financial Report Nothing in this Standard is intended to prohibit or discourage an entity from publishing a complete set of financial statements (as described in IAS 1) in its interim financial report, rather than condensed financial statements and selected explanatory notes. If an entity publishes a complete set of financial statements in its interim financial report, the form and content of those statements shall conform to the requirements of IAS 1 for a complete set of financial statements. An interim financial report shall include, at a minimum, the following components: (a) condensed balance sheet; (b) condensed income statement; (c) condensed statement showing either (i) all changes in equity or (ii) changes in equity other than those arising from capital transactions with owners and distributions to owners; (d) condensed cash flow statement; and (e) selected explanatory notes.

Measurement Measurements for interim reporting purposes should be made on a 'year-to-date' basis, so that the frequency of the entity's reporting should not affect the measurement of its annual results. The same definitions and recognition criteria apply whether dealing with interim or annual financial reports. In deciding how to recognise, measure, classify, or disclose an item for interim financial reporting purposes, materiality shall be assessed in relation to the interim period financial data. In making assessments of materiality, it shall be recognised that interim measurements may rely on estimates to a greater extent than measurements of annual financial data.

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An entity shall apply the same accounting policies in its interim financial statements as are applied in its annual financial statements, except for accounting policy changes made after the date of the most recent annual financial statements that are to be reflected in the next annual financial statements. To achieve that objective, measurements for interim reporting purposes shall be made on a year-to-date basis. The measurement procedures to be followed in an interim financial report shall be designed to ensure that the resulting information is reliable and that all material financial information that is relevant to an understanding of the financial position or performance of the entity is appropriately disclosed. While measurements in both annual and interim financial reports are often based on reasonable estimates, the preparation of interim financial reports generally will require a greater use of estimation methods than annual financial reports.

Q. 1

What is an interim financial report ?

An Interim Financial Report is a financial report containing either a complete set of financial statements or a set of condensed financial statements for an interim period.

Q. 2

What is an interim period ?

An Interim Period is a financial reporting period shorter than a full financial year.

Q. 3

What are the contents of an interim report ?

(1) The minimum contents prescribed by the standard are : l Condensed statement of financial position (balance sheet) l Condensed income statement l Condensed cash flow statement l Condensed statement of changes in equity or STRGL equivalent l Selected explanatory notes. The condensed information must at least have the same headings and subtotals as were in the latest annual financial statements published.

(2) Basic and diluted EPS should be presented in the interim report.

* Also refer to IFRIC 10 - Interim Financial Reporting and Impairment A PRACTICAL APPROACH TO IFRS

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IAS 36

IMPAIRMENT OF ASSETS

OBJECTIVE The objective of this Standard is to prescribe the procedures that an entity applies to ensure that its assets are carried at no more than their recoverable amount. An asset is carried at more than its recoverable amount if its carrying amount exceeds the amount to be recovered through use or sale of the asset. If this is the case, the asset is described as impaired and the Standard requires the entity to recognise an impairment loss. The Standard also specifies when an entity should reverse an impairment loss and prescribes disclosures.

Certain assets are not covered by the Standard, including Inventories (IAS 2) Assets arising from construction contracts (IAS 11) l Deferred tax assets (IAS 12) l Assets arising from employee benefits (IAS 19) l Financial assets dealt with under IAS 39 l Investment property carried at fair value under IAS 40 l Biological assets carried at fair value (IAS 41) l Assets arising from insurance contracts (IFRS 4) l Assets that are held for sale (IFRS 5) l

l

Identifying an asset that may be impaired An entity shall assess at each reporting date whether there is any indication that an asset may be impaired. If any such indication exists, the entity shall estimate the recoverable amount of the asset. Irrespective of whether there is any indication of impairment, an entity shall also: (a) test an intangible asset with an indefinite useful life or an intangible asset not yet available for use for impairment annually by comparing its carrying amount with its recoverable amount. This impairment test may be performed at any time during an annual period, provided it is performed at the same time every year. Different intangible assets may be tested for impairment at different times. However, if such an intangible asset was initially recognised during the current annual period, that intangible asset shall be tested for impairment before the end of the current annual period. (b) test goodwill acquired in a business combination for impairment annually. If there is any indication that an asset may be impaired, recoverable amount shall be estimated for the individual asset. If it is not possible to estimate the recoverable amount of the individual asset, an entity shall determine the recoverable amount of the cash-generating unit to which the asset belongs (the asset's cash-generating unit).

The Standard does apply to Subsidiaries, associates, and joint ventures l Property, plant, and equipment l Investment property carried at cost l Intangible assets and goodwill l

A cash-generating unit is 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. A PRACTICAL APPROACH TO IFRS

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Measuring Recoverable Amount The recoverable amount of an asset or a cash-generating unit is the higher of its fair value less costs to sell and its value in use. It is not always necessary to determine both an asset's fair value less costs to sell and its value in use. If either of these amounts exceeds the Fair value less costs to sell is the asset's carrying amount, the asset is not amount obtainable from the sale of an impaired and it is not necessary to estimate the asset or cash-generating unit in an other amount. arm's length transaction between The following elements shall be reflected in the knowledgeable, willing parties, less the calculation of an asset's value in use: costs of disposal. (a) an estimate of the future cash flows the Value in use is the present value of the future cash flows expected to be entity expects to derive from the asset; derived from an asset or cash(b) expectations about possible variations in generating unit. the amount or timing of those future cash flows; (c) the time value of money, represented by the current market risk-free rate of interest; (d) the price for bearing the uncertainty inherent in the asset; and (e) other factors, such as illiquidity, that market participants would reflect in pricing the future cash flows the entity expects to derive from the asset. Estimates of future cash flows shall include: (a) projections of cash inflows from the continuing use of the asset; (b) projections of cash outflows that are necessarily incurred to generate the cash inflows from continuing use of the asset (including cash outflows to prepare the asset for use) and can be directly attributed, or allocated on a reasonable and consistent basis, to the asset; and (c) net cash flows, if any, to be received (or paid) for the disposal of the asset at the end of its useful life. Future cash flows shall be estimated for the asset in its current condition. Estimates of future cash flows shall not include estimated future cash inflows or outflows that are expected to arise from: (a) a future restructuring to which an entity is not yet committed; or (b) improving or enhancing the asset's performance. Estimates of future cash flows shall not include: (a) cash inflows or outflows from financing activities; or (b) income tax receipts or payments. Recognising and measuring an impairment loss If, and only if, the recoverable amount of an asset is less than its carrying amount, the carrying amount of the asset shall be reduced to its recoverable amount. That reduction is an impairment loss. An impairment loss shall be recognised immediately in profit or loss, unless the asset is carried at revalued amount in accordance with another Standard (for example, in accordance with the revaluation model in IAS 16 Property, Plant and Equipment). Any impairment loss of a revalued asset shall be treated as a revaluation decrease in accordance with that other Standard. A PRACTICAL APPROACH TO IFRS

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An impairment loss shall be recognised for a cash-generating unit (the smallest group of cashgenerating units to which goodwill or a corporate asset has been allocated) if, and only if, the recoverable amount of the unit (group of units) is less than the carrying amount of the unit (group of units). The impairment loss shall be allocated to reduce the carrying amount of the assets of the unit (group of units) in the following order: (a) first, to reduce the carrying amount of any goodwill allocated to the cash-generating unit (group of units); and (b) then, to the other assets of the unit (group of units) pro rata on the basis of the carrying amount of each asset in the unit (group of units). However, an entity shall not reduce the carrying amount of an asset below the highest of: (a) its fair value less costs to sell (if determinable); (b) its value in use (if determinable); and (c) zero. The amount of the impairment loss that would otherwise have been allocated to the asset shall be allocated pro rata to the other assets of the unit (group of units).

Goodwill For the purpose of impairment testing, goodwill acquired in a business combination shall, from the acquisition date, be allocated to each of the acquirer's cash-generating units, or groups of cash-generating units, that is expected to benefit from the synergies of the combination, irrespective of whether other assets or liabilities of the acquiree are assigned to those units or groups of units. The annual impairment test for a cash-generating unit to which goodwill has been allocated may be performed at any time during an annual period, provided the test is performed at the same time every year. Different cash-generating units may be tested for impairment at different times. However, if some or all of the goodwill allocated to a cash-generating unit was acquired in a business combination during the current annual period, that unit shall be tested for impairment before the end of the current annual period. The Standard permits the most recent detailed calculation made in a preceding period of the recoverable amount of a cash-generating unit (group of units) to which goodwill has been allocated to be used in the impairment test for that unit (group of units) in the current period, provided specified criteria are met.

Reversing an Impairment Loss An entity shall assess at each reporting date whether there is any indication that an impairment loss recognised in prior periods for an asset other than goodwill may no longer exist or may have decreased. If any such indication exists, the entity shall estimate the recoverable amount of that asset.

An impairment loss recognised for goodwill shall not be reversed in a subsequent period.

An impairment loss recognised in prior periods for an asset other than goodwill shall be reversed if, and 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. A reversal of an impairment loss for a cash-generating unit shall be allocated to the assets of the unit, except A PRACTICAL APPROACH TO IFRS

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for goodwill, pro rata with the carrying amounts of those assets. The increased carrying amount of an asset other than goodwill attributable to a reversal of an impairment loss shall not exceed the carrying amount that would have been determined (net of amortisation or depreciation) had no impairment loss been recognised for the asset in prior years. A reversal of an impairment loss for an asset other than goodwill shall be recognised immediately in profit or loss, unless the asset is carried at revalued amount in accordance with another Standard (for example, the revaluation model in IAS 16 Property, Plant and Equipment). Any reversal of an impairment loss of a revalued asset shall be treated as a revaluation increase in accordance with that other Standard. An impairment loss recognised for goodwill shall not be reversed in a subsequent period.

Q. 1

What do we mean by 'recoverable amount' ?

A company can recover the amount it has invested in its assets in one of two ways : l it can opt to sell the asset to someone else, generating a net selling price; or l it can trade with the asset, making stuff, selling stuff, providing some form of service and generating cash flow. If we predict cash will be generated from the asset, the asset has what we call a 'value in use'. Value in use is the present value of the future cash flow.

Q. 2

When do we perform an 'impairment test' ?

Non-current assets and goodwill should be reviewed for possible impairment were there are indications that the asset could be impaired. These indications would include both internal and external factors to the business (e.g. damage of asset, future plans, new competitors, etc.)

Goodwill and intangibles with indefinite lives should be tested annually for impairment.

Where possible the review should be carried out on individual assets. However, if this is impractical, a group of assets should be considered. The group of assets should be the smallest group on which cash flows can be identified and is called a cash - generating unit (CGU).

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Q. 3

Can you set out the impairment test ?

Impairment test

Q. 4

Carrying amount

x

Recoverable amount (W1)

x

Impairment loss

xx

Can you calculate recoverable amount ?

(W1) Recoverable amount is the greater of Net Selling price

Value in use (present value of the future cash flow) Which ever is greater becomes the

RECOVERABLE AMOUNT

Q. 5

How is an impairment loss accounted ?

It is like additional depreciation : Dr Income statement Cr Asset account

If an asset has been impaired the asset should be written down to its recoverable amount. If a group of assets is impaired they should be written down to recoverable amount but charging the impairment in the order :

1st

Goodwill allocated to the group

2nd

Other assets pro-rated according to their carrying value (or on some more reasonable basis).

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IAS 37

PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS

OBJECTIVE

The objective of this Standard is to ensure that appropriate recognition criteria and measurement bases are applied to provisions, contingent liabilities and contingent assets and that sufficient information is disclosed in the notes to enable users to understand their nature, timing and amount. IAS 37 prescribes the accounting and disclosure for all provisions, contingent liabilities and contingent assets, except: (a) those resulting from executory contracts, except where the contract is onerous. Executory contracts are contracts under which neither party has performed any of its obligations or both parties have partially performed their obligations to an equal extent; (b)those covered by another Standard.

It is worth noting that previously the term 'provisions' was used very loosely in financial reporting. With the enactment of IAS 37, rules with re s p e c t to re c o g n i t i o n a n d measurement of provisions, contingent liabilities, and contingent assets have been codified. Since then, entities preparing financial statements in accordance with International Financial Reporting Standards (IFRS) used these terms strictly based on their prescribed definitions under IAS 37. Furthermore, IAS 37 also has clarified certain misconceptions about the term 'provision'. For instance, 'provisions' that are envisioned by this standard are now 'liabilities' (of uncertain timing or amount). The 'provision for depreciation' and the 'provision for doubtful debts' are really not provisions according to this standard but are contra accounts or adjustments to the carrying value of assets.

Provisions A provision is a liability of uncertain timing or amount.

Recognition A provision should be recognised when, and only when: (a) an entity has a present obligation (legal or constructive) as a result of a past event; (b) it is probable (i.e. more likely than not) that an outflow of resources embodying economic benefits will be required to settle the

Not all obligations would make it incumbent upon an entity to recognize a provision. Only present obligations resulting for a past obligating event give rise to a provision. An obligation could either be a legal

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obligation; and (c) a reliable estimate can be made of the amount of the obligation. The Standard notes that it is only in extremely rare cases that a reliable estimate will not be possible. 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 account of all available evidence, it is more likely than not that a present obligation exists at the balance sheet date.

Measurement

obligation or a constructive obligation. A legal obligation is an obligation that could (a) Be contractual; or (b) Arise due to a legislation; or (c) Result from other operation of law. A constructive obligation, however, is an obligation that results from an entity's actions where (a) By an established pattern of past practice, published policies, or a sufficiently specific current

statement, the entity has indicated The amount recognised as a provision shall be the to other (third) parties that it will best estimate of the expenditure required to settle accept certain responsibilities; the present obligation at the balance sheet date. and The best estimate of the expenditure required to (b) As a result, the entity has settle the created a valid expectation in the present 'Best estimate' is a matter of minds of those parties that it will obligation is judgment and is usually based discharge those responsibilities. the amount on past experience with similar transactions, evidence that an entity provided by technical or legal would rationally pay to settle the obligation at the experts, or additional evidence balance sheet date or to transfer it to a third party at provided by events after the that time. Risks and uncertainties surrounding events balance sheet date. and circumstances should be considered in arriving at the best estimate of a provision: If a group of items is being measured, it is the 'expected value.' If a single obligation is being measured, it the 'most likely outcome.' Where the provision being measured involves a large population of items, the obligation is estimated by weighting all possible outcomes by their associated probabilities. Where a single obligation is Once recognized as a contingent liability, an entity being measured, the individual most likely outcome should continually assess may be the best estimate of the liability. However, even t h e pro b a b i li t y o f t he in such a case, the entity considers other possible outflow of the future outcomes. economic benefits relating to that contingent liability. If t h e pro b a b i li t y o f t he Contingent Liabilities outflow of the future A contingent liability is: economic benefits changes to more likely than not, then (a) a possible obligation that arises from past events the contingent liability may and whose existence will be confirmed only by the develop into an actual occurrence or non-occurrence of one or more uncertain liability and would need to future events not wholly within the control of the entity; be recognized as a provision. or A PRACTICAL APPROACH TO IFRS

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(b) a present obligation that arises from past events but is not recognised because: (i) it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or (ii) the amount of the obligation cannot be measured with sufficient reliability. An entity should not recognise a contingent liability. An entity should disclose a contingent liability, unless the possibility of an outflow of resources embodying economic benefits is remote.

Contingent Assets A contingent asset is a possible asset that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity. An entity shall not recognise a contingent asset. However, when the realisation of income is virtually certain, then the related asset is not a contingent asset and its recognition is appropriate.

Q. 1

What is a provision ?

A provision is a liability of uncertain timing or amount. A liability is a present obligation of an entity to transfer economic benefits as a result of past transactions or events.

Q. 2

What is a contingent liability ?

A contingent liability is a possible obligation that arises from past events whose outcome is based on uncertain future events, or an obligation that is not recognised because it is not probable or cannot be measured reliably.

Q. 3

What is a contingent asset ?

A contingent asset is a possible asset that arises from past events whose existence will only be confirmed by uncertain future events not wholly within the control of the enterprise.

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Q. 4

When should provisions be recognised ? Provide only when all conditions are met.

It is probable that a transfer of economic benefits will be required to

Has a present obligation (either legal or constructive). The obligation can be measured reliably.

Q. 5

How should a provisions be accounted for ?

When deciding if a provision should be recognised an entity should determine whether the future expenditure can be avoided. If the future expenditure can be avoided no provision should be made.

Q. 6

How should contingent liabilities be accounted for ?

Contingent liabilities should not be recognised in the financial statement. However disclosure should be made unless the possibility of the transfer of economic benefits is remote.

Q. 7

How should contingent assets be accounted for ?

Contingent assets should not be recognised, and disclosure is only allowed if the possible profit is considered probable. Virtually certain profits could be recognised in the financial statements. * Also refer to IFRIC 1 - Changes in Existing Decommissioning, Restoration and Similar Liabilities * Also refer to IFRIC 5 - Rights to Interests Arising from Decommissioning, Restoration and Environmental Funds * Also refer to IFRIC 6 - Liabilities Arising from Participating in a Specific Market * Also refer to IFRIC 17 - Distributions of Non-Cash Assets to Owners A PRACTICAL APPROACH TO IFRS

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IAS 38

INTANGIBLE ASSETS

OBJECTIVE The objective of this standard is to prescribe the accounting treatment for intangible assets that are not dealt with specifically in another standard. This standard requires an entity to recognise an intangible asset if, and only if, specified criteria are met. The standard also specifies how to measure the carrying amount of intangible assets and requires specified disclosures about intangible assets.

KEY DEFINITIONS Intangible asset is an identifiable, nonmonetary asset without physical substance. Asset is a resource controlled by an entity as a result of past events and from which future economic benefits are expected to flow to the entity. Research is an original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding. Development means the application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials, devices, products, processes, systems or services before the start of commercial production or use. Cost is the amount paid or fair value of other consideration given to acquire or construct an asset. Useful life is the period over which an asset is expected to be utilized or the number of production units expected to be obtained from the use of the asset. Residual value of an asset is the estimated amount, less estimated disposal costs, that could be currently realized from the asset's disposal if the asset were already of an age and condition expected at the end of its useful life. Fair value is the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm's-length transaction.

Recognition The recognition of an item as an intangible asset requires an entity to demonstrate that the item meets: (a) the definition of an intangible asset; and (b) the recognition criteria. A PRACTICAL APPROACH TO IFRS

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This requirement applies to costs incurred initially to acquire or internally generate an intangible asset and those incurred subsequently to add to, replace part of, or service it. An asset meets the identifiability criterion in the definition of an intangible asset when it: (a) is separable, i.e. is capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, asset or liability; or

Future economic benefit may include revenue from the sale of products, services, or processes, but also includes cost savings or other benefits from use of an asset. Use of intellectual property can reduce operating costs rather than produce revenue.

(b) arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations. An intangible asset shall be recognised if, and only if: (a) it is probable that the expected future economic benefits that are attributable to the asset will flow to the entity; and (b) the cost of the asset can be measured reliably. The probability recognition criterion is always considered to be satisfied for intangible assets that are acquired separately or in a business combination.

Initial Measurement An intangible asset shall be measured initially at cost. The cost of a separately acquired intangible asset comprises: (a) its purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates; and (b)

any directly attributable cost of preparing the asset for its intended use.

In accordance with IFRS 3 Business Combinations, if an intangible asset is acquired in a business combination, the cost of that intangible asset is its fair value at the acquisition date. The only circumstances in which it might not be possible to measure reliably the fair value of an intangible asset acquired in a business combination are when the intangible asset arises from legal or other contractual rights and either: (a) is not separable; or

Costs that cannot be included are Costs of introducing new products or services, such as advertising Costs of conducting new business l Administration costs l Costs incurred while an asset that is l ready for use is awaiting deployment Costs of redeployment of an asset l Initial operating losses incurred from l operation l

If an intangible asset is acquired in exchange for another asset, then the acquired asset is measured at its fair value unless the exchange lacks commercial substance or the fair value cannot be reliably measured, in which case the acquired asset should be measured at the carrying amount of the asset given up, where carrying amount is equal to cost less accumulated depreciation and impairment losses. For impairment losses, reference

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(b) is separable, but there is no history or evidence of exchange transactions for the same or similar assets, and otherwise estimating fair value would be dependent on immeasurable variables.

should be made to IAS 36. In this context, any compensation received for impairment or loss of an asset shall be included in the income statement

Internally Generated Intangible Assets Internally generated goodwill shall not be recognised as an asset. No intangible asset arising from research (or from the research phase of an internal project) shall be recognised. Expenditure on research (or on the research phase of an internal project) shall be recognised as an expense when it is incurred. An intangible asset arising from development (or from the development phase of an internal project) shall be recognised if, and only if, an entity can demonstrate all of the following: (a) the technical feasibility of completing the intangible asset so that it will be available for use or sale. (b) its intention to complete the intangible asset and use or sell it. (c) its ability to use or sell the intangible asset.

Expenditure on research (or the research phase of an internal project) is to be written off as an expense as and when incurred, as it is not possible to demonstrate that an asset exists that will generate future economic benefit. Examples include Activities aimed at obtaining new knowledge

l

The search for, evaluation, and selection of applications of research findings or knowledge

l

The search for alternatives for materials, devices, products, systems, or processes

l

The formulation, design, evaluation, and selection of possible alternatives for new or improved materials, devices, products, systems, or processes

l

(d) how the intangible asset will generate probable future economic benefits. Among other things, the entity can demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset. (e) the availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset. (f) its ability to measure reliably the expenditure attributable to the intangible asset during its development. Internally generated brands, mastheads, publishing titles, customer lists and items similar in substance shall not be recognised as intangible assets. The cost of an internally generated intangible asset is the sum of expenditure incurred from the date when the intangible asset first meets the recognition. The standard prohibits reinstatement of expenditure previously recognised as an expense. Expenditure on an intangible item shall be recognised as an expense when it is incurred unless: (a) it forms part of the cost of an intangible asset that meets the recognition criteria; or (b) the item is acquired in a business combination and cannot be recognised as an intangible asset. If this is the case, this expenditure (included in the cost of the business A PRACTICAL APPROACH TO IFRS

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combination) shall form part of the amount attributed to goodwill at the acquisition date (see IFRS 3 Business Combinations).

Measurement After Recognition An entity shall choose either the cost model or the revaluation model as its accounting policy. If an intangible asset is accounted for using the revaluation model, all the other assets in its class shall also be accounted for using the same model, unless there is no active market for those assets.

An active market is a market in which all the following conditions exist: (a) the items traded in the market are homogeneous; (b) willing buyers and sellers can normally be found at any time; and

(c) prices are available to the public. Cost model: After initial recognition, an intangible asset shall be carried at its cost less any accumulated amortisation and any accumulated impairment losses. Revaluation model: After initial recognition, an intangible asset shall be carried at a revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated amortisation and any subsequent accumulated impairment losses. For the purpose of revaluations under this Standard, fair value shall be determined by reference to an active market. Revaluations shall be made with such regularity that at the balance sheet date the carrying amount of the asset does not differ materially from its fair value. If an intangible asset's carrying amount is increased as a result of a revaluation, the increase shall be credited directly to equity under the heading of revaluation surplus. However, the increase shall be recognised in profit or loss to the extent that it reverses a revaluation decrease of the same asset previously recognised in profit or loss. If an intangible asset's carrying amount is decreased as a result of a revaluation, the decrease shall be recognised in profit or loss. However, the decrease shall be debited directly to equity under the heading of revaluation surplus to the extent of any credit balance in the revaluation surplus in respect of that asset.

Useful Life An entity shall assess whether the useful life of an intangible asset is finite or indefinite and, if finite, the length of, or number of production or similar units constituting, that useful life. Useful life is: (a) the period over which an asset is expected to be available for use by an entity; or (b) the number of production or similar units expected to be obtained from the asset by an entity. The useful life of an intangible asset that arises from contractual or other legal rights shall not exceed the period of the contractual or other legal rights, but may be

All relevant factors to be considered in the assessment of useful life may include: l Expected usage by the entity and whether it could be used by new management teams l Product life cycles l Rates of technical or commercial change l Industry stability l Likely actions by competitors l Legal restrictions l Whether the useful life is dependent on the useful lives of other assets

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shorter depending on the period over which the entity expects to use the asset. To determine whether an intangible asset is impaired, an entity applies IAS 36 Impairment of Assets.

Intangible Assets with Finite Useful Lives The depreciable amount of an intangible asset with a finite useful life shall be allocated on a systematic basis over its useful life. Depreciable amount is the cost of an asset, or other amount substituted for cost, less its residual value. Amortisation shall begin when the asset is available for use, ie when it is in the location and condition necessary for it to be capable of operating in the manner intended by management.

The amortisation period and the amortisation method for an intangible asset with a finite useful life shall be reviewed at least at each financial year-end. If the expected useful life of the asset is different from previous estimates, the amortisation period shall be changed accordingly. If there has been a change in the expected pattern of consumption of the future economic benefits embodied in the asset, the amortisation method shall be changed to reflect the changed pattern. Such changes shall be accounted for as changes in accounting estimates in accordance with IAS 8.

Amortisation shall cease at the earlier of the date that the asset is classified as held for sale (or included in a disposal group that is classified as held for sale) in accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations and the date that the asset is derecognised. The amortisation method used shall reflect the pattern in which the asset's future economic benefits are expected to be consumed by the entity. If that pattern cannot be determined reliably, the straight-line method shall be used. The amortisation charge for each period shall be recognised in profit or loss unless this or another Standard permits or requires it to be included in the carrying amount of another asset. The residual value of an intangible asset is the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life. The residual value of an intangible asset with a finite useful life shall be assumed to be zero unless: (a) there is a commitment by a third party to purchase the asset at the end of its useful life; or (b) there is an active market for the asset and: (i) residual value can be determined by reference to that market; and (ii) it is probable that such a market will exist at the end of the asset's useful life.

Intangible Assets with Indefinite Useful Lives An intangible asset with an indefinite useful life shall not be amortised. In accordance with IAS 36 Impairment of Assets, an entity is required to test an intangible asset with an indefinite useful life for impairment by comparing its recoverable amount with its carrying amount (a) annually, and (b) whenever there is an indication that the intangible asset may be impaired.

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The useful life of an intangible asset that is not being amortised shall be reviewed each period to determine whether events and circumstances continue to support an indefinite useful life assessment for that asset. If they do not, the change in the useful life assessment from indefinite to finite shall be accounted for as a change in an accounting estimate in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.

Q. 1

What is an intangible asset ?

An intangible asset is an identifiable nonmonetary asset without physical substance. Assets are identifiable because they are separable, or because they are identifiable through legal or contractual rights.

Q. 2

When should intangibles be recognised on a balance sheet?

Intangibles should be recognised if, and only if, the following criteria are met : G It is probable that the future economic benefits will flow to the enterprise; and G The cost of the asset can be measured reliably.

Q. 3

When can you capitalise internally generated intangibles ?

The generation of the asset is classified into : a research phase (never capitalise) a development phase (may be capitalised but criteria need to be met):

Totally importantalways employ attractive men !!

(a) technically feasible (b) intention to complete and use or sell the asset (c) ability to use or sell the asset (d) existence of a market or demonstration of usefulness of intangible (e) availability of technical, financial or other resources to complete the asset (f) measure the cost reliably

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Q. 4

What about purchased intangibles ?

For purchased intangibles the probability criteria is always met (because a price has been paid) and therefore they are recognised on the balance sheet, albeit subject to an impairment review.

For intangibles acquired in a business combination there is an assumption that the probability criteria is met, and there is always information to measure the cost separately from goodwill. This mean the following sorts of intangibles (plus others) must be recognised separately from goodwill:

Customer lists

G

In progress R & D

G

Implement contracts below market rate

G

Order or production backlogs.

G

Q. 5

Once intangibles are on the balance sheet, what then?

Intangible assets should be amortised over their useful economic lives. If no amortisation is charged because the life is indefinite, the asset must be subject to an annual impairment review.

Intangibles can be revalued only if an active market exists for the asset (very rare).

* Also refer to IFRIC 12 - Service Concession Arrangements * Also refer to SIC 32 - Intangible Assets - Website Cost A PRACTICAL APPROACH TO IFRS

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IAS 39

FINANCIAL INSTRUMENTS: MEASUREMENT AND RECOGNITION

OBJECTIVE The objective of this standard is to establish principles for recognising and measuring financial assets, financial liabilities and some contracts to buy or sell nonfinancial items. Requirements for presenting information about financial instruments are in IAS 32 Financial Instruments: Presentation. The requirements for disclosing information about financial instruments are in IFRS 7 Financial Instruments: Disclosures.

KEY DEFINITIONS Financial Instrument is a contract that gives rise to a financial asset of one enterprise and a financial liability of another enterprise. Financial Asset includes: Cash l An Equity instrument of another enterprise l A Contractual right: l (a) To receive cash or another financial asset from another enterprise (b) To exchange financial assets or financial liabilities with another enterprise under conditions that are potentially favourable to the enterprise: or l A contract that will or maybe settled in the enterprise's own equity instruments Financial Liability includes: l A Contractual obligation: (a) To deliver cash or another financial asset to another enterprise or (b) To exchange financial assets or financial liabilities with another enterprise under conditions that are potentially unfavourable to the enterprise. l A contract that will or maybe settled in the enterprise's own equity instruments

Initial Recognition An entity shall recognise a financial asset or a financial liability on its balance sheet when, and only when, the entity becomes a party to the contractual provisions of the instrument.

De-recognition of a Financial Liability An entity shall remove a financial liability (or a part of a financial liability) from its balance sheet when, and only when, it is extinguished—i.e. when the obligation specified in the contract is discharged or cancelled or expires. A PRACTICAL APPROACH TO IFRS

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Initial Measurement of Financial Assets and Financial Liabilities When a financial asset or financial liability is recognised initially, an entity shall measure it at its fair value plus, in the case of a financial asset or financial liability not at fair value through profit or loss, transaction costs that are directly attributable to the acquisition or issue of the financial asset or financial liability. Fair value is the amount for which an asset could be exchanged or a liability settled between knowledgeable, willing parties in an arm's length transaction.

Derecognition of a Financial Asset The following flow chart illustrates the evaluation of whether and to what extent a financial asset is derecognised.

Subsequent Measurement of Financial Assets For the purpose of measuring a financial asset after initial recognition, this Standard classifies financial assets into the following four categories defined in paragraph 9: (a) financial assets at fair value through profit or loss; (b) held-to-maturity investments; (c) loans and receivables; and (d) available-for-sale financial assets. An amendment to the Standard, issued in June 2005, permits an entity to designate a financial asset or financial liability (or a group of financial assets, financial liabilities or both) on initial recognition as one(s) to be measured at fair value, with changes in fair value recognised in profit or loss. To impose discipline on this categorisation, an entity is precluded from reclassifying financial instruments into or out of this category. After initial recognition, an entity shall measure financial assets, including derivatives that are assets, at their fair values, without any deduction for transaction costs it may incur on sale or other disposal, except for the following financial assets: (a) loans and receivables as defined in paragraph 9, which shall be measured at amortised cost using the effective interest method; (b) held-to-maturity investments as defined in paragraph 9, which shall be measured at amortised cost using the effective interest method; and (c) investments in equity instruments that do not have a quoted market price in an active market and whose fair value cannot be reliably measured and derivatives that are linked to and must be settled by delivery of such unquoted equity instruments, which shall be measured at cost. Financial assets that are designated as hedged items are subject to measurement under the hedge accounting. All financial assets except those measured at fair value through profit or loss are subject to review for impairment.

Subsequent Measurement of Financial Liabilities After initial recognition, an entity shall measure all financial liabilities at amortised cost using the effective interest method, except for: A PRACTICAL APPROACH TO IFRS

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(a) financial liabilities at fair value through profit or loss. Such liabilities, including derivatives that are liabilities, shall be measured at fair value except for a derivative liability that is linked to and must be settled by delivery of an unquoted equity instrument whose fair value cannot be reliably measured, which shall be measured at cost. (b) financial liabilities that arise when a transfer of a financial asset does not qualify for derecognition or when the continuing involvement approach applies. Paragraphs 29 and 31 apply to the measurement of such financial liabilities. (c) financial guarantee contracts as defined in paragraph 9. After initial recognition, an issuer of such a contract shall (unless paragraph 47(a) or (b) applies) measure it at the higher of: (i) the amount determined in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets; and (ii) the amount initially recognised (see paragraph 43) less, when appropriate, cumulative amortisation recognised in accordance with IAS 18 Revenue. (d) commitments to provide a loan at a below-market interest rate. After initial recognition, an issuer of such a commitment shall (unless paragraph 47(a) applies) measure it at the higher of: (i)

the amount determined in accordance with IAS 37; and

(ii) the amount initially recognised (see paragraph 43) less, when appropriate, cumulative amortisation recognised in accordance with IAS 18.

Gains and Losses A gain or loss arising from a change in the fair value of a financial asset or financial liability that is not part of a hedging relationship, shall be recognised, as follows. (a) A gain or loss on a financial asset or financial liability classified as at fair value through profit or loss shall be recognised in profit or loss. (b) A gain or loss on an available-for-sale financial asset shall be recognised directly in equity, through the statement of changes in equity, except for impairment losses and foreign exchange gains and losses, until the financial asset is derecognised, at which time the cumulative gain or loss previously recognised in equity shall be recognised in profit or loss. However, interest calculated using the effective interest method is recognised in profit or loss. Dividends on an available-for-sale equity instrument are recognised in profit or loss when the entity's right to receive payment is established. For financial assets and financial liabilities carried at amortised cost a gain or loss is recognised in profit or loss when the financial asset or financial liability is derecognised or impaired, and through the amortisation process. However, for financial assets or financial liabilities that are hedged items the accounting for the gain or loss.

Impairment and Uncollectibility of Financial Assets An entity shall assess at each balance sheet date whether there is any objective evidence that a financial asset or group of financial assets is impaired.

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Hedging If there is a designated hedging relationship between a hedging instrument and a hedged item, accounting for the gain or loss on the hedging instrument and the hedged item shall follow paragraphs 89–102 of IAS 39. Hedging relationships are of three types: (a) Fair value hedge: a hedge of the exposure to changes in fair value of a recognised asset or liability or an unrecognised firm commitment, or an identified portion of such an asset, liability or firm commitment, that is attributable to a particular risk and could affect profit or loss. (b) Cash flow hedge: a hedge of the exposure to variability in cash flows that (i) is attributable to a particular risk associated with a recognised asset or liability (such as all or some future interest payments on variable rate debt) or a highly probable forecast transaction and (ii) could affect profit or loss. (c) Hedge of a net investment in a foreign operation as defined in IAS 21. If a fair value hedge meets the conditions in paragraph 88 of IAS 39 during the period, it shall be accounted for as follows: (a) the gain or loss from remeasuring the hedging instrument at fair value (for a derivative hedging instrument) or the foreign currency component of its carrying amount measured in accordance with IAS 21 (for a non-derivative hedging instrument) shall be recognised in profit or loss; and (b) the gain or loss on the hedged item attributable to the hedged risk shall adjust the carrying amount of the hedged item and be recognised in profit or loss. This applies if the hedged item is otherwise measured at cost. Recognition of the gain or loss attributable to the hedged risk in profit or loss applies if the hedged item is an available-for-sale financial asset. If a cash flow hedge meets the conditions in paragraph 88 during the period, it shall be accounted for as follows: (a) the portion of the gain or loss on the hedging instrument that is determined to be an effective hedge (see paragraph 88) shall be recognised directly in equity through the statement of changes in equity; and (b) the ineffective portion of the gain or loss on the hedging instrument shall be recognised in profit or loss. Hedges of a net investment in a foreign operation including a hedge of a monetary item that is accounted for as part of the net investment (see IAS 21), shall be accounted for similarly to cash flow hedges: (a) the portion of the gain or loss on the hedging instrument that is determined to be an effective hedge (see paragraph 88) shall be recognised directly in equity through the statement of changes in equity; and (b) the ineffective portion shall be recognised in profit or loss.

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Q. 1

How does IAS 39 classify financial liabilities?

IAS 39 recognises two classes of financial liabilities : Financial liabilities at fair value through profit or loss.

G

Other financial liabilities measured at amortised cost using the effective interest method.

G

Q. 2 Period

What is amortised cost? Can you draw up the 'amortised cost table' ?

Amount Borrowed

Interest (at 9.5%) for income statement

Cash Repayment 4% (200,000)

Rolled up Interest

Bal c/fwd - Liability for balance sheet

`

`

`

`

`

1

157.763

14,988

(8,000)

6,988

164,751

2

164,551

15,651

(8,000)

7,651

172,402

3

172,402

16,378

(8,000)

8,378

180,780

4

180,780

17,174

(8,000)

8,174

189,954

5

189,954

18,046

(8,000)

10,046

200,000

Numbers shown for illustration purpose.

Classification of financial assets Remember for every company that raises finance, somebody must be providing it. These companies are purchasing 'investments'. IAS 39 applies to financial assets as well as financial liabilities.

Q. 3

What are the four classes of financial assets ?

Financial assets at fair value through profit or loss. Held-to-maturity investments. G Loans or receivables. G Available-for-sale financial assets. G G

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Q. 4

How are financial assets and liabilities initially recognised ?

Financial assets and liabilities should be recognised when the company becomes party to the contractual provisions of the instrument. The asset or liability is measured at fair value the actual transaction price on the report date.

Q. 5

How are financial assets and liabilities subsequently measured ?

The following table summarises how financial assets and liabilities are measured and how changes in value are recognised:

Item

Measurement on balance sheet

Gains/losses

Assets/at FV through profit or loss

FV

Income Statement

Available for sale

FV

Equity until derecognition of the asset, then recycled to income statement

Held-to-maturity

Amortised cost

n/a

Loans and receivables

Amortised cost

n/a

* Also refer to IFRIC 16 - Hedge of a Net Investments in a Foriegn Operation * Also refer to IFRIC 12 - Service Concession Arrangement * Also refer to IFRIC 9 - Reassessment of Embedded Derivatives A PRACTICAL APPROACH TO IFRS

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IAS 40

INVESTMENT PROPERTY

OBJECTIVE The objective of this Standard is to prescribe the accounting treatment for investment property and related disclosure requirements.

The Standard shall be applied in the recognition, measurement and disclosure of investment property.

KEY DEFINITIONS Investment property is property (land or a building—or part of a building—or both) held (by the owner or by the lessee under a finance lease) 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. A property interest that is held by a lessee under an operating lease may be classified and accounted for as investment property provided that: (a) the rest of the definition of investment property is met; (b) the operating lease is accounted for as if it were a finance lease in accordance with IAS 17 Leases; and (c) the lessee uses the fair value model set out in this Standard for the asset recognised.

Recognition Investment property shall be recognised as an asset when, and only when: (a) it is probable that the future economic benefits that are associated with the investment property will flow to the entity; and (b) the cost of the investment property can be measured reliably. Owner-occupied property is the property held by the owner or the lessee under a finance lease for use in production or supply of goods and services or for administrative purposes. A PRACTICAL APPROACH TO IFRS

One of the distinguishing characteristics of investment property (compared to owner occupied property) is that it generates cash flows that are largely independent from other assets held by an entity. Owner-occupied property is accounted for under IAS 16, Property, Plant and Equipment.

O Pg. 142

Measurement An investment property shall be measured initially at its cost. Transaction costs shall be included in the initial measurement. The initial cost of a property interest held under a lease and classified as an investment property shall be as prescribed for a finance lease by paragraph 20 of IAS 17, ie the asset shall be recognised at the lower of the fair value of the property and the present value of the minimum lease payments. An equivalent amount shall be recognised as a liability in accordance with that same paragraph. The Standard permits entities to choose either: (a) a fair value model, under which an investment property is measured, after initial measurement, at fair value with changes in fair value recognised in profit or loss; or

When applying the fair value model, the fair values should reflect the market conditions at the balance sheet date. Valuations, therefore, carried out at dates too far removed from the balance sheet date could reflect market conditions that are markedly different from those at the balance sheet date and would be unacceptable. In addition, care needs to be taken as equipment, such as lifts, air conditioning and the like, may be recognized as separate assets. Valuations usually include such assets, which should not be double counted.

(b) a cost model. The cost model is specified in IAS 16 and requires an investment property to be measured after initial measurement at depreciated cost (less any accumulated impairment losses). An entity that chooses the cost model discloses the fair value of its investment property. The fair value of investment property is the price at which the property could be exchanged between knowledgeable, willing parties in an arm's length transaction. An investment property shall be derecognised (eliminated from the balance sheet) on disposal or when the investment property is permanently withdrawn from use and no future economic benefits are expected from its disposal. Gains or losses arising from the retirement or disposal of investment property shall be determined as the difference between the net disposal proceeds and the carrying amount of the asset and shall be recognised in profit or loss (unless IAS 17 requires otherwise on a sale and leaseback) in the period of the retirement or disposal

Q. 1

When should provisions be recognised ?

What is an investment property ?

Property held to earn rentals or for capital appreciation - held for its investment potential

A PRACTICAL APPROACH TO IFRS

A property that is owner occupied may not be treated under IAS 40 as IAS 16 applies

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Q. 2

How is an investment property accounted for ?

How is an investment property accounted for ?

Initially at cost

SubsequentlyIt is a choice

Revalued to fair value at each balance sheet date (fair value model). No depreciation.

A PRACTICAL APPROACH TO IFRS

Using the benchmark method in IAS 16 (cost). The properties are depreciated like any other asset.

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IAS 41

AGRICULTURE

OBJECTIVE The objective of this Standard is to prescribe the accounting treatment and disclosures related to agricultural activity.

This Standard applies to biological assets, agricultural produce at the point of harvest, and government grants. The Standard does not apply to land related to agricultural activity, which is covered by IAS 16, Property, Plant, and Equipment, and IAS 40, Investment Property, or to intangible assets related to agricultural activity, which are covered by IAS 38, Intangible Assets.

KEY DEFINITIONS Agricultural activity is the management by an entity of the biological transformation of biological assets for sale into agricultural produce or into additional biological assets. Biological transformation comprises the processes of growth, degeneration, production, and procreation that cause qualitative or quantitative changes in a biological asset. A biological asset is a living animal or plant. Agricultural produce is the harvested product of the entity's biological assets. Harvest is the detachment of produce from a biological asset or the cessation of a biological asset's life processes. IAS 41 prescribes, among other things, the accounting treatment for biological assets during the period of growth, degeneration, production and procreation and for the initial measurement of agricultural produce at the point of harvest. It requires measurement at fair value less estimated point-of-sale costs from initial recognition of biological assets up to the point of harvest, other than when fair value cannot be measured reliably on initial recognition. This standard is applied to agricultural produce, which is the harvested product of the entity's biological assets, only at the point of harvest. Thereafter, IAS 2 Inventories or another applicable Standard is applied. Accordingly, this Standard does not deal with the processing of agricultural produce after harvest; for example, the processing of grapes into wine by a vintner who has grown the grapes.

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Recognition and Measurement An entity should recognize a biological asset or agricultural produce when the enterprise Controls the asset as a result of past events; and

l

It is probable that future economic benefits will flow to the entity. Additionally, the fair value or cost of the asset should be able to be measured reliably. Any biological asset should be measured initially and at each balance sheet date, at its fair value less estimated point-ofsale costs. The only exception to this is where the fair value cannot be measured reliably.

l

If an active market exists for the asset or produce, then the price in that market may be the best way of determining fair value. If an entity has access to different active markets, then the entity will choose the most relevant and reliable price that is the one at which it is most likely to sell the asset.

Agricultural produce should be measured at fair value less estimated point-of-sale costs at the point of the harvest. Unlike a biological asset, there is no exception in cases in which fair value cannot be measured reliably. According to IAS 41, agricultural produce can always be measured reliably. Point-ofsale costs include broker's and dealer's commissions, any levies by regulatory authorities and commodity exchanges, and any transfer taxes and duties. They exclude transport and other costs necessary to get the assets to a market. IAS 41 requires that a change in fair value less estimated point-of-sale costs of a biological asset be included in profit or loss for the period in which it arises. In agricultural activity, a change in physical attributes of a living animal or plant directly enhances or diminishes economic benefits to the entity. IAS 41 does not establish any new principles for land related to agricultural activity. Instead, an entity follows IAS 16 Property, Plant and Equipment or IAS 40 Investment Property, depending on which standard is appropriate in the circumstances. IAS 16 requires land to be measured either at its cost less any accumulated impairment losses or at a revalued amount. IAS 40 requires land that is investment property to be measured at its fair value or cost less any accumulated impairment losses. Biological assets that are physically attached to land (for example, trees in a plantation forest) are measured at their fair value less estimated point-ofsale costs separately from the land. IAS 41 requires that an unconditional government grant related to a biological asset measured at its fair value less estimated point-of-sale costs be recognised as income when, and only when, the government grant becomes receivable. If a government grant is conditional, including where a government grant requires an entity not to engage in specified agricultural activity, an entity should recognise the government grant as income when, and only when, the conditions attaching to the government grant are met. If a government grant relates to a biological asset measured at its cost less any accumulated depreciation and any accumulated impairment losses, IAS 20 Accounting for Government Grants and Disclosure of Government Assistance is applied.

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Q. 1

When does an entity recognise a biological asset?

An enterprise should recognise a biological asset or agricultural produce when, and only when : G the enterprise controls the asset as a result of past events G it is probable that future economic benefits will flow to the enterprise G the fair value or cost of the asset can be measured reliably.

Q. 2

How are biological assets accounted for ?

Biological assets should be measured initially and at each balance sheet at fair value less estimated point of sale.

Any gains or losses generated by measuring at fair value should be recognised in the income statement immediately.

Q. 3

Biological assets should be measured initially and at each balance sheet at fair value less estimated point of sale.

Biological assets should be separately presented on the face of the balance sheet.

What disclosures are required ?

Biological assets

Measure at fair value but split Physical change

Price changes

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IFRS 1

FIRST TIME ADOPTION OF IFRS

OBJECTIVE The objective of this IFRS is to ensure that an entity's first IFRS financial statements, and its interim financial reports for part of the period covered by those financial statements, contain high quality information that: (a) is transparent for users and comparable over all periods presented; (b) provides a suitable starting point for accounting under International Financial Reporting Standards (IFRSs); and (c) can be generated at a cost that does not exceed the benefits to users.

Opening IFRS Balance Sheet An entity shall prepare an opening IFRS balance sheet at the date of transition to IFRSs. This is the starting point for its accounting under IFRSs. An entity need not present its opening IFRS balance sheet in its first IFRS financial statements. In general, the IFRS requires an entity to comply with each IFRS effective at the end of its first IFRS reporting period. In particular, the IFRS requires an entity to do the following in the opening IFRS statement of financial position that it prepares as a starting point for its accounting under IFRSs: (a) recognise all assets and liabilities whose recognition is required by IFRSs; (b) not recognise items as assets or liabilities if IFRSs do not permit such recognition; (c) reclassify items that it recognised under previous GAAP as one type of asset, liability or component of equity, but are a different type of asset, liability or component of equity under IFRSs; and (d) apply IFRSs in measuring all recognised assets and liabilities.

IFRS 1 applies to an entity that presents its first IFRS financial statements and sets out ground rules that an entity needs to follow when it adopts IFRS for the first time as the basis for preparing its generalpurpose financial statements. In other words, it applies to all those entities that present for the first time their financial statements under IFRS. The Standard refers to such entities as 'First-Time Adopters of IFRS'. Furthermore, according to IFRS 1, an entity shall apply this Standard not only in its first IFRS financial statements but also in each interim financial report. An entity's first IFRS financial statements are those that are the first annual financial statements in which the entity adopts IFRS by an explicit and unreserved statement (in those financial statements) of compliance with IFRS.

Presentation and Disclosure A first-time adopter should present at least one year's worth of comparative information. If an entity also presents historical summaries of selected data for periods prior to the first period it presents full comparative information under IFRS, and IFRS does not

l

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require them to be in compliance with IFRS, such data should be labeled prominently as not being in compliance with IFRS and also disclose the nature of the adjustment that would make it IFRS compliant.

IFRS 1 requires that in preparing an 'opening IFRS balance sheet,' the 'first-time adopter' shall use the same accounting policies as it has u s e d t h ro u g h o u t a l l p e r i o d s presented in its first IFRS financial statements.

A first-time adopter should explain how the transition to IFRS affected its reported financial position, financial performance, and cash flows. In order to comply with the requirement, reconciliation of equity and profit and loss as reported under previous GAAP to IFRS should be included in the entity's first IFRS financial statements.

l

If an entity uses fair values in its opening IFRS balance sheet as deemed cost for an item of property, plant, and equipment, an investment property, or an intangible asset, disclosure is required for each line item in the opening IFRS balance sheet: of the aggregate of those fair values and of the aggregate adjustments to the carrying amounts reported under previous GAAP.

l

If an entity presents an interim financial report under IAS 34 for a part of the period covered by its first IFRS financial statements, in addition to disclosures made under IAS 34, the first-time adopter should also present a reconciliation of the equity and profit and loss under previous GAAP for the comparable interim period to its equity and profit and loss under IFRS.

l

Exemptions The IFRS grants limited exemptions from these requirements in specified areas where the cost of complying with them would be likely to exceed the benefits to users of financial statements. The IFRS also prohibits retrospective application of IFRSs in some areas, particularly where retrospective application would require judgements by management about past conditions after the outcome of a particular transaction is already known. The IFRS requires disclosures that explain how the transition from previous GAAP to IFRSs affected the entity's reported financial position, financial performance and cash flows.

Q. 1

When must an entity prepare an opening IFRS statement of financial position (balance sheet) ?

An entity must prepare an opening balance sheet at its transition date to IFRS as a basis for preparing the current and comparative financial statement.

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Q. 2

What exemptions exist from fully retrospective application ?

The exemptions from fully retrospective application are : Property, plant and equipment

A 'frozen' revaluation in previous GAAP is allowed as a deemed cost on transition to IFRS.

Business combinations The rules in IFRS 3 can be applied from any previous business combination as long as all since that date follow the rules. Without any retrospective application, positive goodwill is frozen and subject to annual impairment review, and negative goodwill must be written back to retained earnings. Employee benefits

On transition any actuarial gains and losses can be recognised within the pension asset or liability even if a spreading policy is adopted for those that arise after the transition date.

Exchange difference reserve

It is not required to recognise exchange differences arising before transition as a separate reserve if the were not recognised separately under previous GAAP. The exchange differences would not be recycled on disposal of the foreign subsidiary.

Financial instruments

Very complex rules, but the main issue is that IASs 32 and 39 do not need to be followed in the comparative periods for first-time adopters in 2005.

Any estimates made under previous GAAP should be brought forward into the first IFRS financial statements without adjustment unless they are so incorrect as to make the accounts not show a fair presentation.

Q. 3

What disclosures are required ?

In the first IFRS financial statements the following extra disclosures are required : full balance sheet reconciliations from previous GAAP to IFRS for the beginning of the first reporting period and at the date of transition to IFRS

G

full income statement reconciliation for the comparative period income statement

G

full explanations of the adjustments made in the above reconciliations.

G

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IFRS 2

SHARE – BASED PAYMENT

OBJECTIVE The objective of this IFRS is to specify the financial reporting by an entity when it undertakes a share-based payment transaction. In particular, it requires an entity to reflect in its profit or loss and financial position the effects of share-based payment transactions including expenses associated with transactions in which share options are granted to employees. The IFRS requires an entity to recognise share-based payment transactions in its financial statements including transactions with employees or other parties to be settled in cash, other assets or equity instruments of the entity. There are no Share-based payment. exceptions to the IFRS other than for One in which the entity transactions to which other standards apply. receives or acquires goods This also applies to transfers of equity and services for equity instruments of the entity's parent, or equity instruments of the entity or instruments of another entity in the same group i n c u r s a l i a b i l i t y fo r as the entity to parties that have supplied goods amounts that are based on or services to the entity. the prices of the entity's The IFRS sets out measurement principles and shares or other equity specific requirements for three types of shareinstruments of the entity. based payment transactions: (a) equity-settled share-based payment transactions, in which the entity receives goods or services as consideration for equity instruments of the entity (including shares or share options); (b) cash-settled share-based payment transactions, in which the entity acquires goods or services by incurring liabilities to the supplier of those goods or services for amounts that are based on the price (or value) of the entity's shares or other equity instruments of the entity; and (c) transactions in which the entity receives or acquires goods or services and the terms of the arrangement provide either the entity or the supplier of those goods or services with a choice of whether the entity settles the transaction in cash or by issuing equity instruments.

Equity Settled Transactions For equity-settled share-based payment transactions, the IFRS requires an entity to measure the goods or services received, and the corresponding increase in equity, directly, at the fair value of the goods or services received, unless that fair value cannot be estimated reliably. If the entity cannot estimate reliably the fair value of the goods or services received, the entity is required to measure their value, and the corresponding increase in equity, indirectly, by reference to the fair value of the equity instruments granted. Furthermore: A PRACTICAL APPROACH TO IFRS

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(a) for transactions with employees and others providing similar services, the entity is required to measure the fair value of the equity instruments granted, because it is typically not possible to estimate reliably the fair value of employee services received. The fair value of the equity instruments granted is measured at grant date. (b) for transactions with parties other than employees (and those providing similar services), there is a rebuttable presumption that the fair value of the goods or services received can be estimated reliably. The fair value is measured at the date the entity obtains the goods or the counterparty renders service. In rare cases, if the presumption is rebutted, the transaction is measured by reference to the fair value of the equity instruments granted, measured at the date the entity obtains the goods or the counterparty renders service. (c) for goods or services measured by reference to the fair value of the equity instruments granted, the IFRS specifies that vesting conditions, other than market conditions, are not taken into account when estimating the fair value of the shares or options at the relevant measurement date (as specified above). Instead, vesting conditions are taken into account by adjusting the number of equity instruments included in the measurement of the transaction amount so that, ultimately, the amount recognised for goods or services received as consideration for the equity instruments granted is based on the number of equity instruments that eventually vest. Hence, on a cumulative basis, no amount is recognised for goods or services received if the equity instruments granted do not vest because of failure to satisfy a vesting condition (other than a market condition). (d) the IFRS requires the fair value of equity instruments granted to be based on market prices, if available, and to take into account the terms and conditions upon which those equity instruments were granted. In the absence of market prices, fair value is estimated, using a valuation technique to estimate what the price of those equity instruments would have been on the measurement date in an arm's length transaction between knowledgeable, willing parties. (e) the IFRS also sets out requirements if the terms and conditions of an option or share grant are modified (e.g. an option is repriced) or if a grant is cancelled, repurchased or replaced with another grant of equity instruments. For example, irrespective of any modification, cancellation or settlement of a grant of equity instruments to employees, the IFRS generally requires the entity to recognise, as a minimum, the services received measured at the grant date fair value of the equity instruments granted.

Cash-settled Transactions For cash-settled share-based payment transactions, the IFRS requires an entity to measure the goods or services acquired and the liability incurred at the fair value of the liability. Until the liability is settled, the entity is required to remeasure the fair value of the liability at each reporting date and at the date of settlement, with any changes in value recognised in profit or loss for the period. For share-based payment transactions in which the terms of the arrangement provide either the entity or the supplier of goods or services with a choice of settling the transaction in cash or by issuing equity instruments, the entity is required to account for that transaction, or the components of that transaction as a cash-settled share-based payment transaction if, and to the extent that, the entity has incurred a liability to settle in cash (or other assets), or as an A PRACTICAL APPROACH TO IFRS

O Pg. 152

equity-settled share-based payment transaction if, and to the extent that, no such liability has been incurred. The IFRS prescribes various disclosure requirements to enable users of financial statements to understand: (a) the nature and extent of share-based payment arrangements that existed during the period; (b) how the fair value of the goods or services received, or the fair value of the equity instruments granted, during the period was determined; and (c) the effect of share-based payment transactions on the entity's profit or loss for the period and on its financial position.

Q. 1

How do we calculate the expense ?

For employee service it is the fair value of the equity instruments issued at their grant date.

The fair value of options at the grant date will usually be measured by using a pricing mode (such as Black-Scholes), and must take into account: exercise price of the option

G

life of the option

G

current price of the underlying shares

G

expected volatility of the share price

G

dividends expected on the shares; and

G

risk-free interest rate.

G

Q. 2

What are the accounting entries ? The debit is to the income statement. The credit entry is recognised as a separate item of equity.

Employee remuneration

Options

Salary Pension

A PRACTICAL APPROACH TO IFRS

Gives rise ts of the package doo an expense just as the other part

O Pg. 153

IFRS 3

BUSINESS COMBINATIONS

OBJECTIVE The objective of this IFRS is to specify the financial reporting by an entity when it undertakes a business combination.

Business Combination A business combination is the bringing together of separate entities or businesses into one reporting entity. The result of nearly all business combinations is that one entity, the acquirer, obtains control of one or more other businesses, the acquiree. If an entity obtains control of one or more other entities that are not businesses, the bringing together of those entities is not a business combination.

IFRS 3 applies to all business combinations except combinations of entities under common control, combinations of mutual entities, combinations by contract without exchange of any ownership interest and any joint venture operations

This IFRS: (a) requires all business combinations within its scope to be accounted for by applying the purchase method. (b) requires an acquirer to be identified for every business combination within its scope. The acquirer is the combining entity that obtains control of the other combining entities or businesses. (c) requires an acquirer to measure the cost of a business combination as the aggregate of: the fair values at the date of exchange of assets given, liabilities incurred or assumed, and equity instruments issued by the acquirer in exchange for control of the acquiree; plus any costs directly attributable to the combination.

Purchase method looks at the business combination from the perspective of the a c q u i r i n g c o m p a n y. I t measures the cost of the acquisition and allocates the cost of the acquisition to the net assets acquired.

(d) requires an acquirer to recognise separately, at the acquisition date, the acquiree's identifiable assets, liabilities and contingent liabilities that satisfy the following recognition criteria at that date, regardless of whether they had been previously recognised in the acquiree's financial statements: (i) 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; Control is the power to govern (ii) in the case of a liability other than a contingent the financial and operating liability, it is probable that an outflow of policies of an entity so as to resources embodying economic benefits will obtain benefits from its be required to settle the obligation, and its fair activities. value can be measured reliably; and A PRACTICAL APPROACH TO IFRS

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(iii) in the case of an intangible asset or a contingent liability, its fair value can be measured reliably. (e) requires the identifiable assets, liabilities and contingent liabilities that satisfy the above recognition criteria to be measured initially by the acquirer at their fair values at the acquisition date, irrespective of the extent of any minority interest. (f) requires goodwill acquired in a business combination to be recognised by the acquirer as an asset from the acquisition date, initially measured as the excess of the cost of the business combination over the acquirer's interest in the net fair value of the acquiree's identifiable assets, liabilities and contingent liabilities recognised in accordance with (d) above. (g) prohibits the amortisation of goodwill acquired in a business combination and instead requires the goodwill to be tested for impairment annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired, in accordance with IAS 36 Impairment of Assets. (h) requires the acquirer to reassess the identification and measurement of the acquiree's identifiable assets, liabilities and contingent liabilities and the measurement of the cost of the business combination if the acquirer's interest in the net fair value of the items recognised in accordance with (d) above exceeds the cost of the combination. Any excess remaining after that reassessment must be recognised by the acquirer immediately in profit or loss.

The IFRS assumes that negative goodwill would arise only in exceptional circumstances. Therefore, before determining that negative goodwill has arisen, the acquirer has to reassess the identification and measurement of the net assets and contingent liabilities acquired and also to look at the measurement of the cost of the business combination. If it appears that negative goodwill has arisen, it must be recognized immediately in profit or loss.

(i) requires disclosure of information that enables users of an entity's financial statements to evaluate the nature and financial effect of: (i)

business combinations that were effected during the period;

(ii)

business combinations that were effected after the balance sheet date but before the financial statements are authorised for issue; and

(iii) some business combinations that were effected in previous periods. (j) requires disclosure of information that enables users of an entity's financial statements to evaluate changes in the carrying amount of goodwill during the period. A business combination may involve more than one exchange transaction, for example when it occurs in stages by successive share purchases. If so, each exchange transaction shall be treated separately by the acquirer, using the cost of the transaction and fair value information at the date of each exchange transaction, to determine the amount of any goodwill associated with that transaction. This results in a step-by-step comparison of the cost of the individual investments with the acquirer's interest in the fair values of the acquiree's identifiable assets, liabilities and contingent liabilities at each step.

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the end of the period in which the combination is effected because either the fair values to be assigned to the acquiree's identifiable assets, liabilities or contingent liabilities or the cost of the combination can be determined only provisionally, the acquirer shall account for the combination using those provisional values. The acquirer shall recognise any adjustments to those provisional values as a result of completing the initial accounting: (a) within twelve months of the acquisition date; and (b) from the acquisition date.

Q. 1

What are the five core workings for consolidation of a statement of financial position (balance sheet)?

(W1) Group structure H Date of acq

80% S

This indicates that H owns 80% of the ordinary shares of S and when they were acquired.

(W2) Net assets of subsidiary At date of At the acquisition reporting date Share capital Reserves : Retained earnings (W3) Goodwill on acquisition ` Cost of shares acquired x Less : Share of net assets at acquisition (see W2) (x) Goodwill - parent share x Less : Impairments to date (x) Note you may have to gross x this - see chapter 24

`

`

x x

x x

(W4) Minority (non-controlling) interests ` Share of net assets at balance sheet date (see W2) x

(W5) Group retained earning H reserve (100%) S - group share of post - acquisition reserves Less : Goodwill impairments to date

` x x (x) x

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Q. 2

What are the key concept that you are applying when you consolidate accounts and what does it mean ?

The single entity concept - it means you need to cancel all intra-group transactions.

Q. 3

Give three examples of intra-group transactions that need to be cancelled ?

Intra-group sales (deduct from turnover and from cost of sales (purchases).

G

Intra-group loan (exclude the investment line in the company providing the finance and the loan line in the company receiving the finance).

G

Intra-group assets transferred at a profit (exclude the profit element from the asset and from the reserves).

G

Q. 4

Do we use the book values of the subsidiary's net assets or the fair values ?

The Fair Values.

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IFRS 5

NON-CURRENT ASSETS HELD FOR SALE

OBJECTIVE The objective of this IFRS is to specify the accounting for assets held for sale, and the presentation and disclosure of discontinued operations. In particular, the IFRS requires: (a) assets that meet the criteria to be classified as held for sale to be measured at the lower of carrying amount and fair value less costs to sell, and depreciation on such assets to cease; and (b) assets that meet the criteria to be classified as held for sale to be presented separately on the face of the balance sheet and the results of discontinued operations to be presented separately in the income statement.

The IFRS: (a) adopts the classification 'held for sale'. (b) introduces the concept of a disposal group, being 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.

Held for sale: The carrying amount of a noncurrent asset will be recovered mainly through selling the asset rather than through usage.

(c) classifies an operation as discontinued at the date the operation meets the criteria to be classified as held for sale or when the entity has disposed of the operation. An entity shall classify a non-current asset (or disposal group) as held for sale if its carrying amount will be recovered principally through a sale transaction rather than through continued use. For this to be the case, the asset (or disposal group) must be available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such assets (or disposal groups) and its sale must be highly probable. For the sale to be highly probable, the appropriate level of management must be committed to a plan to sell the asset (or disposal group), and an active programme to locate a buyer and complete the plan must have been initiated. Further, the asset (or disposal group) must be actively marketed for sale at a price that is reasonable in relation to its current fair value. In addition, the sale should be expected to qualify for recognition as a completed sale within one year from the date of classification, and actions required to complete the plan should indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. A discontinued operation is a component of an entity that either has been disposed of, or is classified as held for sale, and A PRACTICAL APPROACH TO IFRS

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(a) represents a separate major line of business or geographical area of operations, (b) is part of a single co-ordinated plan to dispose of a separate major line of business or geographical area of operations or (c) is a subsidiary acquired exclusively with a view to resale. A component of an entity comprises operations and cash flows that can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the entity. In other words, a component of an entity will have been a cash-generating unit or a group of cash-generating units while being held for use. An entity shall not classify as held for sale a non-current asset (or disposal group) that is to be abandoned. This is because its carrying amount will be recovered principally through continuing use.

Q. 1

When is a non-current asset classified as 'held for sale'?

Under IFRS 5, a non-current asset should be classified as 'held for sale' if its carrying amounts will be recovered principally through a sale transaction rather than its continuing use. The criteria which have to be met are : Management committed to a plan

G

Activity trying to find a buyer and marketing assets

G

Assets available for immediate sale

G

Sale is highly probable

G

Sale expected to complete within one year of classification.

G

Q. 2

How are 'held for sale' assets accounted for ?

Non-current assets held for sale should not be depreciated. The assets should be measured at the lower of carrying amount and fair value less costs to sell.

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Q. 3

What is an activity discontinued ?

When the operations and cash flows have been, or will be, eliminated from the on-going operations

When is an activity discontinued?

When it has been disposed of or is classified as held for sale

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When you have no significant continuing involvement

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IFRS 7

FINANCIAL INSTRUMENTS – DISCLOSURE

OBJECTIVE The objective of this IFRS is to require entities to provide disclosures in their financial statements that enable users to evaluate: (a) the significance of financial instruments for the entity's financial position and performance; and (b) the nature and extent of risks arising from financial instruments to which the entity is exposed during the period and at the reporting date, and how the entity manages those risks. The qualitative disclosures describe management's objectives, policies and processes for managing those risks. The quantitative disclosures provide information about the extent to which the entity is exposed to risk, based on information provided internally to the entity's key management personnel. Together, these disclosures provide an overview of the entity's use of financial instruments and the exposures to risks they create.

Scope The IFRS applies to all entities, including entities that have few financial instruments (e.g. a manufacturer whose only financial instruments are accounts receivable and accounts payable) and those that have many financial instruments (e.g. a financial institution most of whose assets and liabilities are financial instruments). When this IFRS requires disclosures by class of financial instrument, an entity shall group financial instruments into classes that are appropriate to the nature of the information disclosed and that take into account the characteristics of those financial instruments. An entity shall provide sufficient information to permit reconciliation to the line items presented in the balance sheet. The principles in this IFRS complement the principles for recognising, measuring and presenting financial assets and financial liabilities in IAS 32 Financial Instruments: Presentation and IAS 39 Financial Instruments: Recognition and Measurement.

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IFRS 8

SEGMENT REPORTING

OBJECTIVE Core principle—An entity shall disclose information to enable users of its financial statements to evaluate the nature and financial effects of the business activities in which it engages and the economic environments in which it operates.

Scope This IFRS shall apply to: (a) the separate or individual financial statements of an entity: (i) whose debt or equity instruments are traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local and regional markets), or (ii) that files, or is in the process of filing, its financial statements with a securities commission or other regulatory organisation for the purpose of issuing any class of instruments in a public market; and (b) the consolidated financial statements of a group with a parent: (i) whose debt or equity instruments are traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local and regional markets), or (ii) that files, or is in the process of filing, the consolidated financial statements with a securities commission or other regulatory organisation for the purpose of issuing any class of instruments in a public market. The IFRS specifies how an entity should report information about its operating segments in annual financial statements and as a consequential amendment to IAS 34 Interim Financial Reporting, requires an entity to report selected information about its operating segments in interim financial reports. It also sets out requirements for related disclosures about products and services, geographical areas and major customers. The IFRS requires an entity to report financial and descriptive information about its reportable segments. Reportable segments are operating segments or aggregations of operating segments that meet specified criteria. Operating segments are components of an entity about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. Generally, financial information is required to be reported on the same basis as is used internally for evaluating operating segment performance and deciding how to allocate resources to operating segments. The IFRS requires an entity to report a measure of operating segment profit or loss and of segment assets. It also requires an entity to report a measure of segment liabilities and particular income and expense items if such measures are regularly provided to the chief operating decision maker. It requires reconciliations of total reportable segment revenues, total profit or loss, total assets, liabilities and other amounts disclosed for reportable A PRACTICAL APPROACH TO IFRS

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segments to corresponding amounts in the entity's financial statements. The IFRS requires an entity to report information about the revenues derived from its products or services (or groups of similar products and services), about the countries in which it earns revenues and holds assets, and about major customers, regardless of whether that information is used by management in making operating decisions. However, the IFRS does not require an entity to report information that is not prepared for internal use if the necessary information is not available and the cost to develop it would be excessive. The IFRS also requires an entity to give descriptive information about the way the operating segments were determined, the products and services provided by the segments, differences between the measurements used in reporting segment information and those used in the entity's financial statements, and changes in the measurement of segment amounts from period to period.

Q. 1

What reconciliations does IFRS 8 require ?

Assets

Profit / Loss

What reconciliations does IFRS 8 require ? Other Amounts

Revenues

Liabilities

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Q. 2

What operating segment disclosures does IFRS 8 required?

Explanations

Reconciliations

What operating segment disclosures does IFRS 8 required?

By product or service by countries in which it earns revenues

A PRACTICAL APPROACH TO IFRS

Descriptive information about the way operating segments were determined

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CHAPTER 4 DIFFERENCES BETWEEN IFRS/GAAP AND ACCOUNTING STANDARDS 'At first glance, a move to IFRS seems to be straight forward. But, it encompasses a company's entire operations, including auditing and oversight, cash management, corporate taxes, technology and software.'

CHAPTER 4

Differences between IFRS/GAAP And Accounting Standards IFRS- 'Are these just guidelines or actual have policies?' IFRS refer to the entire body of IASB pronouncements including standards and interpretations approved by IASB and IAS and SIC interpretations approved by predecessor International Accounting Standards Committee (IASC). The paper issued by ICAI has given a green signal to convergence of the present Indian Accounting Standards to IFRS/GAAP. Lets how by to understand the differences between Indian Accounting stds/and (IFRS) GAAP S.No. Basis 1. a.

IFRS/IAS

Accounting Standard - India

General Differences/Similarity Basis of Accounting

IFRS require financial statements to be prepared on a modified historical cost basis, with a growing emphasis on fair value. The carrying amounts of the following assets and liabilities are based on fair value subsequent to initial recognition:- All derivative, financial assets and financial liabilities held for trading. - Provisions are measured at fair value, which is derived by discounting estimated future cash flows. - Whole classes of PPE maybe revalued to fair value, subject to certain condition. - Investment property maybe measured at fair value. - Cash- settled share-based payment awards are revalued to fair value until settlement. Additionally, discounting and valuebased measurements are in integral part of financial reporting under IFRS in some areas, including impairment testing. A PRACTICAL APPROACH TO IFRS

Indian GAAP requires financial statement to be prepared on historical cost but fixed assets, other than intangibles maybe revalued. Discounting and valuebased measurements are required in impairment testing.

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S.No. Basis b.

True and fair presentation

IFRS/IAS

Accounting Standard - India

The overriding requirement of IFRS is for the financial statements to give a fair presentation (true and fair view) compliance with IFRS, with additional disclosure when necessary is presumed to result in a fair presentation when compliance with a standard or interpretation would be misleading. An entity departs from the required treatment in order to give a fair presentation, if the relevant regulator does not prohibit the override.

The Companies Act, 1956 requires statements to give true and fair view of the state of affairs and its profit of loss. The Act also requires compliance with accounting standards. As per ICAI any material departure from accounting standards would result in an audit qualification, implying that no departure from accounting requirements of a mandatary standard is permitted. Where there is a conflict between an accounting standard and the companies act or other regulatory requirements, the Act prevails.

The overriding requirement of IFRS is for the financial statements to give a fair presentation (true and fair view) compliance with IFRS, with additional disclosure when necessary is presumed to result in a fair presentation when compliance with a standard or interpretation would be misleading. An entity departs from the required treatment in order to give a fair presentation, if the relevant regulator does not prohibit the override. c.

Substance over form

Transactions should be accounted for in accordance with their substance, rather than only their legal form.

Like IFRS, transactions should be accounted for in accordance with their substance, rather than only their legal form.

d.

Contents of Financial Statements

Two years' balance sheets, income statements, cash-flow statements, changes in equity, accounting policies and notes.

Two years' balance sheets, profit and loss accounts, accounting policies and notes. Listed entities are required to give their consolidated financial statements and the

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S.No. Basis

IFRS/IAS

Accounting Standard - India

related notes along with the standalone financial statements. (Financial Statements should also include cash flow statements in certain cases) e.

Reporting Currency

2.

Requires the measurement of profit using the functional currency. Entities may, however, present financial statements in a different currency.

Schedule VI to the Companies Act, 1956 specifies Indian Rupees as the reporting currency.

Presentation of Financial Statements (IAS 1)

Disclosure of Accounting Policies (AS 1)

IAS 1 was revised by IASB in 2007 w.e.f. 1st January, 2005

AS 1 is currently under revision to bring it inline with the current IAS 1. The exposure draft of the revised AS 1 is being finalised on the basis of the comments received on its limited exposure amongst specified bodies.

a.

Preparation

b.

Components of A complete set of financial Financial Statements statements under IFRS are:1. Statement of financial position 2. Statement of comprehensive income 3. Statement of Cash flows 4. Statement of changes in Equity 5. Notes including summary of accounting policies.

The components of financial statements are: 1. Balance Sheet 2. Statement of Profit and Loss 3. Cash flow statement (not mandatory for SMEs) 4. Explanatory Notes including summary of accounting policies.

c.

Balance Sheet

Does not prescribe any particular format. Generally, an entity must present its balance sheet items as current and non-current items. An entity can also use a liquidity presentation when it provides more reliable and relevant information. There are certain minimum items to be presented on the face of the balance sheet.

In India, the laws governing the companies, banking and insurance enterprises prescribe detailed formats for the financial statements to be followed by respective enterprises. So to make the accounting standard acceptable to the regulators, ASB has provided detailed formats (horizontal and vertical) for financial statements for companies in an appendix.

d.

Income Statement

Does not prescribe a particular format. However, an analysis of expenses is presented using a classification based

The companies Act also does not prescribe a particular format. The Company law and accounting standards however, prescribe certain disclosure norms for

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S.No. Basis

e.

Different basis of measurement

3.

IFRS/IAS

Accounting Standard - India

on either the nature of expenses or their function whichever provide information that is reliable and more relevant.

income and expenditures.

IAS 1 requires that if different measurement basis are used, then they should be presented as separate item on the face of the balance sheet.

AS1 does not require separate presentation of such assets on the balance sheet. Rather, it requires seperate presentation in the schedule and notes.

IAS 2- Inventories

AS 2- Valuation of Inventories

a)

Preparation

IAS 2 has been revised in 2003 as a part of IASB's improvement project.

AS 2 is based on IAS 2 revised in 1993.

b)

Scope

IAS2 specifically deals with cost of inventories of an enterprise providing services.

Revised AS2, excludes from its scope the work-in-progress of service providing enterprises.

c)

Cost formula

It requires for the same cost formula to be used for all inventories having a similar nature and use to the entity.

It provides that the formula used in determining the cost of an item of inventory needs to be selected with a view of providing the fairest possible approximation to the cost incurred in bringing the item to its present location and condition. However, there is no stipulation for the use of same cost formula in AS2.

d)

Excluded Costs

IAS2 excludes only 'selling costs' and not Distribution Costs'

AS2 specifically excludes 'selling and distribution costs' from the cost of inventories and provides that it is appropriate to recognize them as expense in the period in which they incurred.

e)

Additional requirement

There are certain additional requirements in IAS2 which are not contained in AS2:-

-

i)

Incase of inventory purchased on deferred terms, the excess over normal price is to be accounted as interest over the period of financing.

ii)

Exchange differences are not includible in inventory valuation.

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S.No. Basis

IFRS/IAS iii)

4.

Accounting Standard - India

Inventory pledged as security for liabilities requires separate disclosures. IAS-7 Cash Flow Statements

a)

Bank Overdraft

b)

Interest and Dividend These maybe classified as operating investing or financing activities in a manner consistent from period to period.

AS-3 Cash Flow Statements

It is included as cash and cash There is no stipulation regarding equivalents if they, from an treatment of bank overdraft. integral part of an entity's cash management. For Financial enterprises: Interest paid and interest received are to be classified as operating activities, dividend paid is to be classified as financing activity. For other enterprises: Interest and Dividend received are required to be classified as investing activities. Interest and Dividend paid are required to be classified as financing activities.

c)

Extra-Ordinary items The cash flow statement does Cash flows arising out of not reflect any items of cash operating, financing and flow as extra-ordinary. investing activities classified as extra-ordinary are separately disclosed.

AS 6 was formulated on the basis of IAS4, Depreciation Accounting, which has been withdrawn. This matter is now covered by IAS I6 and IAS 38. The corresponding accounting standard to this is AS-I0, Accounting for Fixed Assets, which is being revised to bring it in line with IAS I6. Upon the issuance of revised AS-10, AS-6 would also be withdrawn. 5.

IAS-8 Accounting Policies, Changes in Accounting Estimates and Errors.

AS-5 Net Profit or Loss for the period, Prior-period items and Changes in Accounting Policies.

a)

Changes in accounting policies

Requires retrospective application of changes in accounting policies by adjusting the opening balance of the affected item and other comparative amounts as if the new accounting policy had always been applied.

Changes in accounting policy should be made only if required BY STATUE or for more appropriate presentation of financial statements on a prospective basis together with proper disclosure if its impact is material.

b)

Changes in accounting estimate

Applied prospectively by including in the profit or loss in the period of change

Similar to IFRS

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S.No. Basis

IFRS/IAS

Accounting Standard - India

and if it affects future periods, in the profit or loss of these periods. c)

Errors

Errors are corrected by retrospective restatement of prior period figures by restatement of opening balance of assets, liabilities and equity for the earliest period possible.

AS-5 requires prior-period items to be included in the determination of net profit or loan for the current period.

d)

New accounting pronouncements

New Pronouncements issued but not yet effective are to be disclosed and the possible impact disclosed.

No disclosure required

IAS-10 Events after the Reporting Period.

AS-4 Contingencies and Events Occurring after the Balance Sheet Date.

It should not be shown as a liability and recognized only in the period in which it is declared.

Dividends are recognized as an appropriation from profits and recorded as liability if proposed or declared subsequent to the reporting period but before approval of the financial statements.

6.

a)

Proposed Dividend

b)

Non adjusting events Non-adjusting events which are material, are required to be disclosed in the final statements.

7.

a)

Approach

8.

a)

Replacement Costs

Non-adjusting events which are material should be disclosed in the report of the approving authority and not in the financial statement.

IASI2- Income Taxes

AS 22-Accounting for Taxes on Income.

Based on balance sheet approach and therefore temporary differences leads to creation of deferred tax liability e.g.- upward revaluation of assets .

Based on income statement approach and only timing differences lead to creation of deferred tax assets or liability.

AS 16-Property, Plant and Equipments

AS 10-Accounting for Fixed Assets AS 6-Depreciation Accounting

If subsequent costs are incurred for replacement of a part of an item of fixed asset, then such costs should be capitalized and

AS-10 provides that only that expenditure which increases the future benefits is included in the accounting book e.g. Increase in capacity.

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S.No. Basis

IFRS/IAS

Accounting Standard - India

simultaneously the replaced part to be de-capitalised. b)

Depreciation

PPE are componentised and depreciated.

No such provision.

c)

Inspection Costs

Cost of major inspection and overhauls recognized in the balance sheet.

Costs of major inspection are expensed when incurred.

d)

Revaluation

Revaluations are required to No specific requirement w.r.t. be made frequently to ensure frequency of revaluation. that the carrying amount does not materially differ from the amount determined using fair value.

e)

Residual Value

Estimates of residual value needs to be reviewed at least at the end of every year.

Estimates are not required to be update at the end of every year.

f)

Change in method of depreciation

Methods of depreciation include straight line, diminishing value, units of production method. Change in depreciation method is treated as change in accounting estimate and is accounted for prospectively.

The permitted methods are straight line and diminishing value method. AS 10 requires retrospective computation in case of change in methods. Any excess/deficit on such recomputation is required to be adjusted in the period in which change is required.

IAS 17- Lease

AS 19- Leases

9. a)

Direct Costs

The initial direct costs incurred by the lessor to be included in the lease receivable amount in case of finance lease and in the carrying amount of the asset in case of operating lease and does not mandate any accounting policy related disclosure.

The initial direct costs incurred by the lessor to be either charged off at the time of incurrence or to be amortised over the lease period and requires disclosure for accounting policy in the financial statements of the lessor.

b)

Composite Leases

In composite leases, Land and Building are considered separately. Land is normally an operating lease (if there is no transfer of ownership) and buildings are treated as operating or finance lease as the case may be.

As 19 excludes composite leases and land arrangements.

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S.No. Basis

IFRS/IAS

Accounting Standard - India

c)

IAS 17 does not require any separate disclosure for assets acquired under finance lease separately from assets owned

Schedule VI of the Companies Act, 1956, requires separate disclosure for assets acquired under finance lease separately from assets owned.

IAS 18- Revenue

AS 9- Revenue

Disclosure

10. a)

Definition

It's the gross inflow of economic benefits arising in the course of ordinary activities of an entity resulting in increase in equity. Amount collected on behalf of third parities such as sales, sales tax, VAT are excluded from revenues.

It's the gross inflow of cash, receivables and other consideration arising in the course of ordinary activities from sale of goods and rendering of services.

b)

Measurement

Fair value of revenue from sale of goods and services when inflow of cash and cash equivalent is deferred is determined by discounting all future receipts.

Revenue is recognized at the nominal amount of consideration receivable.

c)

Interest

It requires effective interest method prescribed in IAS 39 to be followed for interest income recognition.

Interest is recognized on time proportion basis.

IAS 19- Employee Benefits

AS 15- Employee Benefit

It provides an option to recognize actuarial gain and losses either by following 'Corridor Approach' or immediately in P&L A/c.

Exposure draft on revised AS 15 does not admit 'Corridor Approach'

11. a)

Recognition

b)

Termination Benefits The liability termination benefits has to be recognized on constructive basis e.g. Announcement of formal plan.

12.

a)

IAS 20- Accounting for Government Grants and Disclosure of Government Assistance. Extra Ordinary Items Extra Ordinary Items are not considered at all under IFRS

A PRACTICAL APPROACH TO IFRS

Exposure draft requires an entity to flow AS-29 in this regard.

AS12-Accounting for Government Grants.

It requires disclosure of government grants for financial support /compensation for losses as extra-ordinary items in income statement. O Pg. 174

S.No. Basis

IFRS/IAS

b)

Accounting basis of IAS 20 permits accounting Non-monetary assets either at fair value or acquisition cost.

c)

Disclosure

Accounting Standard - India Requires accounting only at acquisition cost

Requires separate disclosure No such disclosure requirements. of unfulfilled conditions and other contingencies if grant has been recognized.

13.

IAS 21- The Effects of Changes in Foreign Exchange Rates.

AS-11 The Effects of Change in Foreign Exchange Rates.

It is based on 'Functional Currency' Approach. Functional currency is the currency of the economic environment where an entity operates. Foreign currency is a currency other than functional currency.

Based on the integral and non-integral foreign operation approach. Under AS-11, foreign currency is a currency other than reporting currency. Reporting currency is the currency in which the financial statements are presented.

a)

Approach

b)

Changes in functional Change in functional currency currency is applied prospectively

Change in reporting currency is not dealt in AS-11, though reason for change is to be disclosed.

c)

Exchange rate differences

Recognized in the profit and loss account in the period in which they arise.

Similar to IFRS, except exchange differences upto 31st March, 2004 towards acquisition of fixed assets are capitalized.

IAS-23- Borrowing Costs

AS 16- Borrowing Costs

These are expensed as incurred

These costs are required to be capitalized if these costs are attributable to the acquisition, construction or production of a qualifying asset. Recognizing them as expense when incurred is not permitted.

IAS 24- Related party Disclosures

AS 18- Related Party Disclosures

14. a)

Treatment

15. a)

Definition

Related party includes post employment benefit plans (e.g. gratuity, pension fund) of the enterprise or of any entity, which is a related party of the enterprise.

AS 18 does not include this in the context of related party.

b)

Key Management Personal

It includes executive non-executive directors

Excludes non-executive directors from the definition of key management persons.

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IFRS/IAS

Accounting Standard - India

c)

Compensation of key management personnel is disclosed in total & separately for 1. Short – term employee benefits. 2. Post employment benefits. 3. Long term benefits. 4. Termination Benefits. 5. Share-based payments.

Compensation of key management personnel is disclosed in total as an aggregate of all items of compensation except when a separate disclosure is necessary for understanding of the related party transaction.

16.

IAS 26- Accounting and Reporting by Retirement Benefit Plan

There is no Equivalent Standard.

17.

IAS 27- Consolidated and Separate Financial Statements

As 21- Consolidated Financial Statements.

Disclosures

a)

Scope

A parent company is required to prepare consolidated financial statement to consolidate all its subsidiaries. A subsidiary is an entity that is controlled by another entity (known as the parent company).

AS21- does not specify entities that are required to present consolidated financial statements. This standard is to be followed if consolidated financial statements are presented. SEBI requires entities 'listed' and 'to be listed' to present consolidated financial statements.

b)

Definition of Control

Control is the power to govern the financial and operating policies of an enterprise so as to obtain benefits from its activities.

Control is ownership of more then one-half of the voting power of an enterprise or as control over the composition of the governing body of an enterprise so as to obtain economic benefits

c)

Computation of goodwill

Goodwill / Capital reserve on consolidation is computed on fair values of assets/ liabilities

Goodwill/ Capital reserve on consolidation is computed on the basis of carrying value of assets / liabilities.

d)

Disclosures

Does not require additional disclosures of list of all the subsidiaries including the name, country of incorporation, proportion of ownership interest and proportion of voting power held.

Requires disclosure of list of all subsidiaries including the name, country of incorporation proportion of ownership interest and proportion of voting power held.

IAS 28 – Investment in Associates

IAS 23- Accounting for Investments in Associates in Consolidated Financial Statements.

18.

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S.No. Basis

IFRS/IAS

Accounting Standard - India

Method of Accounting

Associates are generally accounted for using equity method except when; • Investment in associate held for sale is accounted in accordance with IFRS 5 • The reporting entity is also a parent and is exempt from preparing CFS under IAS 27 • Where the reporting entity is not a parent

Associates generally are accounted for using the equity method except when investment is acquired and held exclusively with a view of subsequent disposal in the near future.

(b)

Reporting dates

The difference between the reporting date of the associate and that of the investor shall be not more than three months

There is no limit of Three months between the reporting dates.

(c)

Goodwill or capital reserves

Goodwill or Capital Reserves within the investment amount are not required to be separately identified

Goodwill or capital Reserves within the investment amount are required to be separately identified

19.

IAS-29-Financial Reporting in Hyper-Inflationary Economies

There is no Equivalent Standard.

20.

IAS 31- Interests in Joint Ventures

AS:27- Financial Reporting of Interests in Joint Ventures

(a)

Meaning

A Joint venture is a contractual arrangement whereby two or more parties undertake an economic activity that is subject to joint control

Unlike IFRS, sometimes though a contractual arrangement may suggest a joint venture, the investee is accounted as a subsidiary if the investors share in the investee’s equity is greater than 50%.

(b)

Jointly controlled entities

These may be accounted for by proportionate consolidation or equity method.

These are accounted for only by using proportionate consolidation method.

IAS 33-Earnings Per Share

AS 20- Earnings Per Share

Disclosure be made only in the consolidated financial statements of the parent company ie. Parent company can elect not to make disclosure in the separate financial statement.

Requires disclosure of basic and diluted EPS information both in the separate and consolidated financial statement of the parent company.

21. a)

Disclosure

b)

Extra-ordinary items No item is to be presented as extra-ordinary

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S.No. Basis

IFRS/IAS

Accounting Standard - India

22.

IAS 34- Interim Financial Reporting

AS 25- Interim Financial Reporting

a)

Components

Minimum components of Interim Financial Report includes – Statement showing Changes in Equity.

Does not require presentation of condensed statement of changes in equity. But, due to revision in AS-1, limited revision to AS 25 has also been proposed. This requires Co. to present condensed Statement of Changes in Equity as a part of financial statements.

b)

Changes in accounting policies

Incase of change in accounting policies, figures of prior interim periods of the current financial year and comparable figures of corresponding previous year to be restated

Requires statement of figures of prior interim period of the current financial year only.

IAS 36- Impairment of Asset: Goodwill

AS 28- Impairment of Assets

23.

a)

Determination of net For determining net selling selling price price, cost of disposal to be reduced only in cases where asset is intended to be disposed off.

For determining net selling price, cost of disposal to be reduced from fair value of assets in all cases

b)

Impairment losses

Does not permit reversal of impairment losses

Permits reversal of impairment losses.

c)

Allocation of Goodwill

Recommends only bottom– up approach for allocation of goodwill

Allows both bottom-up and top down methods

IAS 37- Provisions, Contingent Assets and Contingent Liabilities

AS 29- Provisions, Contingent Assets and Contingent Liabilities

24.

a)

Recognition

Recognised when an entity Provisions not recognized on has a present obligation as a basis of construction obligations result of a past event except in a few cases e.g.; obligation arising out of normal custom, desire to maintain good business relations.

b)

Discounting

Permits discounting of provisions

Does not permit any discounting.

c)

Disclosure

Requires disclosure of contingent assets in financial statements.

Allows disclosure only in the approving authority report.

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S.No. Basis

IFRS/IAS

Accounting Standard - India

d)

Provides certain basis and statistical methods to be followed for arising at the best estimate of the expenditure for which provision is recognized.

Does not contain any guidance and relies on judgment of management.

IAS 38- Intangible Assets

AS 26- Intangible Assets

Methods

25. a)

Measurement

Measured either at cost or revalued amounts

Measured only at cost.

b)

Useful Life

Useful life maybe finite or indefinite

Useful life cannot be indefinite. There is a rebuttable presumption that useful life of an intangible asset will not exceed to years from the date it is available for use.

c)

Goodwill

Not amortized but to annual Goodwill arising out of impairment test or amalgamation is amortized over whenever required. five years. Goodwill arising on acquisitions is not amortised but tested for impairment.

26.

IAS 40-Investment Property

There is no equivalent standard. At present, this is covered by AS13-Accounting for Investments.

27.

IAS 41- Agriculture

No equivalent standards

28.

IFRS–2 Share Based Payment

There is no equivalent standard. But ICAI has issued a guidance note on Accounting for Employee-Share-based payments. SEBI has also issued the SEBI (Employee stock option scheme and employee stock purchase scheme) Guidelines, 1999.

a)

Recognition

Recognise as an expense over the vesting period.

Similar to IFRS

b)

Valuation

Different valuation techniques maybe applied.

Permits the use of fair value method on the intrinsic value method. But gives preference to fair value method.

IFRS 3- Business Combinations

As 14- Accounting for Amalgamations

Permits purchase method for accounting all business combinations other than entities under common

Amalgamations in the nature of purchase are accounted for either at fair value or book value. Pooling of interest method is

29. a)

Method

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S.No. Basis

IFRS/IAS

Accounting Standard - India

control. Pooling of interest method is prohibited.

acceptable.

b)

Valuation of goodwill Goodwill is valued as a difference between: q Aggregate of (i)Fair value of consideration transferred (ii)Amount of noncontrolling interest and fair value of the identifiable assets acquired and liabilities presumed.

Any excess of amount of consideration over the value of net assets of the transferor company is goodwill. If the amount is less than net assets acquired, then the difference is the capital reserve, a component of equity.

c)

Treatment of goodwill

Goodwill is not amortized but tested for impairment on an annual basis or more frequently if required.

Goodwill is amortized over a period not exceeding five years.

30.

IFRS 4-Insurance Contracts

No Equivalent Standard.

31.

IFRS 5-Non-current Assets AS 24- Discounting Operations held for Sale and AS 10- Accounting for Discontinued Operations. Fixed Assets

a)

Recognition

Non-current assets to be disposed of are classified as held for sale when the asset is available for immediate sale and sale is highly probable. They are measured at lower of carrying value and fair value less selling costs.

No standard dealing with this. As 10 deals with assets held for disposal. These are measured at lower of book value and not realizable value and are shown separately in the financial statements.

b)

Classification

An operation is classified as discontinued when it has been disposed of or classified as held for sale.

An operation is considered as discontinued at the earlier of sale agreement or approval of board of directors of a formal plan and its announcement.

IFRS 6- Exploration for and Evaluation of Mineral Resources.

No Equivalent Standard. But, there is a guidance note on Accounting for Oil and Gas Producing Activities.

These assets are measured at cost or revaluation less accumulated amortization and impairment Len.

These are two methods for accounting: the successful efforts method and the full cost method.

IFRS 7- Financial Instruments : Disclosure

AS 32- Financial Instruments : Disclosure

This standard prescribes the disclosures that enable

No difference b/w AS 32 and IFRS 7

32.

a)

Measured

33. a)

General

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S.No. Basis

IFRS/IAS

Accounting Standard - India

financial statement users to evaluate the significance of financial instruments to an entity, the nature and extent of their risks and how an entity manages these risks. 34.

IFRS – Operating Segments AS 17- Segment Reporting

a)

Identification

Operating segments are Requires enterprises to identify identified based on financial two sets of segment business information that is evaluated and geographical. regularly by chief operating decision maker.

b)

Measurement

Segment profit is reported on the basis used by chief operating decision.

Segment information is prepared in conformity with the accounting policies adopted by the enterprise as a whole.

c)

Disclosures

Requires disclosures of (a) external revenues from each product or service. (b) Revenues from customers in the country foreign countries. (c) Geographical information on non-current assets located in country or foreign countries.

Disclosures are required based on the classification of segments as primary or secondary. Disclosure requirements for secondary reporting are less detailed as compared to primary reporting format.

MEMORY TIPS 1. 2. 3.

4.

5.

6. 7.

The Council of ICAI has approved exposure draft of revised AS 10 to align it with IAS 16. But, there has been no announcement w.r.t. its effective date. After AS 30, Financial Instruments: Recognition and Measurement become effective; there will be no difference b/w IAS 18 and AS 9. When As 30, Financial Instruments: Recognition and Measurement become effective, it will result in limited revision to AS 21. Thereafter, there will be no difference between the two standards IAS 27 and AS 21. After AS 30, Financial Instruments: Recognition and Measurement becomes effective, it will result in limited revision to AS 23. Thereafter, there will be no difference between the two standards IAS 26 and AS 23. After AS 30, Financial Instruments: Recognition and Measurement becomes effective, it will result in limited revision to AS 27. Thereafter, there will be no difference between the two standards IAS 31 and AS 27. AS 31 becomes effective from 1st April,2011 thereafter, there will be no difference between IAS 32 & AS 31. Once AS 30 becomes effective, there will be no difference between IAS 39 and AS 13. A PRACTICAL APPROACH TO IFRS

O Pg. 181

PART - II MUST TO KNOW IAS / IFRS

CHAPTER 5 PRESENTATION OF FINANCIAL STATEMENTS (IAS 1) 'The financial highlights offered at the begining of the report tend to focus on what they (the company) want you to see... but that's just an appetizer... . The second course... the big plate of meat and potatoes... is the financial statement.'

CHAPTER 5 The ENRON Saga Enron was once the seventh largest public- listed entity in USA. In 2002, it became bankrupt leading to doom for many investors. The share value of Enron's shares declined from US$89 to less than US$1. This was all because of presenting misleading financial statements. And therefore, came into existence IAS 1 dealing with presentation of the Financial Statements. IAS 1 Presentation of Financial Statements was issued in December 2003. The International Accounting Standards Board (IASB) reissued IAS 1, Presentation of Financial Statements, in September 2007. The main changes are amendments to presentation and terminology. IAS 1 prescribes the basis for presentation of general purpose financial statements, to ensure comparability both with the entity's financial statements of previous periods and with the financial statements of other entities. IAS 1 does not apply to interim financial statements prepared in accordance with IAS 34 Interim Financial Reporting.

So………… What are the key objectives? •

To set out the overall framework for presenting general purpose financial statements, including guidelines for their structure and the minimum content.

•

It also prescribes the components of the financial statements that together would be considered a complete set of financial statements.

•

To specify disclosures about information to be presented in the financial statements, including judgements, key sources of estimation uncertainty, and accounting policies.

AND, its applicable to all…………. A 'general purpose financial statements' that have been prepared and presented in accordance with International Financial Reporting Standards (IFRS). 'General purpose financial statements' are those intended to meet the needs of users who are not in a position to demand reports that are tailored according to their information needs.

Components of Financial Statements as per IAS 1 A complete set of financial statements comprises of : a balance sheet;

G

an income statement;

G

a statement of changes in equity;

G

a cash flow statement;

G

notes, comprising a summary of significant accounting policies and other explanatory notes; and

G

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a statement of financial position as at the beginning of the earliest comparative period when an entity applies an accounting policy retrospectively or when it reclassifies items in its financial statements.

G

Components of Financial Statement Income and Expenses

Income Statement

Statement Of Changes In Equity Components of Financial Statement

Cash Flow Statement

All changes in equity or changes other than those with equity holders Cash inflows and outflows from operating, financing and investing activities. Significant accounting policies and explanatory notes

Notes

Needful Explanation of IAS 1 IAS 1 specifies the following about the preparation and presentation of financial statements: Fair Presentation

G

This means faithful representation of the effects of transactions, events and conditions in accordance with the definitions and recognition criteria for assets, liabilities, income and expenses set out in the Framework for the Preparation and Presentation of Financial Statements. The application of IFRSs (ie Standards and Interpretations), with additional disclosure whenever necessary, will achieve the objective of fair presentation. Compliance with IFRS

G

i. An entity must make an explicit and unreserved statement of compliance with IFRSs in the notes to the financial statements. Such a statement is only made on compliance with all the requirement of IFRSs. ii. Mere disclosure of the accounting policies used in preparing financial statement or notes or explanatory material does not give an entity a right to apply inappropriate accounting policies. iii. A departure from IFRSs is acceptable only in the extremely rare circumstances in which compliance with IFRSs conflicts with providing information useful to the users in making economic decisions. IAS 1 specifies the disclosures required when an entity departs from a requirement of an IFRS as follows: A PRACTICAL APPROACH TO IFRS

O Pg. 188

(a) That management has concluded that the financial statements present fairly the entity's financial position, financial performance, and cash flows. (b) That it has complied with all applicable Standards and Interpretations except that it has departed from a particular requirement to achieve fair presentation. (c) The title of the Standard or the Interpretation from which the entity has departed, the nature of the departure, including the treatment that the Standard or Interpretation would require, the reason why that treatment would be misleading in the circumstances that it would conflict with the objective of the financial statements set out in the Framework, and the treatment adopted. (d) The financial impact on each item in the financial statements of such a departure for each period presented.

In practice, some entities believe that even if an inappropriate accounting policy were used in presenting the financial statements (say, ignoring the inventory valuation principle of valuing inventories at cost price or market price which ever is less or use of 'cash basis' as opposed to the 'accrual basis' to account for certain expenses), as long as it is disclosed by the entity in notes to the financial statements, the problem would be rectified. Recognizing this tendency, IAS 1 categorically prohibits such shortcut methods from being employed by entities presenting financial statements under IFRS.

EXAMPLE

Going Concern

G

I. Financial statements should be prepared on a going concern assumption unless management either intends to liquidate the entity or to cease trading, or has no realistic alternative but to do so. When management is aware of material uncertainties related to events or conditions that may cast significant doubt upon the entity's ability to continue as a going concern, the entity shall disclose those uncertainties. It is also important for the management in this case to specify the basis for preparing financial statements and its reasons for adopting such a basis.

If an undertaking has departed, in a prior period, from a requirement in a Standard for the measurement of assets (or liabilities) and that departure affects the measurement of changes in assets (and liabilities) recorded in the current period's financial statements, then this needs to be disclosed.

ii. To ascertain the entity's ability to continue as a going concern, it is important to take into account the present status of the business, the future expectations and all other favourable and unfavourable aspects that can occur within 12 months of the Balance Sheet date. Basis of Accounting

G

IAS 1 requires that an entity should prepare its financial statements, except for cash flow information, using the accrual basis of accounting. Accrual basis of accounting is to A PRACTICAL APPROACH TO IFRS

O Pg. 189

recognise all the Assets, Liabilities, Incomes and Expenditures as and when they become payable or receivable rather than when actually paid or received.

EXAMPLE In December, Rahul sells some goods on credit. He receives cash from the client in the month of February. The sale is recorded in the month of December, not when the cash is received according to accrual basis. In November, office rent is paid relating to November, December and January. The rent cost is spread over these 3 months, not just expensed in full in the month that it was paid. This is the accrual basis of accounting.

Consistency of Presentation

G

i. The presentation and classification of items in the financial statements shall be retained from one period to the next unless a change is justified either by a change in circumstances or a requirement of a new IFRS.

When making such changes in presentation, an entity should reclassify its comparative information and present adequate disclosures

ii. A change in presentation and classification of items in the financial statements may be required when there is a significant change in the nature of the entity's operations, another presentation or classification is more appropriate (having considered the criteria of IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors), or when an IFRS requires a change in presentation.

EXAMPLE MNO Ltd. uses FIFO method of valuing inventory. But , the undertakings in the same industry use weighted average method of inventory valuation. In this case, MNO Ltd. should change its valuation policy to enable comparison for the benefit of the users. But the company has to reclassify its comparative information and present adequate disclosures.

Materiality

G

An item is considered to be material if it has the capacity to influence the decision of the various stakeholders in an organisation. An entity should present separately each material class of similar items as well as present separately material items of dissimilar nature or function. If a line item is not individually material, it is aggregated with other items either in those statements or in the notes. It is not necessary for an entity to provide a specific disclosure required by an IFRS if the information is not material. Offsetting

G

Assets and liabilities, income and expenses, may not be offset against each other, unless required or permitted by an IFRS. It is important that assets and liabilities, and income and A PRACTICAL APPROACH TO IFRS

O Pg. 190

EXAMPLE A competitor has filed a lawsuit against a company for a large amount of money. The lawyers are concerned, but management believes the lawsuit to be frivolous. The company should disclose this information as a contingent liability, with expression of management views, and those of the lawyers. expenses, are reported separately. Offsetting in the income statement or the balance sheet, except when this reflects the substance of the transaction, detracts from the ability of users both to understand the transactions that have occurred, and to assess future cash flows. However, the reduction of accounts receivable by provision for doubtful debts , or of property, plant, and equipment by the accumulated depreciation, are acts that reduce these assets by the appropriate valuation accounts to give the true values and are not considered to be offsetting assets and liabilities.

EXAMPLE An entity has an obsolete inventory. Any benefit will be limited to its scrap value. The company can make an obsolescence provision to reduce this inventory's carrying value. This is not regarded as offsetting.

Comparability

G

An entity shall disclose comparative information in respect of the previous period for all amounts reported in the current period's financial statements. It shall include comparative information for narrative and descriptive information when it is relevant to Narrative information provided in the financial statements for the an understanding of the current period's previous period may be relevant in financial statements. When the entity changes the current period. Details of a legal the presentation or classification of items in its dispute, the outcome of which was financial statements, the entity shall reclassify uncertain at the last balance sheet comparative amounts unless reclassification is date, and is yet to be resolved, are disclosed in the current period. Users impracticable. benefit from information that the G Reporting Period uncertainty existed at the last There is a presumption that financial balance sheet date, and about the statements will be prepared at least annually. If steps that have been taken during the the annual reporting period changes and period, to resolve the uncertainty.

EXAMPLE At the start of a lawsuit, the result may be difficult to estimate, and only a contingent liability can be noted. As a lawsuit nears conclusion, the result may be estimable, and a provision or asset may be recorded. Narrative should also be provided to enable users to understand the progress of the case. A PRACTICAL APPROACH TO IFRS

O Pg. 191

financial statements are prepared for a different period, the entity must disclose the reason for the change and a warning about problems of comparability.

Somethings to Ponder…………….? IAS 1 does not prescribe any specific formats but highlights the minimum items on the face of the statement of financial position

G

(a) property, plant and equipment (b) investment property (c) intangible assets (d) financial assets (excluding amounts shown under (e), (h), and (I)) (e) investments accounted for using the equity method (f)

biological assets

(g) inventories (h) trade and other receivables (i)

cash and cash equivalents

(j)

assets held for sale

(k) trade and other payables (l)

provisions

(m) financial liabilities (excluding amounts shown under (k) and (l)) (n) liabilities and assets for current tax, as defined in IAS 12 (o) deferred tax liabilities and deferred tax assets, as defined in IAS 12 (p) liabilities included in disposal groups (q) non-controlling interests , presented within equity and (r) issued capital and reserves attributable to owners IAS 1 gives a choice in case of unusual (exceptional) items, which can be presented either on the face of the income statement or notes to the accounts as desired by the management.

G

It also gives a choice w.r.t treatment of dividends to the owners. It can be either shown in 'Statement of Changes in Equity' or in the 'Notes' to the Balance Sheet.

G

Now, for a standard which has basically been created to allow comparability, there are many choices given w.r.t presentation. Will this help to achieve our objectives?............. A Food for your thought.

A PRACTICAL APPROACH TO IFRS

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Contents of Financial Statements as per IAS 1 Format of Balance Sheet i. As per the revised IAS 1, 2009 Balance Sheet is to be known as Statement of Financial Position. ii. The statement of financial position is a statement that presents assets, liabilities, and shareholders' equity (net worth) at a given point in time. It can be prepared either on time basis or liquidity basis. On adopting time basis, the assets and liabilities are classified as current and non-current separately. But, if a presentation based on liquidity provides information that is reliable and more relevant, then the current/non-current classification can be omitted. Generally, it's the current and non-current classification that is applied.

A liability shall be classified as current, when it satisfies any of the following criteria: (i) it is expected to be settled in normal operating cycle; (ii) it is held primarily for the purpose of being traded; (iii) it is due to be settled within twelve months after the balance sheet date; or (iv) the undertaking does not have an unconditional right to defer settlement of the liability, for at least twelve months after the balance sheet date. All other liabilities shall be classified as non-current.

An asset shall be classified as current, when it satisfies any of the following criteria: (i) it is expected to be converted to cash (or is intended for sale, or consumption) in the normal operating cycle; (ii) it is held primarily for the purpose of being traded; (iii) it is expected to be converted to cash within twelve months, after the balance sheet date; or (iv) it is cash (or a cash equivalent, as defined in IAS 7), unless it is restricted from being exchanged (or used to settle a liability), for at least twelve months after the balance sheet date. All other assets shall be classified as noncurrent.

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Format of the Statement of Financial Position (Balance Sheet) The Statement of Financial Position as at 31st March,2010 ASSETS Non-Current Assets Property, Plant and Equipment Goodwill Other intangible Assets Investments in associates Available for sale Investments

2009 2009

2010 2010

x x x x x

x x x x x x

Current Assets Inventories Trade and other receivables Other current assets Cash and cash equivalents

x x x x

x x x x x

x x

Total Assets EQUITY AND LIABILITIES Equity attributable to the holders of the parent Share capital Other Reserves Retained Earnings Minority (non-controlling) interests Non-current liabilities Long-term Borrowings Deferred Tax Long-Term provisions

x x x

x x

x x x x x

x x x

x x x x x

x Current Liabilities Trade and other payables Short –term borrowings Current portion of long-term borrowings Current tax payable Short- term provisions

x x x x x

Total Equity and Liabilities

x x x x x x

x

x

x

x

An error made by the students is that they try to memorize the full format. Infact, there are things related to advanced stages of accounting eg, consolidated statements for group of companies. The red portions in the above format also relate to advanced accounting. So, all students need not learn the format full for the purpose of giving Exams.

A PRACTICAL APPROACH TO IFRS

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Income Statement

G

I. As per revised format, income statement is to be known as 'Statement of Comprehensive Income'. The term 'profit or loss' is to be used rather than 'net profit or loss' as the descriptive term for the bottom line of the income statement. ii. It includes all the incomes and expenditures that are recognized for that period unless stated otherwise in a standard or its interpretation. iii. An entity can present its comprehensive income statement either as: K a single statement of comprehensive income or K two statements:

a) an income statement displaying components of profit or loss and b) a statement of comprehensive income that begins with profit or loss (bottom line of the income statement) and displays components of other comprehensive income like revaluation gains and losses; actuarial gains and losses. No extraordinary item should be a part of the income statement or the notes. All material items should be disclosed separately. The share of profits of the minority group and equity shareholders should be clearly specified. iv. Minimum items on the face of the statement of comprehensive income should include: K revenue K finance costs K share of the profit or loss of associates and joint ventures accounted for using the

equity method K tax expense K a single

amount comprising the total of (i) the post-tax profit or loss of discontinued operations and (ii) the post-tax gain or loss recognised on the disposal of the assets or disposal group(s) constituting the discontinued operation

K profit or loss K each component of other comprehensive income classified by nature K share

of the other comprehensive income of associates and joint ventures accounted for using the equity method

K total comprehensive income

A PRACTICAL APPROACH TO IFRS

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Practical Applicability

Format of Comprehensive Income in one Statement XYZ Co. statement of comprehensive Income for the year ended March 31st, 2010. 31/3/2010

31/3/2009

Revenue

-

-

Cost of sale

-

-

From Profit

-

-

Other Income

-

-

Administrative Expenses

(

)

(

)

Selling and Distribution Expense

(

)

(

)

Miscellaneous Expenses

(

)

(

)

Provisions Created

(

)

(

)

Financial Expense

(

)

(

)

Goodwill Written off

(

)

(

)

Profit before tax

-

Income Tax

(

Profit for the year

)

-

(

) -

Other Comprehensive Income Revaluation Profit/Loss

-

-

Profit/Loss on sale of Instruments

-

-

Profit/Loss on sale of Item of PPE

-

-

Amount Paid/Received from litigation settlement

-

-

Provision written off

-

-

Income tax related to other comprehensive Income

-

-

-

-

Equity Shareholder

-

-

Minority Interest

-

-

Total comprehensive Income Profit attributable to

Total comprehensive Income attributable to Equity Shareholder

-

-

Minority Interest

-

-

-

-

Earning per share, basic and diluted

A PRACTICAL APPROACH TO IFRS

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Format of Comprehensive Income in Two Statements XYZ Co. Income Statement for the year ended March 31st, 2010. 31/3/2010

31/3/2009

Revenue

-

-

Other Income

-

-

( -)

( -)

Administrative expenses

( -)

( -)

Employee benefit expenses

( -)

( -)

Raw material and consumables used Change in inventoures of finished goods and WIP

Depreciation

( -)

( -)

Amortisation expense

( -)

( -)

Other expenses

( -)

( -)

Financial expenses

( -)

( -)

-

-

Profit before tax Income Tax

(

)

(

)

Profit for the year

-

-

Profit attributable to

-

-

-

-

Equity Shareholder Minority Interest Earning per share, basic and diluted

-

-

-

-

XYZ Co. Statement of comprehensive Income for the year ended March 31st, 2010. 31/3/2010

31/3/2009

Profit for the year (from income statement)

-

-

Other comprehensive Income/Loss

-

-

Revaluation Profit/Loss

-

-

Profit/Loss on sale of Instruments

-

-

Profit/Loss on sale of Item of PPE

-

-

Amount Paid/Received from litigation settlement

-

-

Provision written off

-

-

Income tax related to other comprehensive Income

-

-

-

-

Total comprehensive Income Profit attributable to Equity Shareholder

-

-

Minority Interest

-

-

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Activity 1 Using the information provided in the following financial statement of XYZ Co. for the year ended March 31, 2010, present the information in accordance with IFRS effective through 2008. Phyzax Limited Statement of Operations and Comprehensive Income Year Ended December 31, 2010 (amounts are in lacs) 2010 (`)

2009 (`)

4,33,000

4,00,000

Cost of sales

(2,45, 000)

(2,30,000)

Gross Profit

1,88, 000

1,70,000

Revenue

Selling and administrative expenses Income from operations

39,000

43,000

1,49,000

1,27,000

Other income Interest

10,000

12,000

Income on continuing operations before tax

1,59,000

1,39,000

Income tax

(60,000)

(53,000)

99,000

86,000

Income before extraordinary item Extraordinary item - loss from earthquake, net of `23000 tax Net income

(45,000)

-

54,000

86,000

Other comprehensive income Sale of investments

(3,000)

10,000

Cash flow hedge

(5,000)

(5,000)

3,000

(2,000)

49,000

89,000

Income tax related to other comprehensive income Comprehensive income

Solution Comprehensive income in one statement & expenses by function XYZ Co. Statement of Comprehensive Income Year Ended December 31, 2010 2010 (`) Revenue

2009 (`)

4,33,000

4,00,000

Cost of sales

( 2,45,000)

(2,30,000)

Gross Profit

1,88,000

1,70,000

Other income

21,000

13,000

Distribution costs

(9,000)

(9,000)

(20,000)

(18,000)

Other expenses

Administrative expenses

(2,000)

(5,000)

Finance costs

(8,000)

(11,000)

A PRACTICAL APPROACH TO IFRS

O Pg. 198

Profit before tax

1,70,000

1,40,000

Income tax expense

(40,000)

(40,000)

PROFIT FOR THE YEAR

1,30,000

1,00,000

Available for sale investments

(3,000)

10,000

Cash flow hedge

(5,000)

(5,000)

Other comprehensive income

Income tax related to other comprehensive income

3,000

(2,000)

(5,000)

3,000

TOTAL COMPREHENSIVE INCOME FOR THE YEAR

1,25,000

1,03,000

Profit attributable to:Owners of the parent

1,04,000

80,000

26,000

20,000

1,00,000

83,000

25,000

20,000

0.46

0.30

Other comprehensive income for the year, net of tax

Minority interest Total comprehensive income attributable to: Owners of the parent Minority interest Earnings per share, basic and diluted (in rupees)

Comprehensive income in two statements & expenses by nature XYZ Co. Income Statement for the Year Ended March 31, 2010 Revenue Other income

2010 (`) 4,33,000

2009 (`) 4,00,000

21,000

13,000

Changes in inventories of finished goods & WIP

(99,000)

(95,000)

Raw material and consumables used

(79,000)

(92,000)

Employee benefits expense

(45,000)

(43,000)

Depreciation and amortisation expense

(19,000)

(17,000)

Administrative expenses

(20,000)

-

(6,000)

(8,000)

Finance costs

Other expenses

(16,000)

(18,000)

Profit before tax

1,70,000

1,40,000

Income tax expense

(40,000)

(40,000)

PROFIT FOR THE YEAR

1,30,000

1,00,000

1,04,000

80,000

26,000

20,000

0.46

0.30

Profit attributable to: Owners of the parent Minority interest Earnings per share, basic and diluted (in rupees) XYZ Co. Income Statement for the Year Ended March 31, 2010

Profit for the year A PRACTICAL APPROACH TO IFRS

2010 (`)

2009 (`)

1,30,000

1,00,000

O Pg. 199

Other comprehensive income (loss) Sale of investments

(3,000)

10,000

Cash flow hedge

(5,000)

(5,000)

3,000

(2,000)

(5,000)

3,000

1,25,000

1,03,000

1,00,000

83,000

25,000

20,000

Income tax related to other comprehensive income (loss) Other comprehensive income (loss) for the year, net of tax TOTAL COMPREHENSIVE INCOME FOR THE YEAR Total comprehensive income attributable to: Owners of the parent Minority interest

Statement of Changes in Equity IAS 1 requires an entity to present a statement of changes in equity as a separate component of the financial statements. The statement must show: K total comprehensive income for the period, showing separately amounts attributable to owners of the parent and to non-controlling interests K the effects of retrospective application, when applicable, for each component K reconciliations between the carrying amounts at the beginning and the end of the period for each component of equity, separately disclosing: K profit or loss K each item of other comprehensive income K transactions with owners, showing separately contributions by and distributions to owners and changes in ownership interests in subsidiaries that do not result in a loss of control The following amounts may also be presented on the face of the statement of changes in equity, or they may be presented in the notes: K amount of dividends recognised as distributions, and K the related amount per share.

Notes to the Financial Statements The notes must: K present

information about the basis of preparation of the financial statements and the specific accounting policies used

K disclose

any information required by IFRSs that is not presented elsewhere in the financial statements and

K provide

additional information that is not presented elsewhere in the financial statements but is relevant to an understanding of any of them.

K Disclosure

of judgements.: An entity must disclose, in the summary of significant accounting policies or other notes, the judgements, apart from those involving estimations, that management has made in the process of applying the entity's accounting policies that have the most significant effect on the amounts recognised in the financial statements.

Following are the examples of disclosures of management's judgements in determining: A PRACTICAL APPROACH TO IFRS

O Pg. 200

K whether

financial assets are held-to-maturity investments

K when substantially all the significant risks and

rewards of ownership of financial assets and lease assets are transferred to other entities K whether,

in substance, particular sales of goods are financing arrangements and therefore do not give rise to revenue; and

K whether

the substance of the relationship between the entity and a special purpose entity indicates control

K Disclosure

of key sources of estimation uncertainty: An entity must disclose, in the notes, information about the key assumptions concerning the future, and other key sources of estimation uncertainty at the end of the reporting period, that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year. These disclosures do not involve disclosing budgets or forecasts.

Users should be informed of the measurement bases (historical cost, current cost, net realisable value, fair value or recoverable amount) because the basis on which the financial statements are prepared affects their analysis. When more than one measurement basis is used in the financial statements, for example when particular classes of assets are revalued, it is sufficient to provide an indication of the categories of assets (and liabilities) to which each measurement basis is applied.

Other Disclosures In addition to the distributions information in the statement of changes in equity (see above), the following must be disclosed in the notes: '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 related amount per share and ' the amount of any cumulative preference dividends not recognised.

Capital Disclosures An entity should disclose information about its objectives, policies and processes for managing capital. To comply with this, the disclosures include qualitative information about the entity's objectives, policies and processes for managing capital, including description of capital it manages

G

nature of external capital requirements, if any

G

how it is meeting its objectives

G

K quantitative data about what the entity regards as capital K changes from one period to another K whether the entity has complied with any external capital requirements and if it

has not complied, the consequences of such non-compliance. Statement of Cash Flows As per IAS 1, statement of cash flow should be prepared in accordance with the provisions of IAS 7.

A PRACTICAL APPROACH TO IFRS

O Pg. 201

STUDENT CORNER This is a rather 'Format standard' as there are so many formats to be remembered. But not to worry. Remember, the best way to get familiar with the formats is just to practice, practice and practice. And the really important stuff…….. accounting practice (a) IAS 1 is to be followed by all enterprises in preparing individual and group financial statements. (b) The content of a set of financial statements is: K A statement of financial position as at the end of the period( balance sheet) K A statement of comprehensive income for the period K A statement of changes in equity for the period K A statement of cash flows for the period K Notes,

comprising a summary of significant accounting policies and other explanatory information

K A statement

of financial position as at the beginning of the earliest comparative period when an entity applies an accounting policy retrospectively or makes a retrospective restatement of items in its financial statements or when it reclassifies items in its financial statements.

(c) A choice also exists with the statement 'statement of changes in equity'. The amount of dividend recognized as distribution to owners during the period can be presented either in the statement of changes in equity or in the notes (d) A choice also exists with regard to unusual (exceptional) items, which can be presented either in the statement of changes in equity or in the notes to the accounts.

A PRACTICAL APPROACH TO IFRS

O Pg. 202

WORKSHEET 1. What items are currently required elements of the IFRS income statement? (a) Revenue (b) Cost of sales (c) Comprehensive income (d) (a) and (b) (e) All of the above 2. What change(s) is/are introduced in the revised IAS 1 Presentation of Financial Statements effective 2009? (a) Allows statement of recognized income and expenses (b) Allows statement of comprehensive income (c) Prohibits comprehensive income from being presented in statement of changes in stockholders equity (d) (a) and(c) (e) (b) and (c) 3. Through 2008, how is net income attributed to minority interest presented in the IFRS income statement? (a) Included in net income (b) As a reduction to net income (c) Disclosed on the face of the income statement (d) (a) and (c) (d) (b) and (c ) 4. Which of the following reports is not a component of the financial statements according to IAS 1? (a) Balance sheet. (b) Statement of changes in equity. (c) Director's report. (d) Notes to the financial statements 5. XYZ Inc. decided to extend its reporting period from a year (12-month period) to a 15-month period. Which of the following is not required under IAS 1 in case of change in reporting period? (a) XYZ Inc. should disclose the reason for using a longer period than a period of 12 months. (b) XYZ Inc. should change the reporting period only if other similar entities in the geographical area in which it generally operates have done so in the current year; otherwise its financial statements would not be comparable to others. (c) XYZ Inc. should disclose that comparative amounts used in the financial statements are not entirely comparable. 6. Which of the following information is not specifically a required disclosure of IAS 1? (a) Name of the reporting entity or other means of identification, and any change in that information from the previous year. (b) Names of major/significant shareholders of the entity. A PRACTICAL APPROACH TO IFRS

O Pg. 203

(c) Level of rounding used in presenting the financial statements. (d) Whether the financial statements cover the individual entity or a group of entities. 7. Which one of the following is not required to be presented as minimum information on the face of the balance sheet, according to IAS 1? (a) Investment property. (b) Investments accounted under the equity method. (c) Biological assets. (d) Contingent liability. 8. When an entity opts to present the income statement classifying expenses by function, which of the following is not required to be disclosed as 'additional information'? (a) Depreciation expense. (b) Employee benefits expense. (c) Director's remuneration. (d) Amortization expense. 9. Venus Company's general ledger trial balance includes the following accounts: (a) Cash `60,000 (b) Property, plant and equipment `50,000 (c) Trading liabilities `110,000 (d) Minority interest `4,500 (e) Trading assets `35,000 (f) Goodwill `65,000 (g) Deferred tax liabilities `25,000 (h) Liabilities to customers `95,000 (i) Subscribed capital `1,500 (j) Additional paid in capital `4,000 (k) Deferred tax assets `15,000 (l) Retained earnings `2,500 (m)Translation reserve `7,500 (n) Other assets `25,000 Prepare the balance sheet for Venus Company assuming the assets and liabilities are presented in order of liquidity. 10. From the following information, prepare comprehensive income statement in two statements: 2010 2009 Revenue 250,000 200,000 Raw material and consumables used (60,000) (55,000) Employee benefits expense (50,000) (46,000) Other income 20000 10000 Other expenses (8,000) (7,000)

A PRACTICAL APPROACH TO IFRS

O Pg. 204

Finance costs

(10,000)

(12000)

Changes in inventories of finished goods

(30,000)

(25,000)

Changes in inventories of work in progress

(20,000)

(15,000)

Work performed by the entity and capitalized Depreciation and amortization expense Impairment of property, plant, and equipment

20,000

8,000

(21,000)

(20,000)

(5,000)

-

Share of profit of associates

1 30,000

20,000

Income tax expense

(29,000)

17,000

–

(9,000)

20,000

16,000

Loss for the year from discontinued operations Exchange differences on translating foreign operations Available-for-sale financial assets

(5,000)

24,000

Cash flow hedges

(2,000)

(1,000)

4,000

14,000

Gains on property revaluation Actuarial gains (losses) on defined benefit pension plans Share of other comprehensive income of associates

(10,000)

(8,000)

22,000

(1,000)

(1,750)

(11,250)

Income tax relating to components of other comprehensive income

11. From the following information, prepare comprehensive income statement in two statements: Net sales Cost of sales

2010

2009

2008

44,872

43,979

44,040

(35,541)

(34,873)

(34,924)

Selling expenses

(6,488)

(6,465)

(6,383)

General and administrative expenses

(1,550)

(2388)

(1,766)

62

88

64

(580)

(738)

(334)

Share in income of joint ventures and associates

152

118

104

Income taxes

(91)

214

(140)

79

211

222

(562)

605

(309)

Interest income Financial expense

Income from discontinued operations Exchange rate differences in foreign interests Recognition of cumulative translation differences relating to disinvestment

0

24

1

41

(371)

165

(25)

323

(130)

Income taxes

(6)

14

(8)

Step acquisition joint venture Rimi Baltic AB

33

0

0

Other—net

(1)

0

(15)

Cash flow hedges Fair value gains (losses) in the year Transfers to net income

A PRACTICAL APPROACH TO IFRS

O Pg. 205

ANSWER 1. 5.

(e) (b)

2. (d) 6. (b)

3. (d) 7. (d)

9. Balance Sheet Total : ` 2,50,000 10. Answer: Profit before tax : `116000, `68000 Profit for the year: `87000, `42000 Total comprehensive income after tax

: `94250, `74750

11. Answer: Profit before tax : `927, `(279), `801 Profit for the year: ` 915, `146, `883 Total comprehensive income after tax

: `395, `741, `587

A PRACTICAL APPROACH TO IFRS

O Pg. 206

4. (c) 8. (c)

CHAPTER 6 INVENTORIES (IAS 2) 'Inventories can be managed, but people must be led.'

CHAPTER 6 INVENTORIES (IAS 2) A company needs to take stock of its inventory on a regular basis. Inventory is the itemized list of Company's goods that haven't been sold at the end of the reporting period. This becomes the opening inventory of the next year.

The objective of IAS 2 is to prescribe the accounting treatment for inventories. It provides guidance for determining the cost of inventories and for subsequently recognising an expense, including any writedown to net realisable value. It also provides guidance on the cost formulas that are used to assign costs to inventories.

Well, why is it important to take stock of inventory………..? Because of two reasons: (a) Inventories are shown as an asset in the company's Balance Sheet (Statement of Financial Position). Therefore, their measurement is important as assets must not be carried at a value more than its recoverable amount. (b) Inventory has a direct impact on the measurement of profit.

……or goods in the process of production (work in progress)

Goods held for sale (finished goods)

WHAT IS INVENTORY?

…..or materials to be used in production (raw materials)

OBJECTIVE

The accounting of inventories has always been a complex issue because of the following factors:

The high volume of activity (or turnover) in the account.

q

The various cost flow alternatives that are acceptable.

q

The classification of inventories as raw materials, work-in-progress, finished goods.

q

A PRACTICAL APPROACH TO IFRS

O Pg. 209

IAS 2 is applicable to all inventories except: Work in progress arising under construction contracts (see IAS 11, Construction Contracts)

q

Financial instruments (see IAS 39, Financial Instruments)

q

Biological assets related to agricultural activity and agricultural produce at the point of harvest (see IAS 41, Agriculture).

q

Although, the following are within the scope of the standard, IAS 2 does not apply to the measurement of inventories held by: Producers of agricultural and forest products, agricultural produce after harvest, and minerals and mineral products, to the extent that they are measured at net realisable value (above or below cost) in accordance with well-established practices in those industries. When such inventories are measured at net realisable value, changes in that value are recognised in profit or loss in the period of the change.

q

Commodity brokers and dealers who measure their inventories at fair value less costs for the purpose of selling. In this case, changes in fair value less costs are recognised in profit or loss in the period of the change.

q

KEY DEFINITIONS G Inventory

Assets that are: (a) held for sale in the normal course of business, (b) are in the process of production for such sale, or (c) are in the form of materials or supplies to be consumed in the production process or in the rendering of services. G Net

Fair value relates to the market value but net realisable value may not always relate to market price especially when goods are sold at a price lesser than the market value.

Reliasable Value

The estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. NRV = Selling Price - Trade Discounts - Costs to completion - Marketing, Selling and Distribution costs

A PRACTICAL APPROACH TO IFRS

O Pg. 210

EXAMPLE RST Ltd. has a contract to supply 100 barrels of oil at `25 per barrel. The price is fixed for the 2 months. At the end of the 1st month the market price of oil is `30. (The fair value is `30.) RST buys the 100 barrels at the market price. The net realisable value is `25, less selling costs. There is a loss of `5 Per barrel. Total loss is `500 (100*5).

G Fair

Value

The amount at which an asset could be sold, or a liability settled between knowledgeable willing parties.

EXAMPLE XYZ ltd has to supply 200 pieces of pens @`50 each. This price is fixed for 2 months. At the end of the first month the market value of the pens increased to `60. He company purchased 100 pens in the first month 100 pens in the second month. The market price in the second month decreased to `45. What amount should be transferred to P&L Account? Solution: First Month

Second Month

Net realisable value `50 Fair Value

`60

Loss

(`10) per piece

Total Loss (10*100) (`1000)

`50 `45 Profit `5 per piece Total profit (5*100) `500

The total loss is `500.

Fundamental Principle of Measurement of Inventories Inventories are required to be stated at the lower of cost and net realisable value (NRV). Accounting For Inventories

Item of Inventories for measurement

YES

Cost of item is value of inventory

NO

NRV is the value of inventory

In the cost of item of inventory lower than NRV

A PRACTICAL APPROACH TO IFRS

O Pg. 211

Cost of Inventories The cost of inventories include all: (a) Costs of purchase (including taxes, transport, and handling) net of trade discounts received/ Cost of production. (b) Costs of conversion (including fixed and variable manufacturing overheads) and (c) Other costs incurred in bringing the inventories to their present location and condition.

Other Costs

Cost of Purchase

Cost of Conversion

Cost of Purchase: This is the sum total of: (a) The purchase price (b) Import Duties (c) Transportation Costs (d) Handling costs directly pertaining to the acquisition of the goods. From the total of the above amount trade discounts and rebates are deducted.

Incase of any by-products, they are measured at net realisable value and deducted from the cost of inventory. Incase of joint products, the cost of conversion should be based on rational and consistent basis such as 'Relative Sales Value Method'.

EXAMPLE Sameer is an importer. At the end of each year, he receives a rebate equal to 5% of the total purchases from the supplier. Assuming the total cost of inventory to be `5,00,000, show the treatment in the books of accounts? The total amount of rebate will be: 5% of `5,00,000 = `25,000 The following journal entries will be recorded: (a)

Inventory a/c

Dr

To Cash a/c

5,00,000 5,00,000

(Being inventory purchased) (b)

Cash a/c To inventory a/c

Dr

25,000 25,000

(Being rebate received from the supplier at the end of the year)

A PRACTICAL APPROACH TO IFRS

O Pg. 212

Cost of Conversion Conversion costs for manufactured goods should include all costs that are directly associated with the units produced, such as labor and overhead. The allocation of overhead costs, however, must be systematic and rational as these costs include fixed and variable overheads also. In the case of fixed overhead costs (i.e., those which do not vary directly with level of production like factory rent, depreciation), the allocation process should be based on normal production levels. In periods of unusually low levels of production, a portion of fixed overhead costs must accordingly be charged directly to operations, and not taken into inventory.

q

Variable production overheads are assigned to each unit of production on the basis of the actual use of the production facilities.

q

Unallocated Overheads are recognized as an expense in the period in which they are incurred.

q

Other Costs Costs other than material and conversion costs are inventoriable only to the extent they are necessary to bring the goods to their present condition and location. Examples might include certain design costs and other types of preproduction expenditures if intended to benefit specific classes of customers.

Exclusions Inventory cost should not include: (a) Abnormal waste (b) Storage costs (c) Administrative overheads unrelated to production (d) Selling costs (e) Foreign exchange differences arising directly on the recent acquisition of inventories invoiced in a foreign currency (f) Interest cost when inventories are purchased with deferred settlement terms.

Inventory purchased on Deferred Settlement Terms When Inventory is purchased on Deferred Settlement Terms and the price includes a financing element then that amount is recognised as interest expense over the period of credit e.g. A supplier offers to sell goods at ` 10000 in cash or one year’s credit at a price of ` 12000. In this case, if the company chooses the credit option then the inventory would be recorded at ` 10000 and ` 2000 would be recorded as finance expense.

Inventories of Service Providers The inventories of service providers usually includes work-in-progress that has not yet been billed to customers. These costs relate to labor and other costs of personnel directly involved in providing the services. The costs of inventories of service providers should not include profit margins that will be charged when the work is billed. A PRACTICAL APPROACH TO IFRS

O Pg. 213

EXAMPLE Which of the cost categories do the following costs belong to? Selling costs, Direct labor, Design of finished goods, Import duties on raw material, Fixed Production Overheads, Abnormal amounts of wasted material, Purchase of raw material. Solution: Selling Costs Excluded Direct labor Cost of conversion Design of finished goods Other costs Import duties on raw materials Cost of purchase Fixed production overheads Cost of Conversion Abnormal amounts of wasted materials Excluded Purchase of raw materials Cost of purchase

Techniques for the Measurement of Cost Techniques for the measurement of the cost of inventories, such as the standard cost method or the retail method, may be used for convenience if the results approximate cost. Standard costs take into account normal levels of materials and supplies, labour, efficiency and capacity utilisation. They are regularly reviewed and, if necessary, revised in the light of current conditions. The retail method is often used in the retail industry for measuring inventories of large numbers of rapidly changing items with similar margins for which it is impracticable to use other costing methods. The cost of the inventory is determined by reducing the sales value of the inventory by the appropriate percentage gross margin. The percentage used takes into consideration inventory that has been marked down to below its original selling price. An average percentage for each retail department is often used.

Cost Formulas q The cost

of inventories of items that are not ordinarily interchangeable and goods or services produced and segregated for specific projects shall be assigned by using specific identification of their individual costs.

q Specific identification of cost means that specific costs are attributed to identified items

of inventory. This is the appropriate treatment for items that are segregated for a specific project, regardless of whether they have been bought or produced. However, specific identification of costs is inappropriate when there are large numbers of items of inventory that are ordinarily interchangeable. In such circumstances, the method of selecting those items that remain in inventories could be used to obtain predetermined effects on profit or loss. q In all other cases the cost of inventories shall be assigned by using the:

(a) First-in, First-out (FIFO) or (b) Weighted Average Cost Formula. An entity shall use the same cost formula for all inventories having a similar nature and use to the entity. For inventories with a different nature or use, different cost formulas may be justified. A PRACTICAL APPROACH TO IFRS

O Pg. 214

First-in, First-out (FIFO) The FIFO formula assumes that the items of inventory that were purchased or produced first are sold first, and consequently the items remaining in inventory at the end of the period are those most recently purchased or produced.

EXAMPLE 1. The 'Received' side of the Stores Ledger Account shows the following particulars : Jan 1

Opening Balance :

500 units @ `4

Jan 5

Received from vendor :

200 units @ `4.25

Jan 12

Received from vendor :

150 units @ `4.10

Jan 20

Received from vendor :

300 units @ `4.50

Jan 25

Received from vendor :

400 units @ `4

Issues of material were as follows : Jan.4 - 200 units ; Jan.10 - 400 units ; Jan.15 - 100 units ; Jan.19 - 100 units ; Jan.26 - 200 units ; Jan.30 - 250 units. Issues are to be priced on the principle of ‘First In First Out’. Write out the stores Ledger Account in respect of the materials for the month of January.

SOLUTION STORES LEDGER ACCOUNT Date

Particulars

Receipts

Issues

Balance

Quantity Total Cost Unit Cost Quantity Total Cost Unit Cost Quantity Amount (Units) (`) (`) (Units) (`) (`) (Units) (`)

Per Unit (`)

Jan. 1

Balance b/d

-

-

-

-

-

-

500

2,000

4

Jan. 4

Requisition Slip No...

-

-

-

200

800

4

300

1,200

4

Jan. 5

Goods Received Note No...

200

850

4,25

-

-

-

300

1,200

4

200

850

4.25

-

-

-

300

1,200

4

100

425

4.25

100

425

4.25

150

615

4.10

-

-

-

100

425

4.25

-

-

-

100

410

4.10

300

1,350

4.50

-

-

-

Jan. 10 Requisition Slip No... Jan. 12 Goods Received Note No... Jan. 19 Requisition Slip No... Jan. 20 Goods Received Note No... Jan. 25 Goods Received Note No...

400

1,600

4.00

-

-

205

-

615

4.10

50

205

4.10 4.10

50

205

300

1,350

4.50

50

205

4.10

300

1,350

4.50

400

1,600

4.00

150

675

4.50

Jan. 26 Requisition Slip No...

-

-

-

50 150

675

4.50

400

1,600

4.00

Jan. 30 Requisition Slip No...

-

-

-

150

675

4.50

300

1,200

4.00

100

400

4.00

A PRACTICAL APPROACH TO IFRS

4.10

150

O Pg. 215

Last in, First out (LIFO) This is not an acceptable method as per IAS 2. Weighted Average Method Under the weighted average cost formula, the cost of each item is determined from the weighted average of the cost of similar items at the beginning of a period and the cost of similar items purchased or produced during the period. The average may be calculated on a periodic basis, or as each additional shipment is received, depending upon the circumstances of the entity.

EXAMPLE 2. The following transactions took place in respect of an item of material: Receipts Rate Issue Quantity ` Quantity 2-9-2006

200

10-9-206

300

2.00

2.40

15-9-2006

250

18-9-2006

250

2.60

20-9-20060

200

Record the above transactions in the Stores Ledger, pricing the issues at :

Solution :

Weighted Average Rate

STORES LEDGER ACCOUNT Receipts Quantity

Balance

Date

Reference

`

`

`

`

2-9-2006

Goods Received Note No.....

200

400

2.00

-

-

-

200

400

10-9-206

Goods Received Note No.....

300

720

2.40

-

-

-

500

1,120

15-9-2006 Requisition Slip 18-9-2006 Goods Received Note No..... 20-9-2006 Requisition Slip No.....

(

` 400 + ` 70 200 + 300

(

= ` 2.24

Total Cost

Issues

Cost Quantity Total Cost Quantity Amount Per Unit Cost Per Unit Per Unit

`

-

-

-

250

560

2.24*

250

560

250

650

2.60

-

-

-

500

1,210

-

-

-

200

300

726

(

484 2.42**

` 560 + ` 650 250 + 250

(

= ` 2.42

Net Realisable Value The cost of inventories may not be recoverable if those inventories are damaged, if they have become wholly or partially obsolete, or if their selling prices have declined. The cost of inventories may also not be recoverable if the estimated costs of completion or the estimated costs to be incurred to make the sale have increased. The practice of writing inventories down below cost to net realisable value is

G

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consistent with the view that assets should not be carried in excess of amounts expected to be realised from their sale or use. Inventories are usually written down to net realisable value item by item. In some circumstances, however, it may be appropriate to group similar or related items. This may be the case with items of inventory relating to the same product line that have similar purposes or end uses, are produced and marketed in the same geographical area, and cannot be practicably evaluated separately from other items in that product line. It is not appropriate to write inventories down on the basis of a classification of inventory, for example, finished goods, or all the inventories in a particular industry or geographical segment. Service providers generally accumulate costs in respect of each service for which a separate selling price is charged. Therefore, each such service is treated as a separate item.

G

Estimates of net realisable value also take into consideration the purpose for which the inventory is held. For example, the net realisable value of the quantity of inventory held to satisfy firm sales or service contracts is based on the contract price. If the sales contracts are for less than the inventory quantities held, the net realisable value of the excess is based on general selling prices. Provisions may arise from firm sales contracts in excess of inventory quantities held or from firm purchase contracts. Such provisions are dealt with under IAS 37 Provisions, Contingent Liabilities and Contingent Assets.

G

Materials and other supplies held for use in the production of inventories are not written down below cost if the finished products in which they will be incorporated are expected to be sold at or above cost. However, when a decline in the price of materials indicates that the cost of the finished products exceeds net realisable value, the materials are written down to net realisable value. In such circumstances, the replacement cost of the materials may be the best available measure of their net realisable value.

G

A new assessment is made of net realisable value in each subsequent period. When the circumstances that previously caused inventories to be written down below cost no longer exist or when there is clear evidence of an increase in net realisable value because of changed economic circumstances, the amount of the write-down is reversed (ie the reversal is limited to the amount of the original write-down) so that the new carrying amount is the lower of the cost and the revised net realisable value. This occurs, for example, when an item of inventory that is carried at net realisable value, because its selling price has declined, is still on hand in a subsequent period and its selling price has increased.

G

Recognition as an Expense When inventories are sold, the carrying amount of those inventories shall be recognised as an expense in the period in which the related revenue is recognised. The amount of any writedown of inventories to net realisable value and all losses of inventories shall be recognised as an expense in the period the write-down or loss occurs. The amount of any reversal of any write-down of inventories, arising from an increase in net realisable value, shall be recognised as a reduction in the amount of inventories recognised as an expense in the period in which the reversal occurs. A PRACTICAL APPROACH TO IFRS

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MEMORY TIPS The common mistake made by students is to either exclude all costs or include all costs mentioned in the question. Beware of carriage costs – carriage inwards included in valuing the inventories of a manufacturing company, but it would NOT be appropriate to include carriage outwards. It is important to watch the dates in the questions – students often end up with opening inventory on the balance sheet rather than closing inventory. \

Disclosures The financial statements shall disclose: (a) the accounting policies adopted in measuring inventories, including the cost formula used; (b) the total carrying amount of inventories and the carrying amount in classifications appropriate to the entity; (c) the carrying amount of inventories carried at fair value less costs to sell; (d) the amount of inventories recognised as an expense during the period; (e) the amount of any write-down of inventories recognised as an expense in the period (f) 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. (g) the circumstances or events that led to the reversal of a write-down of inventories. (h) the carrying amount of inventories pledged as security for liabilities.

Impact of valuation methods on Financial Statements _ If inventory is overvalued _ Assets are overstated in the Balance Sheet _ Profit is overstated in the Income Statement _ If inventory is undervalued _ Assets are understated in the Balance Sheet _ Profit is understated in the Income

EXAMPLE Company ABC started their commercial activity in the accounting period with capital stock 500,000000, contributed by its owners. The Company bought 1,000 units of inventories for 100,000,000, for which the freight charges were 10,000,000. During the year, the Company sold 750 units at 150,000 per unit. At the end of year ABC had 250 units of inventories; but 50 of them were damaged. Damaged units could be sold at 25,000 per unit and the rest, 200 units, at 150,000 per unit.

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1 Calculate the value of the inventory as at the end of year 2 Show the impact of the sale of damaged units on income statement for the current financial reporting period

Solution (1) Cost of inventory Cost of inventory per unit 100,000,000 + 10,000,000 = 110,000,000/1,000 units = `110,000 per unit Net realizable value • damaged items (25,000 per unit) • undamaged items (150,000 per unit) In the balance sheet inventories are recorded at the lower of cost and net realizable value: Damaged items 50 x 25,000 = 1,250,000 Undamaged items 200 x 110,000 = 22,000,000 Total value of inventories (2) Impact of sale Sales revenue Cost of goods sold

23,250,000

750 x 150,000 = 112,500,000 750 x 110,000 = -82,500,000

Losses from damaged items: Net realisable value Cost Losses from damaged items

50 x 25,000 = 1,250,000 50 x 110,000 = -5,500,000 -4,250,000

Gross margin on sales

25,750,000

EXAMPLE XYZ enterprises is a retailer of consumer products and has five major product lines : Soaps, Shampoos, Hair Oil, Deodorants, Moisturiser. On December 31, 2009, quantity on hand, cost per unit and net realisable value (NRV) per unit of the product lines are as follows : Product Line

Quantity on Hand

Cost Per Unit

NRV Per Unit (`)

Soaps

100

1000

1020

Shampoos

200

500

450

Hair Oil

300

1500

1600

Deodrants

400

750

770

Moisturisers

500

250

200

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Complete the valuation of the inventory of XYZ enterprises as on December 31, 2009 under AS 2 using the 'Lower of cost and NRV' principle. Solution Product Line

Quantity on Hand

Cost per Unit (`)

NRV/ Per Unit (`)

Lower of Cost and NRV (`)

Soaps

100

1000

1020

1,00,000

Shampoos

200

500

450

90,000

Hair Oil

300

1500

1600

450,000

Deodrants

400

750

770

3,00,000

Moisturisers

500

250

200

1,00,000 10,40,00

Value of closing inventory is `10,40,000

STUDENT CORNER Inventory eh? Well, it could be a stock of famous art work or stock of books in a library or stock of consumables in a grocery store. For a company its an itemized list of goods that haven't been sold at the end of the reporting period. These inventories are shown as an asset on the company's balance sheet. Their measurement is important as assets must not be carried at more than their recoverable amount unless we want to mislead the user of the accounts as inventories have a direct impact on the measurement of profits. And the really important stuff……….accounting practice Inventories should be valued at total of the lower of cost (all costs incurred in bringing to present location and condition) and net realizable value of separate items of stock.

G

Net realizable value is the estimated selling price in the ordinary course of business less estimated completion and selling costs.

G

Inventories can be valued on the first in first out ( FIFO) basis or using a weighted average method. Other methods are rarely used. Last in first out (LIFO) method is totally forbidden.

G

Inventories should be sub-classified in the notes into main categories (e.g. raw materials, work-in-progress and finished goods).

G

The common mistake made by students is to either exclude all costs or include all costs mentioned in the question. Beware of carriage costs – carriage inwards included in valuing the inventories of a manufacturing company, but it would NOT be appropriate to include carriage outwards. It is important to watch the dates in the questions – students often end up with opening inventory on the balance sheet rather than closing inventory.

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WORKSHEET 1.

2.

3.

4.

5.

MULTIPLE-CHOICE QUESTIONS Inventory should be stated at (a) Lower of cost and fair value. (b) Lower of cost and net realizable value. (c) Lower of cost and nominal value. (d) Lower of cost and net selling price. (e) Choices b and d. (f) Choices a and c. (g) Choices a, b, and d. Which of the following costs of conversion cannot be included in cost of inventory? (a) Cost of direct labor. (b) Factory rent and utilities. (c) Salaries of sales staff (sales department shares the building with factory supervisor). (d) Factory overheads based on normal capacity. Inventories are assets (a) Used in the production or supply of goods and services for administrative purposes. (b) Held for sale in the ordinary course of business. (c) Held for long-term capital appreciation. (d) In the process of production for such sale. (e) In the form of materials or supplies to be consumed in the production process or the rendering of services. (f) Choices b and d. (g) Choices b, d, and e. The cost of inventory should not include (a) Purchase price. (b) Import duties and other taxes. (c) Abnormal amounts of wasted materials. (d) Administrative overhead. (e) Fixed and variable production overhead. (f) Selling costs. (g) Choices c, d, and f. ABC LLC manufactures and sells paper envelopes. The stock of envelopes was included in the closing inventory as of December 31, 2005, at a cost of `50 each per pack. During the final audit, the auditors noted that the subsequent sale price for the inventory at January 15, 2006, was `40 each per pack. Furthermore, inquiry reveals that during the physical stock take, a water leakage has created damages to the paper and the glue. Accordingly, in the following week, ABC Ltd. spent a total of `15 per pack for repairing and reapplying glue to

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the envelopes. The net realizable value and inventory write-down (loss) amount to (a) `40 and `10 respectively. (b) `45 and `10 respectively. (c) `25 and `25 respectively. (d) `35 and `25 respectively. (e) `30 and `15 respectively. 6. In line with IAS 2, identify the cost category the following costs belong to? (a) Abnormal amounts of wasted materials (b) Administrative overheads that do not contribute to bringing inventories to their present location and condition (c) Depreciation of manufacturing machinery (d) Direct labour costs associated with production (e) Purchase price (f) Rebates received (g) Selling costs. (h) Special design cost of a unique product (i) Storage costs, unless those costs are necessary in the production process prior to a further production stage (j) Variable production overhead. 7. a) Discuss the term Net Realisable Value mean in the context of the valuation of inventories? b) Illustrate the way in which the net realisable value method works by using an example of your own.

ANSWER 1. 5.

(b)

2. (c)

3. (g)

4. (g)

Answer: (c) The net realizable value is the subsequent sale price, `40, less any cost incurred to bring the good to its salable condition, `15. Thus, NRV= `40 – `15 =`25 per pack. The loss (inventory write-down) per pack is the difference between cost and net realizable value: `50 –`25= `25 per pack.

6. Answer: (a) Excluded from inventory cost. (b) Excluded from inventory cost (c) Conversion cost (d) Conversion cost (e) cost of purchases (f) to be deducted from the amount of purchases (g) Excluded from inventory cost (h) Conversion cost (i) Excluded from inventory cost (j) Conversion cost

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CHAPTER 7 CASH FLOW STATEMENT (IAS 7) 'Profit is an illusion, Cash flow is a fact.'

CHAPTER 7 CASH FLOW STATEMENT (IAS 7) OBJECTIVE The purpose of the statement of cash flows is to provide information about the operating cash receipts and cash payments of an entity during a period, as well as providing insight into its various investing and financing activities. It is a vitally important financial statement, because the ultimate concern of investors is the reporting entity's ability to generate cash flows which will support payments (typically but not necessarily in the form of dividends) to the shareholders. More specifically, the statement of cash flows should help investors and creditors assess; 1. The ability to generate future positive cash flows 2. The ability to meet obligations and pay dividends 3. Reasons for differences between income and cash receipts and payments 4. Both cash and non-cash aspects of entities' investing and financing transactions

Benefits of Cash Flow Statement The perceived benefits of presenting the statement of cash flows in conjunction with the statement of financial position (balance sheet) and the statement of income (or operations) have been highlighted by IAS 7 to be as follows; K It provides an insight into the financial structure of the enterprise (including its liquidity

and solvency) and its ability to affect the amounts and timing of cash flows in order to adapt to changing circumstances and opportunities. K It provides

additional information to the users of financial statements for evaluating changes, in assets, liabilities, and equity of an enterprise.

K It enhances

the comparability of reporting of operating performance by different enterprises because it eliminates the effects of using different accounting treatments for the same transactions and events.

K It serves

as an indicator of the amount, timing, and certainty of future cash flows. Furthermore, if an enterprise has a system in place to project its future cash flows, the statement of cash flows could be used as a touchstone to evaluate the accuracy of past projections of those future cash flows. This benefit is elucidated by the standard as follows:

a.

The statement of cash flows is useful in comparing past assessments of future cash flows against current year's cash flow information, and

b. It is of value in appraising the relationship between profitability and net cash flows, and in assessing the impact of changing prices.

Presentation of Cash Flow Statement K As per

guidelines of IAS 7, Cash Flow Statement is classified into three components, namely:

(a) Cash Flow from Operating Activities. A PRACTICAL APPROACH TO IFRS

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(b) Cash Flow from Investing Activities. (c) Cash Flow from Financing Activities. K The

cash flows from the Operating Activities, Investing Activities and Financing Activities along with Cash and Cash Equivalents helps in reporting the flow of cash in an organisation in a year.

Operating Activities Start From Here

Financing Activities The Last Part

Cash Flow Format

Investing Activities The Middle Part

Cash Flow from Operating Activities K Operating

activities are the principal revenue-producing activities (main activities carried on by the business to earn profits) of the entity and other activities that are not investing or financing activities. For eg.

(a) Cash receipts from the sale of goods and rendering of services. (b) Cash receipts from royalties, fees, commission. (c) Cash payments to suppliers of goods and services. (d) Cash payments to employees as wages. (e) Cash receipts and payments of an insurance company for premiums and claims, annuities and other policy benefits. (f) Cash payments or refund of income taxes unless specifically identified with financing and investing activities. K 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 financing. Information about the specific components of historical operating cash flows is useful, in conjunction with other information, in forecasting future operating cash flows. A PRACTICAL APPROACH TO IFRS

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Cash Flow from Investing Activities Investing Activities are the acquisition and disposal of long-term assets and other investments that are not considered to be cash equivalents. These include transactions involving purchase and sale of long term productive assets like buildings, machinery, land not held for resale. For e.g.; (a) Payments to acquire property, plant and equipments(includes development costs and selfconstructed property), intangibles and other long term assets. (b) Receipts from sale of property, plant and equipments, intangibles and other long term assets. (c) Payments made to acquire shares, warranty or debt-instruments of other enterprises and interest in Joint Ventures (other than those held for trading purpose).

FLOW OF CASH The cash flow arises when the net effect of the transaction is either to increase or decrease the amount of cash or cash equivalents. Any transaction which affects either: (a) Any Current Account (other than cash and cash equivalent) and Cash and Cash equivalent account eg; Cash received from debtors (b) Any Non- Current Account and Cash/Cash Equivalent Account e.g.; Purchase of goodwill results in either inflow or outflow of cash.

(d) Receipts from sale of shares and debt instruments of other entities. (e) Loans and Advances made to third parties(unless made by a financial institution) (f) Receipts from repayments of advances and loans. (g) Payments relating to future contracts, forward contracts, options and swap contracts other than those classified as financing activities. (h) Receipts relating to future contracts, forward contracts, options and swap contracts other than those classified as financing activities.

The separate disclosure of cash flows arising from investing activities is important because the cash flows represent the extent to which expenditures have been made for resources intended to generate future income and cash flows.

The aggregate cash flows arising from acquisitions and from disposals of subsidiaries or other business units shall be presented separately and classified as investing activities.

Cash Flow from Financing Activities Financing activities are activities that result in changes in the size and composition of the contributed equity and borrowings of the entity. The separate disclosure of cash flows arising from financing activities is important because it is useful in predicting claims on future cash flows by providers of capital to the entity. For e.g.; (a) Cash proceeds from issue of share or other similar equity instruments. (b) Cash proceeds from issue of debentures, bonds and other short term and long term borrowings.

A single transaction may include the cash flow belonging to two different activities; for instance, if a machinery has been purchased on hire-purchase instalments, each instalment will include interest and a part of principal. The cash paid for interest is a Financial Activity whereas the cash payment for principal amount is an Investing Activity.

(c) Repayments of loans including redemption of debentures. A PRACTICAL APPROACH TO IFRS

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(d) Payment of interest on debentures and loans. (e) Payment of equity and preference dividends. Classification of Business Activities as per AS-3, showing the Inflow and Outflow of Cash Operating Activities

Cash Inflow (i) Cash Sales (ii) Cash received from Debtors (iii) Cash received from Commission and Fees (iv) Royalty In the case of Financial Companies (v) Cash received for interest and dividends (vi) Sale of securities

Cash Outflow (i) Cash Purchases (ii) Payment to Creditors (iii) Cash Operating Expenses (iv) Payment of Wages (v) Income Tax In the case of Financial Companies (vi) Cash paid for interest (vii) Purchase of Securities

Investing Activities

Cash Inflow (i) Sale of Fixed Assets (ii) Sale of Investments (iii) Interest Received (iv) Dividends Received

Cash Outflow (i) Purchase of Fixed Assets (ii) Purchase of Investments

Financing Activities

Cash Inflow (i) Issue of Shares in Cash (ii) Issue of Debentures in Cash (iii) Proceeds from Long-term Borrowings

Cash Outflow (i) Payment of Loans (ii) Redemption of Preference Shares (iii) Buy-back of Equity Shares (iv) Payment of Dividend (v) Payment of Interest

Cash and Cash Equivalents K Cash comprises cash on hand and demand deposits. K Cash

equivalents are 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.

K Cash

equivalents are held for the purpose of meeting short-term cash commitments A PRACTICAL APPROACH TO IFRS

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rather than for investment or other purposes. For an investment to qualify as a cash equivalent it must be readily convertible to a known amount of cash and be subject to an insignificant risk of changes in value. Therefore, an investment normally qualifies as a cash equivalent only when it has a short maturity of, say, three months or less from the date of acquisition. Equity investments are excluded from cash equivalents unless they are, in substance, cash equivalents, for example in the case of preferred shares acquired within a short period of their maturity and with a specified redemption date. K Bank

borrowings are generally considered to be financing activities. However, in some countries, bank overdrafts which are repayable on demand form an integral part of an entity's cash management. In these circumstances, bank overdrafts are included as a component of cash and cash equivalents. A characteristic of such banking arrangements is that the bank balance often fluctuates from being positive to overdrawn.

K Cash flows exclude movements between items that constitute cash or cash equivalents

because these components are part of the cash management of an entity rather than part of its operating, investing and financing activities. Cash management includes the investment of excess cash in cash equivalents

EXAMPLE Identify the transactions as belonging to (i) Operating, (ii) Investing, (iii) Financing Activities, and (iv) Cash Equivalents. 1. Cash Sales; 2. Issue of Share Capital; 3. Issue of Debentures; 4. Purchase of Machines; 5. Sale of Machines; 6. Cash received from Debtors; 7. Commission and Royalty received; 8. Purchase of Investments; 9. Redemption of Debentures and Preference Shares; 10. Repayment of a Long-term Loan; 11. Interest paid on Debentures on long-term loans by (a) Finance company, and (b) Non-finance company; 12. Office Expenses; 13. Dividend received on Shares by (a) Finance company, and (b) Non-Fiancne company; 15. Manufacturing Expenses; 16. Rent received by a company whose main business is (a) real estate business, (b) manufacturing; 17. Selling and distribution Expenses; 18. Sale of Investments by (a) Finance company, and (b) Non-finance company; 19. Purchase of Goodwill; 20. Dividends paid; 21. Cash Purchase; 22. Cash paid to Creditors; 23. Sale of Patents; 24. Income Tax Paid; 25. Income Tax refund received; 26. Bank Balance; 27. Cash Credit; 28. Short-term deposits in Banks; 28. Investments in Marketable Securities (Short-term); 30. Rent paid and 31. Buy-back of Equity shares. Solutions: Operative Activities : 1, 6, 7, 11 (a), 12, 13 (a), 14 (a), 15, 16 (a), 17, 18 (a), 21, 22, 24, 25, 30. Investing Activities : 4, 5, 8, 13 (b), 14 (b), 16 (b), 18 (b), 19, 23. Financing Activities: 2, 3, 9, 10, 11 (b), 20, 31. Cash Equivalents : 26, 27, 28, 29.

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EXAMPLE State which of the following would result in the inflowoutflow of Cash or Cash Equivalents : (i)

Sale of fixed assets (book value ` 50,000) at a loss of ` 5,000;

(ii)

Purchase of stock-in-trade for cash;

(iii) Purchase of fixed assets by issue of shares; (iv)

Cash received from debtors ` 10,000;

(v)

Cash deposited into Bank;

(vi)

Cash withdrawn from Bank;

(vii) Issue of fully paid bonus shares; (viii) Sale of marketable securities for cash at par; (ix)

Declaration of final dividend; and

(x)

Writing off bad debts against the provision for doubtful debts.

Solutions :

STATEMENT SHOWING THE EFFECT OF TRANSACTIONS ON CASH AND CASH EQUIVALENTS

Transaction Effect on Cash or

Reason

Cash Equivalents

(i)

Inflow

Cash is increased by the amount of ` 45,000.

(ii)

Outflow

Cash is decreased by the amount of stock-in-trade.

(iii)

No effect

Cash is not affected.

(iv)

Inflow

Cash is increased by ` 10,000

(v)

No effect

Cash includes bank deposits also.

(vi)

No effect

Cash includes bank deposits also.

(vii)

No effect

Cash is not affected. It is capitalisation of profits.

(viii)

No effect

Cash which includes bank deposits also is not affected.

(ix)

No effect

Cash is not affected because final dividend declared will be paid in the following year.

(x)

No effect

Cash is not affected.

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Reporting Cash Flows from Operating Activities K An entity shall report cash flows from operating activities using either:

(a) the direct method, whereby major classes of gross cash receipts and gross cash payments are disclosed; or (b) the indirect method, whereby 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. K Entities

are encouraged to report cash flows from operating activities using the direct method. The direct method provides information which may be useful in estimating future cash flows and which is not available under the indirect method. Under the direct method, information about major classes of gross cash receipts and gross cash payments may be obtained either:

(a) from the accounting records of the entity; or (b) by adjusting sales, cost of sales (interest and similar income and interest expense and similar charges for a financial institution) and other items in the statement of comprehensive income for: (i)

changes during the period in inventories and operating receivables and payables;

(ii) other non-cash items; and (iii) other items for which the cash effects are investing or financing cash flows. K The

direct method shows each major class of gross cash receipts and gross cash payments. The operating cash flows section of the cash flow statement under the direct method would appear something like this:

CASH FLOW FROM OPERATING ACTIVITIES (DIRECT METHOD)

K The

Cash receipts from customers

xx,xxx

Cash paid to suppliers

(xx,xxx)

Cash paid to employees

(xx,xxx)

Cash paid for other operating expenses

(xx,xxx)

Interest paid

(xx,xxx)

Income taxes paid

(xx,xxx)

Net cash from operating activities

xx,xxx

indirect method adjusts accrual basis net profit or loss for the effects of non-cash

transactions. The operating cash flows section of the cash flow statement under the indirect method would appear something like this: A PRACTICAL APPROACH TO IFRS

O Pg. 231

CASH FLOW FROM OPERATING ACTIVITIES (INDIRECT METHOD) Profit before interest and income taxes

xx,xxx

Add : Non-Cash and Non Operating Activities Depreciation

xx,xxx

Amortization of goodwill

xx,xxx

Transfer to reserve

xx,xxx

Proposed Dividend for the year

xx,xxx

Interim Dividend paid during the year

xx,xxx

Provision of tax made during the year

xx,xxx

Preliminary Expenses w/o

xx,xxx

Discount on issue of shares, debentures w/o

xx,xxx

Premium on redemption of debentures

xx,xxx

Loss on sale of Fixed Assets

xx,xxx

Less: Non-Operating Incomes Profit on sale of Fixed Assets

(xx,xxx)

Refund of taxes

(xx,xxx)

Extra provision w/o

(xx,xxx)

Extraordinary items credited to P&L account

(xx,xxx)

Operating Profit Before Working Capital Changes

xx,xxx

Add:

Decrease in Current Assets

xx,xxx

Increase in Liabilities

xx,xxx

Increase in Current Assets

(xx,xxx)

Decrease in Current Liabilities

(xx,xxx)

Less:

Cash generated from operations before Tax

xx,xxx

Less: Tax paid

(xx,xxx)

Cash Flow from Operating Activities

xx,xxx

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Cash Flow from Operating Activities with Missing Accounts Under the Direct Method. Activity 1 : From the following information, calculate the Cash Flows from Operating Activities by applying the Direct Method: PROFIT AND LOSS ACCOUNT for the year ended 31st March, 2008 Dr. Cr. Particulars ` Particulars ` To Cost of Goods Sold 70,000 By Sales: To Gross Profit c/d 50,000 Cash 40,000 Credit 80,000 1,20,000 1,20,000 1,20,000 To To To To

Salaries Insurance Premium Depreciation Net Profit

Additional Information: Debtors Creditors Stock Salaries Outstanding Prepaid Insurance

10,000 5,000 15,000 20,000 50,000

By Gross Profit b/d

1st April, 2007 ` 20,000 7,000 22,000 2,000 1,000

50,000

50,000 31st March, 2008 ` 24,000 5,000 27,000 2,500 1,200

Solutions: CASH FLOW FROM OPERATING ACTIVITIES (DIRECT METHOD) Particulars (a) Operating Cash Receipts (i) Cash Sales (ii) Cash received from Debtors (Note 1) (b) Operating Cash Payments (i) Cash paid to Creditors (Note 2) (ii) Cash paid for Salaries (Note 3) (iii) Insurance Premium (Note 4)

`

`

40,000 76,000

1,16,000

77,000 9,500 5,200

91,700

Cash Flow from Operating Activities (a - b)

24,300

Working Notes : Calculation of missing figures : 1. Opening Debtors Add: Credit Sales

` ` 20,000 3. Opening Salaries Outstanding 2,000 80,000 Add: Salaries Expenses incurred during the year 10,000 1,00,000 12,000 Less: Closing Debtors 24,000 Less: Closing Salaries Outstanding 2,500 Cash received from Debtors 76,000 Cash Paid for Salaries during the year 9,500 2. Purchases (Assumed as credit) Note. 5) 75,000 4. Closing Prepaid Insurance 1,200 Add: Opening Creditors 7,000 Add: Insurance Expenses incurred during the year 5,000 82,000 6,200 Less: Closing Creditors 5,000 Less: Opening Prepaid Insurance 1,000 Cash Paid to Creditors 77,000 Cash Paid for Insurance Premium during the year 5,200 5. Total Purchase = Cost of Goods Sold + Closing Stock - Opening Stock = `70,000 + `27,000 - `22,000 = 75,000 A PRACTICAL APPROACH TO IFRS

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Activity 2 Compute the Cash Flow from Operating Activities from the following Profit and Loss Account by the Indirect Method. Dr.

Cr.

Particulars

`

Particulars

` 15,000

Salary

15,000

Gross Profit

Rent

10,000

Profit on Sale of Land

4,000

Income Tax Refund

4,000

Depreciation

2,000

Loss on Sale of Plant

1,000

Goodwill Written Off

4,000

Proposed Dividend

5,000

Provision of Taxation

5,000

Net Profit

11,000 53,000

53,000

Solution: Particulars

`

Net Profit before Tax (See Note Below)

17,000

Adjustments Add: Depreciation

2,000

Goodwill Written off

4,000

Less on Sale of Plant

1,000

7,000 24,000

Less: Profit on Sale of Land

(4,000)

Cash from Operation before Taxes

20,000

Less: Income Tax Paid (`5,000 - `4,000)

(1,000)

Net Cash Flow from Operating Activities

19,000

Note : ` Net Profit

11,000

Add: Proposed Dividend Provision for Tax

5,000 5,000 21,000

Less: Refund of Tax

4,000

Net Profit before Tax

17,000

A PRACTICAL APPROACH TO IFRS

O Pg. 234

Reporting Cash Flows From Investing and Financing Activities. An entity shall report separately major classes of gross cash receipts and gross cash payments arising from investing and financing activities, except to the extent that cash flows described are reported on a net basis.

Cash flows from Investing Activities Proceeds from sale of Fixed assets

xxxx

Proceeds from sale of investments

xxxx

Proceeds from sale of Intangible Assets

xxxx

Interest and Dividend received (non-financial companies)

xxxx

Rent Income

xxxx

Purchase of Fixed Assets

(xxxx)

Purchase of Investments

(xxxx)

Purchase of Intangible Assets (Goodwill)

(xxxx)

Extraordinary items (+/-)

(xxxx)

Net cash from (or used in) Investing Activities

xxxx

Amounts In Brackets Indicate Negative Amounts, Ie, Amounts That Are To Be Deducted.

Cash Flow from Financing Activities Proceeds from issue of shares and Debentures

xxxx

Proceeds from long term borrowings

xxxx

Dividend paid

(xxxx)

Interim Dividend paid

(xxxx)

Interest on loans and Debentures paid

(xxxx)

Repayment of loans

(xxxx)

Redemption of Debentures/Preference Shares

(xxxx)

A PRACTICAL APPROACH TO IFRS

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DIRECT METHOD FORMAT FOR CASH FLOW STATEMENT for the year ended... [As per Accounting Standard - 3 (Revised)] Particulars I.

`

Cash Flow from Operating Activities (A) Operating Cash Receipts, e.g., - Cash Sales

....

- Cash received from Customers

....

- Trading Commissions received

....

- Royalties received

....

(B) Operating Cash Payments, e.g., - Cash Purchases

(....)

- Cash Paid to the Suppliers

(....)

- Cash Paid for Business Expenses like Office Expenses, Manufacturing Expenses, Selling and Distribution Expenses, etc.

(....)

(C) Cash generated from Operations (A - B)

....

(D) Income Tax Paid (Net of Tax Refund received)

(....)

(E) Cash Flow before Extraordinary item (F)

....

Extraordinary items (Receipt/Payment)

(+/-)....

(G) Net Cash from (or used in) Operating Activities II.

(....)

....

Cash Flow from Investing Activities (Same as under Indirect Method)

....

III. Cash Flow from Financing Activities (Same as under Indirect Method)

....

IV. Net Increase/Decrease in Cash and Cash Equivalents (Same as under Indirect Method - I + II + III) V.

....

Add Cash and Cash Equivalents in the beginning of the year (Same as under Indirect Method)

....

VI. Cash and Cash Equivalents in the end of the year

A PRACTICAL APPROACH TO IFRS

....

O Pg. 236

INDIRECT METHOD FORMAT FOR CASH FLOW STATEMENT for the year ended... [As per Accounting Standard - 3 (Revised)] Particulars I.

`

Cash Flow from Operating Activities Net Profit as per Profit and Loss A/c or Differences between Closing Balance and Opening Balance of Profit and Loss A/c Add: Transfer to reserve Proposed dividend for current year Interim dividend paid during the year Provision for tax made during the current year Extraordinary item, if any, debited to the Profit and Loss A/c Less: Extraordinary item, if any, credited to the Profit and Loss A/c Refund of tax credited to Profit and Loss A/c (A) Net Profit before Taxation and Extraordinary items Adjustment for Non-cash and Non-operating items (B) Add: Items to be added - Depreciation - Preliminary Expenses/Discount on Issue of Shares and Debentures written off - Goodwill, Patents and Trade Makes Amortised - Interest on Borrowings and Debentures - Loss on Sale of Fixed Assets (C) Less: Items to be Deducted - Interest Income - Dividend Income - Rental Income - Profit on Sale of Fixed Assets (D) Operating Profit before Working Capital Changes (A+B-C) (E) Add: Decrease in Current Assets and Increase in Current Liabilities Detail: - Decrease in Stock/Inventories - Decrease in Debtors/Bills Receivables - Decrease in Accrued Incomes - Decrease in Prepaid Expenses - Increase in Creditors/Bills Payables - Increase in Outstanding Expenses - Increase in Advance Incomes - Increase in Provision for Doubtful Debts (F) Less: Increase in Current Assets and Decrease in Current Liabilities Details:

A PRACTICAL APPROACH TO IFRS

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.... .... .... .... .... (....) (....) ....

... .... .... .... .... .... .... ....

.... .... .... .... .... .... .... ....

....

.... ....

....

- Increase in Stock/Inventories - Increase in Debtors/Bills Receivables - Increase in Accrued Incomes - Increase in Prepaid Expenses - Decrease in Creditors/Bills Payables - Decrease in Outstanding Expenses - Decrease in Advance Incomes - Decrease in Provision for Doubtful Debts (G) Cash Generated from Operations (D + E - F) (H) Less: Income Tax Paid (Net of Tax Refund received) (I) Cash Flow from before Extraordinary Items Extraordinary items (+/-) (J) Net Cash from (or used in) Operating Activities II. Cash from Investing Activities Proceeds from Sale of Fixed Assets Proceeds from Sale of Investments Proceeds from Sale of Intangible Assets Interest and Dividends received (For Non-financial Companies only) Rent Income Purchase of Fixed Assets Purchase of Investments Purchase Intangible Assets like Goodwill Extraordinary Items (+/-) Net Cash from (or used in) Investing Activities III. Cash Flows from Financing Activities Proceeds from Issue of Shares and Debentures Proceeds from Other Long-term Borowings Final Dividend Paid Interim Dividend Paid Interest on Debentures and Loans Paid Repayment of Loans Redemption of Debentures/Preferences Shares Extraordinary Items (+/-) Net Cash from (or used in) Financing Activities IV. Net Increase/Decrease in Cash and Cash Equivalents (I+II+III) V. Add: Cash and Cash Equivalents in the beginning of the year Cash in Hand Cash at Bank (Less: Bank Overdraft) Short-term Deposits Marketable Securities VI. Cash and Cash Equivalents in the end of year Cash in Hand Cash in Bank (Less: Bank Overdraft) Short-term Deposits Marketable Securities

.... .... .... .... .... .... .... ....

.... .... .... .... ....

.... .... .... .... .... (....) (....) (....) (....)

.... ....

.... .... (....) (....) (....) (....) (....) (....) .... ....

.... .... .... .... .... .... .... ....

Note : Amounts in brackets indicate negative amounts, i.e., amounts that are to be deducted. A PRACTICAL APPROACH TO IFRS

O Pg. 238

Treatment of Interest Paid and Tax Paid The amount of Interest and Taxes shown in the Income Statement is not necessarily the same as interest and tax paid out in cash terms because of the application of accrual concept in the income statement. So, it is necessary to look in the Balance Sheet to see if there are any liabilities for interest and tax in the beginning or end of the year. There MAY be one for interest but there is pretty well ALWAYS a tax liability. The following proforma workings should be used to calculate the actual cash paid to be shown in Cash Flow Statement.

(Working 1)

Interest Paid Outstanding Interest in the beginning of the year

xxxxxx

Add: Interest charge for the year from the income statement

xxxxx

Less: Outstanding interest at the end of the year

xxxxx

Interest paid during the year

Alternatively, an account can also be prepared. It's a personal preference which method to use.

Interest Paid

Interest paid

Balance B/d

during the year

xxxxx

Interest charge in the

Balance C/d

xxxxx

income statement

A PRACTICAL APPROACH TO IFRS

O Pg. 239

xxxxx

xxxxx

Working 2: Tax Paid During The Year

Tax paid during the year

xxxxx

Balance b/d

xxxxx

Tax charge for the current year

xxxxx

(Balancing figure)

Balance c/d

xxxxx

(Income statement)

Foreign Currency Cash Flows Cash flows arising from transactions in a foreign currency shall be recorded in an entity's K functional currency by applying to the foreign currency amount the exchange rate between the functional currency and the foreign currency at the date of the cash flow. The cash flows of a foreign subsidiary shall be translated at the exchange rates between the functional currency and the foreign currency at the dates of the cash flows.

Interest and Dividends K Cash

flows from interest and dividends received and paid shall each be disclosed separately. Each shall be classified in a consistent manner from period to period as either operating, investing or financing activities.

K The total amount of interest paid during a period is disclosed in the cash flows statement

whether it has been recognised as an expense in profit or loss or capitalised in accordance with IAS 23 Borrowing Costs. K Interest paid and interest and dividends received are usually classified as operating cash

flows for a financial institution. However, there is no consensus on the classification of these cash flows for other entities. Interest paid and interest and dividends received may be classified as operating cash flows because they enter into the determination of profit or loss. Alternatively, interest paid and interest and dividends received may be classified as financing cash flows and investing cash flows respectively, because they are costs of obtaining financial resources or returns on investments. K Dividends

paid may be classified as a financing cash flow because they are a cost of obtaining financial resources. Alternatively, dividends paid may be classified as a component of cash flows from operating activities in order to assist users to determine the ability of an entity to pay dividends out of operating cash flows. A PRACTICAL APPROACH TO IFRS

O Pg. 240

Taxes on Income K Cash

flows arising from taxes on income shall be separately disclosed and shall be classified as cash flows from operating activities unless they can be specifically identified with financing and investing activities.

K Taxes

on income arise on transactions that give rise to cash flows that are classified as operating, investing or financing activities in a statement of cash flow. While tax expense may be readily identifiable with investing or financing activities, the related tax cash flows are often impracticable to identify and may arise in a different period from the cash flows of the underlying transaction. Therefore, taxes paid are usually classified as cash flows from operating activities. However, when it is practicable to identify the tax cash flow with an individual transaction that gives rise to cash flows that are classified as investing or financing activities the tax cash flow is classified as an investing or financing activity as appropriate. When tax cash flows are allocated over more than one class of activity, the total amount of taxes paid is disclosed.

Investments in Subsidiaries, Associates and Joint Ventures K When

accounting for an investment in an associate or a subsidiary is accounted for by using equity or cost method, an investor restricts its reporting in the statement of cash flow as the cash flows between itself and the investee. In case of joint ventures, when proportionate consolidation method is used, the cash flow statement should include the venturer's share.

Non-Cash Transactions K Many investing and financing activities do not have a direct impact on current cash flows

although they do affect the capital and asset structure of an entity. The exclusion of noncash transactions from the statement of cash flows is consistent with the objective of a statement of cash flows as these items do not involve cash flows in the current period. Examples of non-cash transactions are: (a) the acquisition of assets either by assuming directly related liabilities or by means of a finance lease; (b) the acquisition of an entity by means of an equity issue; and (c) the conversion of debt to equity.

Other Disclosures K An entity shall disclose, together with notes from management, the amount of significant

cash and cash equivalent balances held by the entity that are not available for use by the group. K There are various circumstances in which cash and cash equivalent balances held by an

entity are not available for use by the group. Examples include cash and cash equivalent balances held by a subsidiary that operates in a country where exchange controls or other legal restrictions apply when the balances are not available for general use by the parent or other subsidiaries. K Additional information may be relevant to users in understanding the financial position

and liquidity of an entity. Disclosure of this information, together with a commentary by management, is encouraged and may include: A PRACTICAL APPROACH TO IFRS

O Pg. 241

(a) the amount of undrawn borrowing facilities that may be available for future operating activities and to settle capital commitments, indicating any restrictions on the use of these facilities; (b) the aggregate amounts of the cash flows from each of operating, investing and financing activities related to interests in joint ventures reported using proportionate consolidation; (c) the aggregate amount of cash flows that represent increases in operating capacity separately from those cash flows that are required to maintain operating capacity; and (d) the amount of the cash flows arising from the operating, investing and financing activities of each reportable segment (see IFRS 8 Operating Segments). K The separate disclosure of cash flows that represent increases in operating capacity and

cash flows that are required to maintain operating capacity is useful in enabling the user to determine whether the entity is investing adequately in the maintenance of its operating capacity. An entity that does not invest adequately in the maintenance of its operating capacity may be prejudicing future profitability for the sake of current liquidity and distributions to owners. K The disclosure of segmental cash flows enables users to obtain a better understanding of

the relationship between the cash flows of the business as a whole and those of its component parts and the availability and variability of segmental cash flows. Activity 3 From the summary cash account of X Ltd. prepare that Cash Flow Statement for the year ended 31st March, 2008 by Direct Method. SUMMARY CASH ACCOUNT for the year ended 31st March, 2008 Dr.

Cr.

Particulars

`

Balance on 1.4.2006 Issue of Equity Shares Receipts from Customers Sale of Fixed Assets

50,000 3,00,000 28,00,000 1,00,000

Particulars

`

Payment to Suppliers

20,00,000

Purchased of Fixed Assets

2,00,000

Overhead Expenses

2,00,000

Wages and Salaries

1,00,000

Tax Paid

2,50,000

Dividend Paid

50,000

Repayment of Bank Loan

3,00,000

Balance on 31.3.2007

1,50,000

32,50,000

32,50,000

Solution: CASH FLOW STATEMENT OF X LTD. (DIRECT METHOD) for the year ended 31st March, 2008

`

Particulars

(A)

Cash Flow from Operating Activities Cash Received from Customers Cash Paid to Suppliers A PRACTICAL APPROACH TO IFRS

28,00,000 20,00,000 1,00,000 O Pg. 242

Wages and Salaries

2,00,000

(23,00,000)

Overhead Expenses

5,00,000

Cash Generated from Operations

2,50,000

Less: Tax Paid

2,50,000

Net Cash from Operating Activities (B)

Cash Flow from Investing Activities Purchase of Fixed Assets

(2,00,000)

Proceeds from Sale of Fixed Assets

1,00,00

Net Cash Used in Investing Activities (C)

(1,00,000)

Cash Flow from Financing Activities Proceeds from Issue of Equity Shares

3,00,000

Payment of Bank Loan

(3,00,000)

Dividend Paid

(50,000)

Net Cash Used in Financing Activities

(50,000)

Net Increase in Cash and Cash Equivalents (A+B+C)

1,00,000

Cash and Cash Equivalent at the beginning of the year

50,000

Cash and Cash Equivalents at the end of the year

1,50,000

Activity 3 From the following Balance Sheets of Bhushan Steel Ltd., prepare the Cash Flow Statement: Liabilities

31.3.2007

`

31.3.2008 Assets

31.3.2007 31.3.2008

`

Equity Share Capital

6,00,000

8,00,000 Fixed Assets

12% Preference Share Capital

2,00,000

1,50,000 Investments

15% Debentures

4,00,000

5,00,000 Stock

`

`

4,00,000 10,00,000 80,000

90,000

3,00,000

4,00,000

Securities Premium

....

1,20,000 Debtors

3,52,000

1,12,000

Profit and Loss A/c

....

1,44,000 Bank

1,88,000

4,28,000

Accumulated Depreciation

60,000

96,000 Discount on Issue of Debentures

40,000

32,000

Provision for Doubtful Debts

20,000

32,000 Profit and Loss A/c

20,000

....

Creditors

1,00,000

2,20,000

13,80,000

20,62,000

13,80,000 20,62,000

Additional Information: (i)

Dividend paid during the year ` 72,000.

(ii)

Investment costing ` 20,000 were sold at a profit of 40%.

(iii) Fixed Assets costing `40,000 (accumulated depreciation `16,000) were sold for `34,000. (iv) Additional debentures amounting to `1,00,000 issued on 1st August 2007. Interest on debentures is paid on 31st March every year. A PRACTICAL APPROACH TO IFRS

O Pg. 243

Solution: Bhushan Steel Ltd. CASH FLOW STATEMENT for the year ended 31st March, 2008 Particulars I.

`

`

Cash Flow from Operating Activities Net Profit before tax : Profit during the year (Note 1) Add: Dividend paid being Financing Activities

1,64,000 72,000

2,36,000

Add: Items to be added: Depreciation on Fixed Assets (Note 3) Discount on Issue of Debentures Written off Interest Paid (Note 5) being Financing Activity

52,000 8,000 70,000

1,30,000 3,66,000

Less: Profit on Sale of Investment being Investing Activity Profit on Sale of Fixed Assets being Investing Activity

8,000 10,000

Operating Profit before Working Capital Change

18,000 3,48,000

Add: Decrease in Current Assets: Debtors

2,40,000

Increase in Current Liabilities: Creditors

1,20,000

Provision for Doubtful Debts

12,000

3,72,000 7,20,000

Less: Increase in Current Assets: Stock

1,00,000

Net Cash Flow from Operating Activities II.

6,20,000

6,20,000

Cash Flow from Investing Activities Purchase of Fixed Assets (Notes 2 and 3)

(6,40,000)

Sale of Fixed Assets

34,000

Purchase of Investment (Note 4)

(30,000)

Sale of Investments

28,000

Net Cash Used in Investing Activities

6,08,000

6,08,000

III. Cash Flow from Financing Activities Cash Proceeds from Issue of Shares

2,00,000

Premium Received on Issue of Shares

1,20,000

Cash Proceeds from Issue of Debentures

1,00,000

Redemption of Preference Shares

(50,000)

Dividend Paid

(72,000)

Interest Paid

(70,000)

Net Cash from Financing Activities

2,28,000

Net Increase in Cash and Cash Equivalents

2,28,000 2,40,000

Cash and Cash Equivalents at the Beginning of the Period

1,88,000

Cash and Cash Equivalents at the End of the period

4,28,000

Notes: 1. Profit and Loss Account Balance of `20,000 appearing on the assets side of previous year's balance sheet represents and amount of loss. In the current year, after covering this A PRACTICAL APPROACH TO IFRS

O Pg. 244

loss of `20,000, the net profit of `1,44,000 is appearing on the liabilities side. It means that during the current year net profit earned by the company is `1,44,000 + `20,000 = `1,64,000. 2. Dr.

FIXED ASSETS ACCOUNT

Particulars

`

To Balance b/d

4,00,000

To Profit and Loss A/c

10,000

(Profit on Sale of Fixed Assets)

Cr.

Particulars

`

By Bank A/c (Sale)

34,000

By Accumulated Depreciation A/c

16,000

(Being Depreciation on Fixed Assets sold)

To Bank A/c (Bal, Fig., being Purchases)

6,40,000

By Balance c/d

10,00,000

10,50,000

3. Dr.

10,50,000

ACCUMULATED DEPRECIATION ACCOUNT

Particulars

`

To Fixed Assets A/c

16,000

(Transfer of Depreciation on Fixed Assets Sold

Cr.

Particulars

`

By Balance c/d

60,000

By Profit and Loss A/c (Bal. Fig., being

52,000

Current Year's Depreciation)

To Balance c/d

96,000 1,12,000

4. Dr.

1,12,000

INVESTMENT ACCOUNT

Particulars

`

To Balance b/d

80,000

To Profit and Loss A/c (Profit on Sales)

8,000

To Bank A/c (Bal. Fig., being Purchases)

30,000

Cr.

Particulars

`

By Bank A/c (Sale) (20,000 + 40% of `20,000) By Balance c/d

28,000 90,000

1,18,000

1,18,000

5. Interest on Debentures = [`4,00,000 x 15/100] + [`1,00,000 x 15/100 x 8/12] = `60,000 + `10,000 = 70,000.

STUDENT CORNER During your accountancy studies you generally hear the phrase 'Cash is reality' or 'Cash is the king'. Its certainly true as companies fail due to lack of cash rather than lack of profits. Therefore, it becomes imperative to keep a check on the flow of cash in an organization on an yearly basis. IAS 7 attempts to ensure that companies report their cash generation and absorption in a way which helps provide information to assist users who make economic decisions based on the accounts. Often when students start this topic it seems very difficult with the size of the format being pretty formidable. When you first begin, therefore, break it down into three key sections and learn the format chunk by chunk – treat it as three topics and not as one.

A PRACTICAL APPROACH TO IFRS

O Pg. 245

MEMORY TIPS K The starting point is company's profit from the current year income statement. To this

add back all non-operating and non-cash items and deduct all non-operating incomes and gains. And you get operating cash flow before working capital changes. K To this

add all decreases in current assets and increases in current liabilities. Also, deduct all increases in current assets and decreases in current liabilities.

K If your movement of cash worsens (ie the figure is negative) then put it in brackets.

Worsens = ( ) Improves = no ( ) K Don't forget that this is a cash flow statement not an income statement. The amounts

in the income statement for interest and tax will not necessarily be the same as the interest and tax paid out in cash terms. Therefore, it is important to look at the balance sheet to see if there are any liabilities for interest or tax at the start of the year or at the end of the year. K A common

mistake made by students is to put the profit from the disposal of equipment in the cash flow rather than cash proceeds. This profit should be deducted from cash from operating activities and shown as a part of cash flow from investing activities.

A PRACTICAL APPROACH TO IFRS

O Pg. 246

WORKSHEET 1. According to U.S. GAAP and IFRS, cash flows are divided into all of the following activities except (a) Operating (b) Investing (c) Financing (c) Directing 2. Unlike IFRS, which of the following would not be considered cash and cash equivalents according to US GAAP? (a) Bank overdrafts (b) Marketable securities (c) Treasury bills (d) Money market holdings 3. According to U.S. GAAP, which of the following cash flow transactions would be considered an operating activity? (a) Interest received (b) Dividends received (c) Interest paid (d) All of the above 4. An entity purchases a building and the seller accepts payment partly in equity shares and partly in debentures of the entity. This transaction should be treated in the cash flow statement as follows: (a) The purchase of the building should be investing cash outflow and the issuance of shares and the debentures financing cash outflows. (b) The purchase of the building should be investing cash outflow and the issuance of debentures financing cash outflows while the issuance of shares investing cash outflow. (c) This does not belong in a cash flow statement and should be disclosed only in the footnotes to the financial statements. (d) Ignore the transaction totally since it is a noncash transaction. No mention is required in either the cash flow statement or anywhere else in the financial statements. 5. An entity (other than a financial institution) receives dividends from its investment in shares. How should it disclose the dividends received in the cash flow statement prepared under IAS 7? (a) Operating cash inflow. (b) Either as operating cash inflow or as investing cash inflow. (c) Either as operating cash inflow or as financing cash inflow. (d) As an adjustment in the 'operating activities' section of the cash flow because it is included in the net income for the year and as a cash inflow in the 'financing activities' section of the cash flow statement.

A PRACTICAL APPROACH TO IFRS

O Pg. 247

6. How should gain on sale of an office building owned by the entity be presented in a cash flow statement? (a) As an inflow in the investing activities section of the cash flow because it pertains to a long-term asset. (b) As an inflow in the 'financing activities' section of the cash flow statement because the building was constructed with a longterm loan from a bank that needs to be repaid from the sale proceeds. (c) As an adjustment to the net income in the 'operating activities' section of the cash flow statement prepared under the indirect method. (d) Added to the sale proceeds and presented in the 'investing activities' section of the cash flow statement. 7. How should an unrealized gain on foreign currency translation be presented in a cash flow statement? (a) As an inflow in the 'financing activities' section of the cash flow statement because it arises from a foreign currency translation. (b) It should be ignored for the purposes of the cash flow statement as it is an unrealized gain. (c) It should be ignored for the purposes of the cash flow statement as it is an unrealized gain but it should be disclosed in the footnotes to the financial statements by way of abundant precaution. (d) As an adjustment to the net income in the 'operating activities' section of the statement of cash flows. 8. How should repayment of a long-term loan comprising repayment of the principal amount and interest due to date on the loan be treated in a cash flow statement? (a) The repayment of the principal portion of the loan and interest is a cash flow belonging in the 'finanicing activities' section; the interest payment is also treated as an adjustment in the 'operating activities' section. (b) The repayment of the principal portion of the loan is a cash flow belonging in the 'investing activities' section; the interest payment belongs either in the 'operating activities' section or the 'investing activities' section. (c) The repayment of the principal portion of the loan is a cash flow belonging in the 'investing activities' section; the interest payment belongs in the 'operating activities' section (because IAS 7 does not permit any alternatives in case of interest payments). (d) The repayment of the principal portion of the loan is a cash flow belonging in the 'investing activities' section; the interest payment should be netted against interest received on bank deposits, and the net amount activities' section. 9. The maximum maturity of a cash equivalent is: (a) 3 months. (b) 6 months. (c) 1 year. 10. Bank borrowing are generally considered to be: (a) Operating activities.

A PRACTICAL APPROACH TO IFRS

O Pg. 248

(b) Investing activities. (c) Financial activities. (d) Cash equivalents. 11. If bank overdrafts form an integral part of an undertaking's cash management, they are considered to be: (a) Operating activities. (b) Investing activities. (c) Financial activities. (d) Cash equivalents. 12. A single transaction: (a) May include cash flows that are classified differently. (b) Must be included in full in one of the three headings. (c) May be spread over more than one period. 13. The amount of cash flows arising from operating activities is a key indicator of the extent to which the operations have generated sufficient cash flows to: (a) Repay loans. (b) Maintain the operating capability of the undertaking. (c) Pay dividends. (d) Make new investments. (e) All 14. Cash flows, arising from transactions in a foreign currency, should be recorded in: (a) Local currency. (b) An undertaking's functional currency, at the rate of the date of the transaction. (c) An undertaking's functional currency, at the rate at the end of the period. 15. Unrealised gains (and losses) arising from changes in foreign currency exchange rates are: (a) Translated at closing rate. (b) Translated at opening rate. (c) Not cash flows. 16. Cash flows from interest and dividends received, and paid, should: (a) Each be disclosed separately. (b) Be shown as a net figure. (c) Be excluded from the cash flow statement. 17. Taxes paid are usually classified as cash flows from: (a) Operating activities. (b) Investing activities. (c) Financial activities. 18. When accounting for an associate, an investor reports the cash flows: (a) Using proportional consolidation. (b) Only the cash flows between itself and the investee. (c) In a separate cash flow statement.

A PRACTICAL APPROACH TO IFRS

O Pg. 249

19. When accounting for a joint venture, an investor reports the cash flows: (a) Using proportional consolidation. (b) Only the cash flows between itself and the investee. (c) In a separate cash flow statement.

ANSWER 1 5. 9. 13. 17.

(d) (d) (a) (e) (a)

2. 6. 10. 14. 18.

(d) (c) (c) (b) (b)

3. 7. 11. 15. 19.

(d) (d) (d) (c) (a)

A PRACTICAL APPROACH TO IFRS

O Pg. 250

4. 8. 12. 16.

(a) (a) (a) (a)

CHAPTER 8 ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS (IAS 8) 'There is nothing wrong with change, if it is in the right direction.'

CHAPTER 8 ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS (IAS 8) OBJECTIVE The objective of this Standard is to prescribe the criteria for selecting and changing accounting policies, together with the accounting treatment and disclosure of changes in accounting policies, changes in accounting estimates and corrections of errors. The Standard is intended to enhance the relevance and reliability of an entity's financial statements, and the comparability of those financial statements over time and with the financial statements of other entities.

KEY DEFINITIONS Accounting Policies Accounting policies are the specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements. Change in accounting estimate A change in accounting estimates is an adjustment of the carrying amount of an asset or a liability or the consumption of the asset. Changes in accounting estimates result from new information or new developments and, accordingly, are not corrections of errors.

IAS 8 covers: (a) Selecting or changing accounting policies; (b) Changes in accounting estimates; (c) Correction of priorperiod errors.

Prior-period errors Omissions and misstatements in financial statements for one or more prior periods arising from a failure to use or misuse of reliable information that was available at the time and could reasonably be expected to have been obtained and taken into account in the preparation and presentation of financial statements. Materiality Omissions or misstatements of items are material if they could, by their size or nature, individually or collectively, influence the economic decisions of users taken on the basis of the financial statements. Retrospective application is applying a new policy as if that policy had always been applied. Retrospective restatement is restating financial statements as if a prior-period error had never occurred. Impracticable Error correction may be impracticable if: (a) the impact cannot be determined; (b) assumptions on management's intent must be made; (c) restatement requires evidence that is not available. Prospective application is applying a change in current and future periods.

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Accounting Policies An entity should clearly outline all significant accounting policies it has used in preparing the financial statements. Because under International Financial Reporting Standards (IFRS) alternative treatments are possible, it becomes all the more important for an entity to clearly state which accounting policy it has used in the preparation of the financial statements.

Accounting policies are essential for a proper understanding of the information contained in the financial statements prepared by the management of an entity.

For instance, under IAS 2, an entity has the choice of the weighted-average method or the first-in, first-out (FIFO) method in valuing its inventory. Unless the entity discloses which method of inventory valuation it has used in the preparation of its financial statements, users of these financial statements would not be able to use the financial statements properly to make relative comparisons with other entities.

Selection and Application of Accounting Policies As per IAS 8, the organization should apply the relevant standard to determine the accounting policy when a Standard or an Interpretation specifically applies to a transaction.

EXAMPLE XYZ Co. has to value its inventory at the end of an accounting period. In all the circumstances it would have to follow the provisions contained in IAS 2 on Inventory to determine the accounting policy. Guidance is available from specific IAS/IFRS, the Framework and other IASB publications. Other standard-setting bodies may also be referred to when the issue is not covered by IAS/IFRS.

Consistency of Accounting Policies An undertaking shall apply its policies consistently for similar transactions or categories.

EXAMPLE XYZ Co. has to value its inventory at the end of an accounting period for which it refers to IAS 2 on Inventory. As per the provisions contained in the standard, the company can either adopt First-In-First-Out (FIFO) or weighted average method. The method adopted by the company initially should be followed consistently every year.. Policies should be consistent from period to period to allow comparisons to be made.

Changes in Accounting Policies As required by the IFRS, accounting policies can be changed for the purpose of getting better information. A PRACTICAL APPROACH TO IFRS

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EXAMPLE (a) The inventory of ABC Co. has been accounted for by using LIFO method. IAS 2 Inventories has now removed LIFO as an option. The company can change its policy to weighted-average in accordance with IFRS. (b) XYZ Co. is using Financial Instruments for the first time for which it applies IAS 39. Application of an IFRs for the first time is not considered as change in accounting policies.

Applying Changes in Accounting Policies (a) If a Standard or Interpretation contains no transitional provisions or if an accounting policy is changed voluntarily, the change shall be applied retrospectively. That is to say, the new policy is applied to transactions, other events, and conditions as if the policy had always been applied. The practical impact of this is that corresponding amounts (or 'comparatives') presented in financial statements must be restated as if the new policy had always been applied. The impact of the new policy on the retained earnings prior to the earliest period presented should be adjusted against the opening balance of retained earnings.

EXAMPLE Your joint venture has been accounted for using the equity method. You voluntarily change your policy to proportional consolidation for the benefit of users. This is a voluntary change of policy, so the comparative figures must also reflect proportional consolidation.

(b) Early application of a Standard is not a voluntary change in accounting policy. This is because if not today, then tomorrow it would be compulsory to adopt the new standard.

EXAMPLE A new Standard has been issued which will come into force in 2010. You introduce its provisions into your 2009 financial statements which is permitted but not compulsory. This is not a voluntary change in policy so no change of comparative figures is necessary.

Retrospective Application (a) Accounting policy applied retrospectively requires adjustment of the prior opening balance of each component of equity. This may also affect the historical summaries. The effect would be as if the new accounting policy had always been applied. A PRACTICAL APPROACH TO IFRS

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EXAMPLE- Retrospective Application Your jointly-controlled entity has been accounted for at equity method. You change your policy to the proportionate consolidation for the benefit of users. This is a voluntary change of policy. The change must be made retrospectively. This requires you to change the figures for all periods that feature in your financial statements.

(b) Retrospective application is not practicable, unless cumulative impact in both the opening and closing balance sheets, in the period, can be determined.

EXAMPLE ABC Co. previously expensed borrowing costs (debited to profit & loss account), but now decided to capitalise them under IAS 23. The records are only available for the last 3 years but they have no adequate analysis for the earliest period. Adjustments have to be limited to the last 2 years due to the impracticality of not having a detailed opening balance sheet for the earliest period. A change in accounting policy shall be applied retrospectively from when it is practicable.

Disclosure (a) When initial application of a Standard has an impact on the current, past or future period the organization should disclose the: (a) title of the Standard ; (b) changes in accounting policy made in accordance with transitional provisions and description of them; (c) present and future impact;

EXAMPLE ABC Co. decides to revalue property previously held at cost. The appreciation in the amounts will increase the depreciation charges in the current and future periods. This needs to be quantified and noted.

And also show: 1. the adjustment for the current period and each prior-period for each financial statement line; 2. adjustment to Earnings per Share if applicable; 3. if retrospective application is impracticable how and when the change in accounting policy has been applied;

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EXAMPLE You change your policy on intangible assets and retroactively apply them to the last 7 years' figures. You only present 5 years' figures in your financial statements. You detail the reasons for the change and the impact on the 2 years prior to those presented. 4. reasons for applying a voluntary change in policy reliable and how it provides more relevant information.

EXAMPLE ABC Co. values inventory on FIFO basis. It wants to change to weighted average method for better information. The company would have to disclose the reasons for such a change and how would such a change provide reliable information. (b) If a new Standard has been issued but is not yet effective, disclose the likely impact of its future application.

EXAMPLE A new Standard has been issued which will come into force in 2XX8. You will not apply it to your 2XX7 financial statements. Disclose the likely impact on future application 2XX8 financial statements in 2XX7. Optional disclose: 1. Nature of the impending changes in accounting policy; 2. Effective date for application of the Standard and mandatory date; 3. Discussion of the impact of the Standard or a statement that the impact is not known.

Changes in Accounting Estimates (a) Estimation involves judgments based on the latest available information. Many items in the financial statements cannot be measured with accuracy and are thus estimated. This is due to uncertainties inherent in business activities. Accounting, the language of business, has to translate these uncertainties into figures that are then reported in the financial statements. Thus accounting estimates are a very important part of the process of financial reporting. Common examples of accounting estimates include: Bad debts

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Inventory obsolescence

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Useful lives of property, plant, and equipment

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Fair values of financial assets or financial liabilities

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Provision for warranty obligations

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EXAMPLE XYZ Co. was incorporated on January 1, 20X1, and follows IFRS in preparing its financial statements. In preparing its financial statements for financial year ending December 31, 20X3, XYZ Co. used the following useful lives for its property, plant, and equipment: Buildings

:

15 years

Plant and machinery

:

10 years

Furniture and fixtures

:

7 years

On January 1, 20X4, the entity decides to review the useful lives of the property, plant, and equipment. For this purpose it hired external valuation experts. These independent experts certified the remaining useful lives of the property, plant, and equipment of XYZ Co. at the beginning of 20X4 as: Buildings

:

10 years

Plant and machinery

:

7 years

Furniture and fixtures

:

5 years

XYZ Co. uses the straight-line method of depreciation. The original cost of the various components of property, plant, and equipment were: Buildings

:

` 15,000,000

Plant and machinery

:

` 10,000,000

Furniture and fixtures

:

` 3,500,000

Compute the impact on the income statement for the year ending December 31, 20X4, if XYZ Co. decides to change the useful lives of the property, plant, and equipment in compliance with the recommendations of external valuation experts. Assume that there were no salvage values for the three components of the property, plant, and equipment either initially or at the time the useful lives were revisited and revised.

Solution i.

The annual depreciation charges prior to the change in estimate were Buildings

: ` 15,000,000/ 15 = ` 1,000,000 p.a

Plant and machinery

: ` 10,000,000 / 10 = ` 1,000,000 p.a

Furniture and fixtures : ` 3,500,000 / 7 =` 500,000 p.a Total

: ` 2,500,000 (i)

ii. The revised annual depreciation for the year ending December 31, 20X4, would be Buildings

: [` 15,000,000 – ` 1,000,000 × 3)] / 10 = ` 1,200,000

Plant and machinery

: [` 10,000,000 – (` 1,000,000 × 3)] / 7 = `1,000,000

Furniture and fixtures : [` 3,500,000 – (` 500,000 × 3)] / 5 = ` 400,000 Total

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iii. The impact on Income Statement for the year ending December 31, 20X4 = (ii) – (i) = ` 2,600,000 – ` 2,500,000 = `100,000 (b) A change in the measurement basis is a change in a policy and not a change in an estimate.

EXAMPLE An investment property has been accounted for at cost. You revalue your property and because is at the revalued amount. This change in value is because the measurement basis which is a change in a policy and is not a change in an estimate. ( c) Record a change in an estimate from the period of change onwards. This is called prospective recognition.

EXAMPLE You sell televisions and videos. You provide an after-sale warranty to cover service for the first two years. Experience has shown that 5% of the sets will need service under the warrantee scheme. A new range of sets indicates that the only 3% of sets will need to be serviced. The warranty will be adjusted in this period onwards. When it is difficult to distinguish a change in a policy from a change in an estimate the change is treated as a change in an estimate.

Disclosure Changes in estimates are disclosed, except when it is impracticable to estimate the impact and then reason for non-disclosure should be disclosed.

Errors, including Fraud Financial statements do not comply with IFRS if they contain material errors. For material errors discovered in a subsequent period either these are: Error of the last period - Restate comparative information

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Error before last period - Correct opening balances

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EXAMPLE During your audit for 2XX6 it is found that the 2XX5 sales figure had been materially inflated by fictitious invoices. The comparative figures for 2XX5 should be restated to correct this error.

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EXAMPLE You run a leasing firm. You find that revenue has been recognised too early for the last 7 years in order to inflate profits. Your financial statements only report 5 years. You restate the opening balances of assets liabilities and equity for the earliest period presented and the adjustments thereafter.

Limitations on Retrospective Restatement Where impracticable to correct the prior period, restate the opening balances for the earliest period practicable.

IAS 8 prescribes the criteria for selecting and changing accounting policies, together with the accounting treatments for changes in accounting policy and the correction of errors.

EXAMPLE For at least the last 10 years, administration overheads have been capitalised into inventory. You can eliminate the overhead from the last 2 years' figures but do not have information to correct figures before them. So, only two years can be corrected.

STUDENT CORNER All companies have to decide which accounting policies they are planning to adopt. There is a difference of opinion on how accounting standards should work. One view is that they should be rule-based and the other is principlesbased approach. Its like when you were a teenager going out for the first time – Your parents could give you a list of rules – things you must not do. e.g.; 'do not come home later than 10:00 pm', 'do not drink' etc. Or maybe your parents adopted a principles based approach – 'Be Good'!!- a catch all which automatically includes all dos and don'ts. This is the approach adopted by IAS 8.

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MEMORY TIPS 1. Accounting policies selected should be in accordance with International Accounting Standards or Interpretations. If no standard is applicable, policies should be selected in accordance with: Relevance

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Reliability

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Faithful representation

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Substance over form neutrality

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Prudence

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Completeness.

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( A principles- based approach: Be Good) 2. Changes in accounting policy arise if required by a new standard, or because the new policy is more relevant and reliable. It is not a change in policy if a new policy is applied to a new type of transaction. 3. Changes in new policy should be applied retrospectively unless it is impracticable to do so. Significant disclosures are required about the change in policy. 4. Changes in accounting estimates should be applied prospectively. A change in estimate is not a change in policy and occurs if new information becomes available that was not previously known. As a result they cannot be treated as errors. 5. Correction of material prior period errors should be accounted for retrospectively unless it is impracticable to do so. Significant disclosures are required if an error has occurred. 6. In accordance with the principle of consistency, an entity should apply the same accounting policy from one period to the next unless: The change is required by a standard or interpretation.

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The change will result in the financial statements providing reliable and more relevant information about the effects of transactions on entity's financial position.

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Students often get confused between identifying whether a change is a change in accounting policy or a change in an accounting estimate. If we are told that a company changes its method of valuation of inventory from weighted average to FIFO method this is a clear example of change in accounting policy with the accounting being performed retrospectively. However, when we are told that a company changes the useful life of an asset from 10 to 8 years, then this is often mistaken for a change in accounting policy. Infact the company's accounting policy has NOT changed- the policy was and still is to depreciate the asset over its useful life . What we have here is a change in accounting estimate which needs to be accounted for prospectively.

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Changes in Accounting Policies

Changes in Accounting Estimates

Examples

# Changes in legislation

Bad Debts #

# A new accounting

# Inventory

standard # Changing Revenue

Obsolescense # Useful lives of

recognition Practices

property, Plant and equipment

# Changing inventory

valuation From weighted average to FIFO

# Fair values of

financial Assets and liabilities Examples

# A change from

measuring a Class of assets at depreciated Historical cost to a policy of regular revaluation.

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WORKSHEET 1. XYZ Inc. changes its method of valuation of inventories from weighted-average method to first-in, first-out (FIFO) method. XYZ Inc. should account for this change as: (a) A change in estimate and account for it prospectively. (b) A change in accounting policy and account for it prospectively. (c) A change in accounting policy and account for it retrospectively. (d) Account for it as a correction of an error and account for it retrospectively. 2. Change in accounting policy does not include: (a) Change in useful life from 10 years to 7 years. (b) Change of method of valuation of inventory from FIFO to weighted-average. (c) Change of method of valuation of inventory from weighted-average to FIFO. (d) Change from the practice (convention) of paying as Christmas bonus one month's salary to staff before the end of the year to the new practice of paying one-half month's salary only. 3. When a public shareholding company changes an accounting policy voluntarily, it has to (a) Inform shareholders prior to taking the decision. (b) Account for it retrospectively. (c) Treat the effect of the change as an extraordinary item. (d) Treat it prospectively and adjust the effect of the change in the current period and future periods. 4. When it is difficult to distinguish between a change of estimate and a change in accounting policy, then an entity should: (a) Treat the entire change as a change in estimate with appropriate disclosure. (b) Apportion, on a reasonable basis, the relative amounts of change in estimate and the change in accounting policy and treat each one accordingly. (c) Treat the entire change as a change in accounting policy. (d) Since this change is a mixture of two types of changes, it is best if it is ignored in the year of the change; the entity should then wait for the following year to see how the change develops and then treat it accordingly. 5.

When an independent valuation expert advises an entity that the salvage value of its plant and machinery had drastically changed and thus the change is material, the entity should (a) Retrospectively change the depreciation charge based on the revised salvage value. (b) Change the depreciation charge and treat it as a correction of an error. (c) Change the annual depreciation for the current year and future years. (d) Ignore the effect of the change on annual depreciation, because changes in salvage values would normally affect the future only since these are expected to be recovered in future. A PRACTICAL APPROACH TO IFRS

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6.

Errors include: (i) Mathematical mistakes. (ii) Mistakes in applying accounting policies. (iii) Oversights or misinterpretations of facts. (iv) Fraud. (v) Changes in provisions for bad debts. (a) i - ii (b) i - iii (c) i - iv (d) i - v

7.

Applying a new policy to transactions other events and conditions as if that policy had always been applied. This is: (a) Retrospective restatement. (b) Retrospective application. (c) Change in accounting estimate.

8.

Correcting the recognition measurement and disclosure of amounts in financial statements as if a prior-period error had never occurred. This is: (a) Retrospective restatement. (b) Retrospective application. (c) Change in accounting estimate.

9.

You accept advice to accelerate your depreciation policy. To make the change, you will need: (a) Retrospective restatement. (b) Retrospective application. (c) Prospective application.

10. In selecting an accounting policy you should review: (a) The Standards only. (b) The Interpretations only. (c) The Framework only. (d) Standards Interpretations and Framework. 11. In the absence of a Standard or an Interpretation management shall use judgement in developing an accounting policy that results in information that is relevant to the needs of users; and reliable in that the financial statements: i Represent the financial position financial performance and cash flows of the undertaking. ii Reflect the economic substance of transactions other events and conditions and not merely the legal form. iii Are free from bias. iv Are prudent. v Are complete in all material respects. vi Comply with national tax laws. A PRACTICAL APPROACH TO IFRS

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(a) (b) (c) (d) (e)

i - ii i - iii i - iv i-v i - vi

12. Changes in accounting policies: (a) Should be applied only in the year of the change. (b) Should make the change to all periods reported. (c) Should only make the change in the following period. 13. It is impractical to make a retrospective application to a period unless you can determine the impact of the change in: (a) The opening balance sheet. (b) The closing balance sheet. (c) Both opening and closing balance sheets 14. If it is impractical to make a retrospective application to a period (a) Make the change only to the current period. (b) Apply the change to the earliest period that is practical. (c) Do not make the change at all. 15. When you have not applied a new Standard that has been issued but is not yet effective: (a) You should note this and estimate its impact. (b) Your accounts will not comply with IFRS. (c) You should ignore it. 16. Accounting estimates are made for: i ii iii iv v vi (a) (b) (c) (d) (e)

Bad debts. Inventory obsolescence. The fair value of financial assets or financial liabilities. The useful lives of or expected consumption of the benefits embodied in depreciable assets. Warranty obligations. Changes in accounting policy. i - ii i - iii i - iv i-v i–v

17. A change of estimate should be made to the income statements of: (a) The period of the original estimate. (b) All previous periods reported. (c ) The current period and future periods. (d) Future periods only.

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18. Prior-period errors, including fraud, should be corrected: (a) Only in the period when the error has been discovered. (b ) In the earliest period that is practical. (c) In future periods only. 19. A gain recorded on the outcome of a contingency, such as a lawsuit, is: (a) A change in estimate. (b) A correction of an error. (c) A retrospective restatement. 20. You are introducing a new policy to provide a warranty provision of 2% of product sales. When you review past warranty data the average was 2% but in one year the cost was 10% and in another year it was 0%. When applying your retrospective figures as a provision you use: (a) The actual costs incurred. (b) 2%. (c) 2% unless there was no charge in a particular year. 21. Retrospective application involves using information that was available: (a) Only at the balance sheet date. (b) When the accounts were approved. (c) At any time.

ANSWER 1.

(c)

2. (a)

3. (b)

4. (a)

5.

(c)

6. (a)

7. (b)

8. (a)

9.

(c)

10. (d)

11. (d)

12. (b)

13. (c)

14. (b)

15. (a)

16. (d)

17. (c)

18. (b)

19. (a)

20. (b)

21. (a)

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CHAPTER 9 EVENTS AFTER BALANCE SHEET DATE (IAS 10) 'To state the facts is not to despair the future nor indict the past. The prudent heir takes careful inventory of his legacies and gives a faithful accounting to those whom he owes an obligation of trust.'

CHAPTER 9 EVENTS AFTER BALANCE SHEET DATE (IAS 10) The balance sheet date is the pivotal date at which the financial position of an entity is determined and reported. Thus, events that occur up to that date are critical in arriving at an entity's financial results and the financial position. However, sometimes events occurring after the balance sheet date may provide additional information about events that occurred before and up to the balance sheet date. This information may have an impact on the financial results and the financial position of the entity.

Companies have six months grace for filing their accounts.

Therefore, it is imperative that those post–balance sheet events up to a certain 'cutoff date'be taken into account in preparing the financial statements for the year ended and as at the balance sheet.

OBJECTIVE IAS 10 details the post-balance-sheet events and how they should be recorded. Post-balance-sheet events happen in the period starting immediately after the balance sheet date and ending at the date of approval of the financial statements. BUT, establishing the exact date of approval is necessary to comply with the Standard.

KEY DEFINITIONS Events After the Balance Sheet Date Those post–balance sheet events, both favorable and unfavorable, that occur between the balance sheet date and the date when the financial statements are authorized for issue (ie, the post balance sheet period). Events after the balance sheet date include all events up to the date when the financial statements are approved for issue, even if those events occur after the public announcement of profit, or of other selected financial information.

EXAMPLE A company makes preliminary announcements to the local Stock Exchange every quarter, based on interim financial statements prepared by management. These summarise the key figures in an abbreviated set of financial statements. Before the IFRS financial statements, (that will be sent to shareholders) are approved by the board, the company undertakes a major acquisition (or another material event, covered by IAS 10, occurs). This event must be included in the notes to the IFRS financial statements.

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Adjusting Events Events that arise after the Balance Sheet date but before the final approval that require the Balance Sheet to be amended. Non-Adjusting Events Events and conditions that arise after the Balance Sheet date relating to conditions not existing at the end of the reporting period.

Approval or Authorization Date K This

is the date when Financial Statements are considered legally authorized for issue. This date is the end of the post balance sheet period. It is crucial to determine this date as it serves as a cut-off point to classify events as adjusting or non-adjusting events.

K When

an entity is required to submit its financial statements to its shareholders for approval after they have already been issued, the authorization date in this case would mean the date of original issuance and not the date when these are approved by the shareholders; and

K When an entity is required to issue its financial statements to a supervisory board made

up wholly of nonexecutives, 'authorization date' would mean the date on which management authorizes them for issue to the supervisory board.

EXAMPLE 1.

On 25 April 2009, management of an undertaking completes draft financial statements for the year to 31 March,2009.

2. On 10 May 2009, the board of directors reviews the financial statements and approves them for issue. 3. On 16 May 2009, the undertaking announces its profit and selected other financial information on 19 May 2009. 4. On 19 May, the financial statements are made available to shareholders, and others. 5. On 24 May 2009, the shareholders approve the financial statements at the annual meeting. 6. On 28 May 2009, the approved financial statements are then filed with a regulatory body The period for post balance sheet events ends on 10 May, 2009. (date of board approval for issue).

Activity 1 Problem On 12 February 2XX8, the management of an undertaking approves financial statements for issue to its supervisory board. The supervisory board is made up solely of nonexecutives, and may include representatives of employees, and other outside interests. On 23 February 2XX8, the supervisory board approves the financial statements. On 14 March 2XX8, the financial statements are made available to shareholders, and others. On 19 April 2XX8, the shareholders approve the financial statements at their annual meeting. A PRACTICAL APPROACH TO IFRS

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On 29 April 2XX8, the financial statements are filed with a regulatory body.

Solution The financial statements are approved for issue on 12 February 2XX8 which is the end of the post balance sheet period. Adjusting Events after the Balance Sheet Date Adjusting events are those post–balance sheet events that provide evidence of conditions that actually existed at the balance sheet date, albeit they were not known at the time. Financial statements should be adjusted to reflect adjusting events after the balance sheet date.

Typical examples of adjusting events are K The bankruptcy of a customer after the balance sheet date usually suggests a loss of trade receivable at the balance sheet date. K The sale of inventory at a price substantially lower than its cost after the balance sheet date confirms its net realizable value at the balance sheet date.

An undertaking shall adjust the amounts recorded in its financial statements, to reflect adjusting events after the balance sheet date.

EXAMPLE XYZ Co, has been sued for anticompetitive behaviour. This was been denied by the firm and no provision was made in the financial statements as on 31st December 2009. On January 14, 2010 the court awards `5 crore damages against the firm. In this case, the receipt of information, after the balance sheet date indicates that an asset was impaired at the balance sheet date and that the amount of a previously recorded impairment loss for that asset needs to be adjusted. Therefore, it is important to create a provision for `5 crore in the financial statements to 31st December 2009.

EXAMPLE ABC Ltd. is a manufacturing firm. On 31st March 2009, the biggest Machinery got damaged and was sent for repairs. It has a book-value of `2 crore in the financial statements. On April 16th 2009, the company is informed that the Machinery is irreparable, and the scrap value is only `40 lakhs. In this case since the financial statements have not been approved, it is important to acknowledge this information in the books. Reduce the book- value of the press to `40 lakh in the financial statements to 31st December 2XX4.

EXAMPLE ABC Ltd. has a client that owes `8 lakhs on 31st December 2009. On January 9,2010 the client goes into liquidation. The company is informed that it will receive nothing from the liquidation. Since, the financial statements have not been approved, reduce the book- value of financial statements receivable by `8 lakh in the financial statements as on 31st December 2009.

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Non-Adjusting Events Non-adjusting events require notes to the financial statements. The financial figures remain unaltered. An example of a non-adjusting event after the balance sheet date is a decline in market value of investments, between the balance sheet and approval date. The decline in market value does not normally relate to the value of the investments at the balance sheet date, but reflects circumstances that have arisen since that time.

EXAMPLE A firm has invested heavily in Far-Eastern stocks, that have performed well in the period to 31st December 2008. On January 14th 2009, a series of earthquakes hit the region, causing major industrial devastation. Stock markets plummet, and remain very depressed until the date of approval of the company's financial statements. The company does not change the figures in the financial statements to 31st December 2008, but note the post-balance-sheet decline of investments and amounts involved.

Dividends If an undertaking declares dividends to shareholders after the balance sheet date, the undertaking shall not record those dividends as a liability at the balance sheet date. If dividends are declared after the balance sheet date, but before the financial statements are approved for issue, the dividends are disclosed in the notes to the financial statements.

EXAMPLE A firm has prepared its financial statements for the period to 31st December 2009. On January 24th 2009, the directors declare dividends totaling `70 lakhs. The firm does not change the figures in its financial statements to 31st December 2008, but quantify the post-balance-sheet dividends, in the note on retained earnings.

Going-concern An undertaking shall not prepare its financial statements on a going-concern basis, if management determines after the balance sheet date either that it intends to liquidate the undertaking, or to cease trading, or that it has no realistic alternative but to do so.

EXAMPLE Your firm is preparing its financial statements for the period to 31st December 2008. On January 4th 2009, your directors decide to sell the firm's assets and liquidate the firm. The financial statements to 31st December 2008 should be produce on a liquidation basis, not a going-concern basis.

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IAS 1 specifies required disclosures if: (i) the financial statements are not prepared on a going-concern basis; or (ii) m a n a g e m e n t i s a w a r e o f m a t e r i a l uncertainties related to events, or conditions, that may cast significant doubt upon the undertaking's ability to continue as a goingconcern. The events, or conditions, requiring disclosure may arise after the balance sheet date.

Deterioration in operating results and financial position, after the balance sheet date, may indicate a need to consider whether the going concern assumption is still appropriate. If the going-concern assumption is no longer appropriate, IAS 10 requires a fundamental change in the basis of accounting, rather than an adjustment to the amounts recorded within the original basis of accounting.

EXAMPLE A firm has a client that owes `5 million on 31st December 2008. On January 13th 2009, the client goes into liquidation. The firm is informed that it will receive nothing from the liquidation. The firm may be able to raise funds to recover from this disaster, but is unable to secure any commitment by the date that the financial statements are to be approved. The financial statements to 31st December 2008 should be produce on a liquidation basis, not a going-concern basis, due to the uncertainty.

Non-adjusting Events after the Balance Sheet Date If non-adjusting events after the balance sheet date are material, non-disclosure could influence the economic decisions of users taken on the basis of the financial statements. An undertaking shall disclose the following for each material category of non-adjusting event after the balance sheet date: (i) the nature of the event; and (ii) an estimate of its financial effect, or a statement that such an estimate cannot be made. The following are examples of non-adjusting events after the balance sheet date that would generally result in disclosure: (i) a major business combination after the balance sheet date, or disposing of a major subsidiary; (ii) announcing a plan to discontinue an operation, disposing of assets, or settling liabilities attributable to a discontinuing operation, or entering into binding agreements to sell such assets, or settle such liabilities; (iii) major purchases and disposals of assets, or expropriation of major assets by government;

EXAMPLE 'On January 5th 2009, the government announced that a new road would be built. This road will result in the destruction of the firm's head office. Negotiations have started with the government for compensation. The carrying value of the head office building, and the land on which it stands was `6.3 million, as at 31st December 2008.' A PRACTICAL APPROACH TO IFRS

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(iv) the destruction of a major production plant by a fire after the balance sheet date; (v) announcing, or commencing the implementation of, a major restructuring;

EXAMPLE ' On January 9th 2009, the board of directors announced that the group would cease operating in shops smaller than 5,000 square meters. Existing shops that are smaller than 5,000 square meters will be phased out over the next 18 months. In the year to 31st December 2008, such shops provided revenues of `129 million, and a net loss of `2 million. Such shops comprised fixed assets of `18 million as at 31st December 2008, including property subject to finance leases of `4 million. 2,368 people were employed in such shops, as at 31st December 2008. Many of the jobs will be relocated to other group premises, but a provision of `3 million will been made for redundancy costs.' (vi) major ordinary share transactions, or disposing of a major subsidiary; (vii) announcing a plan to discontinue an operation, disposing of assets, or settling liabilities attributable to a discontinuing operation, or entering into binding agreements to sell such assets, or settle such liabilities; (viii) major purchases and disposals of assets, or expropriation of major assets by government;

EXAMPLE 'On January 5th 2009, the government announced that a new road would be built. This road will result in the destruction of the firm's head office. Negotiations have started with the government for compensation. The carrying value of the head office building, and the land on which it stands was `6.3 million, as at 31st December 2008.' (ix) (x)

the destruction of a major production plant by a fire after the balance sheet date; announcing, or commencing the implementation of, a major restructuring;

STUDENT CORNER As we know from IAS 1, companies are required to prepare a balance sheet as at an agreed date. The end of the reporting period is the point at which the financial position of the company is determined and reported. Of course, we cannot actually prepare the Balance Sheet on the reporting period date as we do not have all the information available. The companies have six months to gather all the information and file their accounts. This means that there is a time lag between the reporting period and the date on which the financial statements are finally prepared (Date of Authorisation). During this time lag, we may come to know many events which might have occurred after the reporting period or events which might have occurred during the reporting period but we came to know only later on. AND, WE HAVE TO MAKE DECISIONS REGARDING THIS STUFF.

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Therefore, we need IAS 10 which explains the duties of companies and directors in looking for and adjusting for events after the reporting period.

Two types of Events

Adjusting Events

Non-Adjusting Events

Those events that provide evidence of conditions that actually existed at the end of the reporting period, albeit they were not known at that time

Those post-balance sheet events that are indicative of conditions that arose after the end of the reporting period.

ADJUST THE ACCOUNTS

DISCLOSE IN THE NOTES

AND the really important stuff………….accounting practice The financial statements should be changed to include events after the reporting period if they are adjusting events. The financial statements should disclose the events in the notes if they are material non-adjusting events after the reporting period. Dividends declared after the reporting period (and therefore not an obligation at the reporting period) are treated as non-adjusting events. The going concern basis should not be followed if management determines that, after the reporting period, the company intends to liquidate, or has no realistic alternative but to do so.

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WORKSHEET 1. IAS 10 identifies the period covered by these events as starting immediately after the balance sheet date, and ending at the date of: (a) Issue of the financial statements. (b) Approval of the financial statements. (c ) Publication of the financial statements. 2. (a) On 29 January 2009, management of an undertaking completes draft financial statements for the year to 31 December 2008. (b) On 4 February 2009, the board of directors reviews the financial statements and approves them for issue. (c) On 15 February 2009, the undertaking announces its profit and selected other financial information on 19 March 2008. (d) On 18 March 2009, The financial statements are made available to shareholders, and others. (e) On 25 April 2009, the shareholders approve the financial statements at the annual meeting. (f) On 29 April 2009, the approved financial statements are then filed with a regulatory body . Which of the above dates marks the end of the period covered by IAS 10? 3. The statutory audit of Star Ltd. for year ended June 30, 2009 was completed on August 30, 2009. The financial statements were signed by the managing director on September 8, 2008, and approved by the shareholders on October 10, 2009. The next events have occurred. (a) On July 15, 2009, a customer owing `900,000 to Star Ltd. filed for bankruptcy. The financial statements include an allowance for doubtful debts pertaining to this customer only of `50,000. (b) Star Ltd.'s issued capital comprised 100,000 equity shares. The company announced a bonus issue of 25,000 shares on August 1, 2009. (c) Specialized equipment costing `545,000 purchased on March 1, 2009, was destroyed by fire on June 13, 2009. On June 30, 2009, Star Ltd. has booked a receivable of `400,000 from the insurance company pertaining to this claim. After the insurance company completed its investigation, it was discovered that the fire took place due to negligence of the machine operator. As a result, the insurer's liability was zero on this claim by Star Ltd. How should Star Ltd. account for these three post–balance sheet events? 4. If there is a public announcement of profit, or other information. (a) The period ends for IAS 10 purposes. (b) The period ends only when the supervisory board approves the IFRS financial statements. (c) The period ends only when the management approves the IFRS financial statements. 5. There is a settlement, after the balance sheet date, of a court case that confirms that the undertaking had a present obligation, at the balance sheet date. You need to: A PRACTICAL APPROACH TO IFRS

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(a) Adjust the financial statements. (b ) Leave the financial statements, but note the details. (c) Ignore it. 6. There is receipt of information, after the balance sheet date indicating that an asset was impaired at the balance sheet date. You need to: (a) Adjust the financial statements. (b) Leave the financial statements, but note the details. (c) Ignore it. 7. International Inc. deals extensively with foreign entities, and its financial statements reflect these foreign currency transactions. Subsequent to the balance sheet date, and before the 'date of authorization' of the issuance of the financial statements, there were abnormal fluctuations in foreign currency rates. International Inc. should (a) Adjust the foreign exchange year-end balances to reflect the abnormal adverse fluctuations in foreign exchange rates. (b) Adjust the foreign exchange year-end balances to reflect all the abnormal fluctuations in foreign exchange rates (and not just adverse movements). (c) Disclose the post–balance sheet event in footnotes as a non adjusting event. (d) Ignore the post–balance sheet event. 8. There is receipt of information, after the balance sheet date indicating that the amount of a previously-recorded impairment loss for that asset needs to be adjusted. You need to: (a) Adjust the financial statements. (b) Leave the financial statements, but note the details. (c) Ignore it. 9. You learn of the bankruptcy of a customer, that occurs after the balance sheet date. You need to: (a) Adjust the financial statements. (b) Leave the financial statements, but note the details. (c) Ignore it. 10. You learn of the determination after the balance sheet date of the cost of assets purchased. You need to: (a) Adjust the financial statements. (b) Leave the financial statements, but note the details. (c) Ignore it. 11. You learn of a change to the proceeds from assets sold, before the balance sheet date. You need to: (a) Adjust the financial statements. (b) Leave the financial statements, but note the details. (c) Ignore it.

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12. Sun Ltd built a new factory building during 2008 at a cost of `20 million. At December 31, 2008, the net book value of the building was `19 million. Subsequent to year-end, on March 15, 2009, the building was destroyed by fire and the claim against the insurance company proved futile because the cause of the fire was negligence on the part of the caretaker of the building. If the date of authorization of the financial statements for the year ended December 31, 2008, was March 31, 2009, Sun Ltd. should (a) Write off the net book value to its scrap value because the insurance claim would not fetch any compensation. (b) Make a provision for one-half of the net book value of the building. (c) Make a provision for three-fourths of the net book value of the building based on prudence. (d) Disclose this non adjusting event in the footnotes. 13. You receive the calculation of the amount of profit-sharing payments, relating to the period of the financial statements, after the balance sheet date. You need to: (a) Adjust the financial statements. (b) Leave the financial statements, but note the details. (c) Ignore it. 14. You are informed of a fraud, that shows that financial statements, that you are about to approve to be incorrect. You need to: (a) Adjust the financial statements. (b) Leave the financial statements, but note the details. (c) Ignore it. 15. At the balance sheet date, December 31, 2008, XYZ Inc. carried a receivable from PQR, a major customer, at `10 million. The 'authorization date' of the financial statements is on February 16, 2009. PQR declared bankruptcy on Valentine's Day (February 14, 2009). ABC Inc. will (a) Disclose the fact that PQR has declared bankruptcy in the footnotes. (b) Make a provision for this post–balance sheet event in its financial statements (as opposed to disclosure in footnotes). (c) Ignore the event and wait for the outcome of the bankruptcy because the event took place after the year-end. (d) Reverse the sale pertaining to this receivable in the comparatives for the prior period and treat this as an 'error' under IAS 8. 16. You learn of a decline in market value of investments, between the balance sheet date, and the date when the financial statements are approved for issue. You need to: (a) Adjust the financial statements. (b) Leave the financial statements, but note the details. (c) Ignore it. 17. You make a major acquisition, between the balance sheet date, and the date when the financial statements are approved for issue. You need to: A PRACTICAL APPROACH TO IFRS

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(a) Adjust the financial statements. (b) Leave the financial statements, but note the details. (c) Ignore it. 18. ABC Ltd. decided to operate a new amusement park that will cost `1 million to build in the year 2008. Its financial year-end is December 31, 2008. ABC Ltd. has applied for a letter of guarantee for `7,00,000. The letter of guarantee was issued on March 31, 2009. The audited financial statements have been authorized to be issued on April 18, 2009. The adjustment required to be made to the financial statement for the year ended December 31, 2008, should be (a) Booking a `7,00,000 long-term payable. (b) Disclosing `7,00,000 as a contingent liability in 2008 financial statement. (c) Increasing the contingency reserve by `7,00,000. (d) Do nothing. 19. You announce plans to reorganise your group, between the balance sheet date, and the date when the financial statements are approved for issue. The plans include the disposal of a major division. You need to: (a) Adjust the financial statements. (b) Leave the financial statements, but note the details. (c) Ignore it. 20. A new drug named 'EEE' was introduced by Cosmos Inc. in the market on December 1, 2008. Cosmos Inc.'s financial year ends on December 31, 2008. It was the only company that was permitted to manufacture this patented drug. The drug is used by patients suffering from an irregular heartbeat. On March 31, 2009, after the drug was introduced, more than 1,000 patients died. After a series of investigations, authorities discovered that when this drug was simultaneously used with another drug to regulate hypertension, the patient's blood would clot and the patient suffered a stroke. A lawsuit for `100,000,000 has been filed against Cosmos Inc. The financial statements were authorized for issuance on April 30, 2009. Which of the following options is the appropriate accounting treatment for this post– balance sheet event under IAS 10? (a) The entity should provide `100,000,000 because this is an 'adjusting event' and the financial statements were authorized to be issued after the accident. (b) The entity should disclose `100,000,000 as a contingent liability because it is an 'adjusting event.' (c) The entity should disclose `100,000,000 as a 'contingent liability' because it is a present obligation with an improbable outflow. (d) Assuming the probability of the lawsuit being decided against Genius Inc. is remote, the entity should disclose it in the footnotes, because it is a non adjusting material event. 21. Your company declares a dividend, between the balance sheet date, and the date when the financial statements are approved for issue. You need to: (a) Adjust the financial statements.

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(b) Leave the financial statements, but note the details. (c) Ignore it. 22. Your board decide to sell the assets of the firm and liquidate it, between the balance sheet date, and the date when the financial statements are approved for issue. You need to: (a) Adjust the financial statements. (b) Leave the financial statements, but note the details. (c) Ignore it. 23. A client goes into liquidation, between the balance sheet date, and the date when the financial statements are approved for issue. The client owes you a large amount of money, and your firm will not survive the loss. You need to: (a) Adjust the financial statements. (b) Leave the financial statements, but note the details. (c) Ignore it. 24. A client goes into liquidation, between the balance sheet date, and the date when the financial statements are approved for issue. The client owes you a large amount of money. You do are unable to secure finance to ensure the firm's survival before the financial statements are to be approved. You need to: (a) Adjust the financial statements. (b) Leave the financial statements, but note the details. (c) Ignore it. 25. Your firm has been sued for anticompetitive behaviour. This has been denied by your firm, and there was only a contingent liability for `10 million your financial statements at 31st December 2008. On January 1st 2009, the court awards `10 million damages against your firm. You need to: (a) Adjust the financial statements. (b) Leave the financial statements, but note the details. (c) Ignore it. 26. 5% of your assets are held in Euros. Your currency loses 1% of its value against the Euro, before the financial statements are approved. You need to: (a) Adjust the financial statements. (b) Leave the financial statements, but note the details. (c) Ignore it. 27. During the year 2008, Taj Corp. was sued by a competitor for `15 million for infringement of a trademark. Based on the advice of the company's legal counsel, Taj Corp. accrued the sum of `10 million as a provision in its financial statements for the year ended December 31, 2008. Subsequent to the balance sheet date, on February 15, 2009, the Supreme Court decided in favor of the party alleging infringement of the trademark and ordered the defendant to pay the aggrieved

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party a sum of `14 million. The financial statements were prepared by the company's management on January 31, 2009 and approved by the board on February 22, 2009. Should Taj Corp. adjust its financial statements for the year ended December 31, 2008? 28. The preparation of the financial statements of Wellness Corp. for the accounting period ended December 31, 2008, was completed by the management on March 15, 2009. The draft financial statements were considered at the meeting of the board of directors held on March 20, 2009, on which date the board approved them and authorized them for issuance. The annual general meeting (AGM) was held on April 10, 2009, after allowing for printing and the requisite notice period mandated by the corporate statute. At the AGM the shareholders approved the financial statements. The approved financial statements were filed by the corporation with the Company Law Board (the statutory body of the country that regulates corporations) on April 20, 2009. Required Given these facts, what is the 'authorization date' in terms of IAS 10?

ANSWER 1. 3.

2. (b) (b) Solution (a) ABC Inc. should increase its allowance for doubtful debts to `900,000 because the customer's bankruptcy is indicative of a financial condition that existed at the balance sheet date. This is an 'adjusting event.' (b) IAS 33, Earnings Per Share, requires a disclosure of transactions as 'stock splits' or 'rights issue', which are of significant importance at the balance sheet. This is a non adjusting event, and only disclosure is needed. (c) This is an adjusting event because it relates to an asset that was recognized at the balance sheet date. However, as the insurance company's liability is zero, ABC Inc. must adjust its receivable on the claim to zero. 4. (c) 5. (a) 6. (a) 7. (c) 8. (a) 9. (a) 10. (a) 11. (a) 12. (d) 13. (a) 14. (a) 15. (b) 16. (b) 17. (b) 18. (d) 19. (b) 20. (c) 21. (b) 22. (a) 23. (a) 24. (a) 25. (a) 26. (c) 27. Solution Taj Corp. should adjust the provision upward by `4 million to reflect the award decreed by the Supreme Court (assumed to be the final appellate authority on the matter in this example) to be paid by Taj Corp. to its competitor. Had the judgment of the Supreme Court been delivered on February 25, 2008, or later, this post–balance sheet event would have occurred after the cutoff point (i.e., the date the financial statements were

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authorized for original issuance). If so, adjustment of financial statements would not have been required. 28. Solution The date of authorization of the financial statements of Wellness Corp. for the year ended December 31, 2008, is March 20, 2009, the date when the board approved them and authorized them for issue (and not the date they were approved in the AGM by the shareholders). Thus, all post–balance sheet events between December 31, 2008, and March 20, 2009, need to be considered by Wellness Corp. for the purposes of evaluating whether they are to be accounted or reported under IAS 10.

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CHAPTER 10 CONSTRUCTION CONTRACTS ( IAS 11) 'Each of us is carving a stone, erecting a column, or cutting a piece of stained glass in the construction of something much bigger than ourselves.'

CHAPTER 10 CONSTRUCTION CONTRACTS OBJECTIVE The objective of this Standard is to prescribe the accounting treatment of revenue and costs associated with construction contracts. Because of the nature of the activity undertaken in construction contracts, the date at which the contract activity is entered into and the date when the activity is completed usually fall into different accounting periods. Therefore, the primary issue in accounting for construction contracts is the allocation of contract revenue and contract costs to the accounting periods in which construction work is performed.

Construction contracts include: (a) Services related to the construction, such as project managers and architects. (b) Contracts for destruction, or restoration, of assets and the restoration of the environment.

KEY DEFINITIONS Construction contract: A contract specifically negotiated for the construction of an asset or combination of assets that are closely interrelated or interdependent in terms of their design, technology, function, or ultimate use or purpose. Fixed price contract: A construction contract in which the contractor agrees to a fixed price. Cost-plus contract: A construction contract in which the contractor is reimbursed for allowable or defined costs plus a percentage of such costs or a fixed fee. Variation: An instruction by the customer for the change in the scope of the work to be performed in the contract. Claim: An amount that the contract seeks to collect from a customer or another party as reimbursement for costs not included in the contract price.

EXAMPLE There is a contract to demolish some houses, and build new ones. The contractor is promised vacant possession. When the work is to begin it is found that the tenants still occupy the old houses. It takes a month to rehouse them, delaying the start of work. The contractor may demand for a claim for the delay in the work. Incentive payment:. Additional amounts paid to the contractor if specified performance standards are met or exceeded.

Combining and Segmenting Construction Contracts When a contract covers more than a single asset, the construction of each asset should be treated as a separate contract when: A PRACTICAL APPROACH TO IFRS

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1. Separate proposals have been submitted for each asset; 2. Each asset has been a separate negotiation and each party could reject the part of the contract applying to that asset; and 3. Costs and revenues of each asset can be measured.

EXAMPLE XYX company receives a contract to build 600 houses for a developer over a 2-year period, in different locations throughout the region. The cost for each group of houses is negotiated separately, and it receives a 10% profit, based on the agreed cost. Each group should be treated as a separate contract. A group of contracts, with one client or more, should be treated as a single contract when: 1. The contracts were signed as a single package; 2. The contracts are so closely related that they are, in substance, part of a single project with an overall profit margin: and 3. The contracts are performed concurrently, or in a continuous sequence.

EXAMPLE PQR contracts to build 12 standard hotels. Land preparation is done by the client, so building costs are similar for each hotel. This should be treated as a single contract.

Contract Revenue Contract revenue shall comprise: (a) the initial amount of revenue agreed in the contract; and (b) variations in contract work, claims and incentive payments: (i) to the extent that it is probable that they will result in revenue; and (ii) they are capable of being reliably measured Contract revenue is measured at the fair value of the consideration received or receivable.

Variations may increase, decrease, or redesign the scope of the contract, with a matching change in revenue. They are only included in revenue when it is likely that the client will approve the variation and its impact on the revenue, and the change in revenue can be reliably measured.

The contract revenue may change from one period to the next, as a result of contract variations, claims, penalties, and cost-escalation clauses.

EXAMPLE In a contract for building a road the original plan called for a bridge over a railway, but the authorities now insist on a tunnel under the railway instead. This is a variation.

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Contract Costs Contract costs shall comprise: (a) costs that relate directly to the specific contract; (b) costs that are attributable to contract activity in general and can be allocated to the contract; and (c) such other costs as are specifically chargeable to the customer under the terms of the contract. Common examples of costs that are considered related directly to specific contracts are:

Costs that may be attributable to contract activity in general and can be allocated to specific c o n t ra c t s a re i n s u ra n c e , construction overhead, and borrowing costs etc. General contract activity costs must be allocated on a systematic and rational basis assuming a 'normal' level of construction activity.

Site labor costs, including site supervisions

l

Materials used in construction

l

Depreciation of machinery, plant, and equipment used in construction

l

Cost of hiring plant (if not owned by the contractor)

l

Cost of moving plant to and from contract site

l

Design and technical assistance costs directly related to the contract

l

Cost of rectification and guarantee work, including warranty costs

l

Claims from third parties

l

Costs that cannot be attributed to contract activity or cannot be allocated to a contract are excluded from costs of construction contract. Examples of such costs are: Selling and marketing costs

l

General and administrative costs for which the reimbursement is not specified in the contract

l

Research and development costs for which reimbursement is not specified in the contract

l

Depreciation on idle plant and equipment whose use cannot be attributable to any construction contract.

l

Recognition of Contract Revenue and Expenses Contract revenue and costs should be recognised by reference to the stage of completion ('percentage of completion') of the contract at the balance sheet date. Any expected loss on the contract should be recognised immediately.

EXAMPLE A contractor is notified by a subcontractor that his costs for next year will increase by 15%. The contractor cannot bill his client for this increase. This will cause him a loss on the contract as he can find no alternative supplier. Recognise the anticipated loss immediately. With respect to a fixed price contract, the outcome can be estimated reliably when A PRACTICAL APPROACH TO IFRS

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Total contract revenue can be measured reliably;

l

It is probable that the economic benefit of the contract will flow to the entity;

l

Both the costs to complete the contract and the stage of completion can be reliably estimated: and

l

The costs attributable to the contract can be clearly identified and measured.

l

With respect to a cost-plus contract, the outcome can be reliably estimated when It is probable that the economic benefit of the contract will flow to the entity; and

l

The costs attributable to the contract, whether specifically reimbursable or not, can be clearly identified and measured.

l

Stage of Completion Calculation The stage of completion of a contract in a particular year can be calculated on the basis of the following: 1. Cost method: This method deals with the proportion of the costs incurred for the work to date to the estimated total costs.

EXAMPLE A contractor is building a complex, for which the cost will be `12million. So far the contractor has spent `4million. The estimated future expenditure is `6million.

% of completion =

2

Expenditure till date 4 million * 100 = * Estimated total costs (4million + 6million)

100 = 40%

Work Certified Method: This method deals with proportion of work completed that is certified to the total contract price.

EXAMPLE A contractor is building a factory, for which the cost will be `12 million. So far the expenditure incurred and certified is for `4million. % of completion =

3

Work certified till date Contract Price

=

4million * 100 = 33.33% 12 million

Surveys of the work done.

EXAMPLE A contractor is building an airport. The client's surveyors have confirmed that 37% of the work is complete, and recommended payment for the work.

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4. Completion of a physical portion of the work.

EXAMPLE A contractor is building 300 houses. 75 are complete, and no work has been done on the other 225. In this case only 25% of the contract should be considered as complete, unless there is any evidence to the contrary. Costs incurred relating to future work on the contract, including advance payments to subcontractors, should not be included in the calculation. Note: Progress payments and advances received from clients often do not reflect the work done.

Practical Insight In order to take advantage of bulk or volume discounts on purchase of construction materials, such as steel or cement, contractors sometimes buy significant quantities of those items and stock them at a site where a big construction contract is in progress. The costs of such materials are future costs because these are not meant for immediate consumption at the site where they are stored. Such costs are recognized as an asset, provided it is probable that they will be recovered. Such costs represent amounts incurred on behalf of the customer and are thus amounts due from a customer. These costs are often classified as 'contract work in progress.'At year-end they may need to be estimated in order to report them on the balance sheet as 'contract work in progress.' When the outcome of a Contract cannot be estimated: q No profit is recognised, though an expected loss should be recognised immediately. q Revenue

should only be recognised to the extent that it is likely to be chargeable to the client.

q Costs should be recognised in the period in which they are incurred.

Common causes of such uncertainty over the outcome include: 1. Financial difficulties of contractor, or client.

EXAMPLE A client has not paid the contractor for the work on the agreed date. Arguments ensue, but the contractor thinks that theclient has serious financial problems, and the contract is at risk. 2. Pending litigation or legislation.

EXAMPLE A contractor is rebuilding a chemical plant. The government finds toxic effluent has been leaking from the site, and applies to the court for an order to stop work.

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3. Lack of clarity in the contract on reimbursement of costs.

EXAMPLE A contractor is building a hotel. Government officials demand additional safety features, which are not covered by the contract. He submits a variation proposal to the client, who refuses it, claiming the cost is yours.

4. Anticipated failure to complete the contract.

EXAMPLE A contractor is building a road 200kms long. Part of the route becomes flooded, and it cannot be determined whether or not the road will be completed within the contract period.

Recognition of Expected Losses and Changes in Estimates Any anticipated excess of total contract costs over total contract revenue should be recognised immediately regardless of: 1.

Whether or not work has started on the contract.

EXAMPLE You are going to build a hotel on a cliff. You hire staff, machinery and materials. You travel to the cliff, and find that it has fallen into the sea. The client offers another site, but for the same contract price. This would reduce your loss, but not eliminate it. Recognise the loss immediately.

2.

The stage of completion.

3.

The amount of profits on other contracts.

EXAMPLE You have 5 separate construction contracts with the same client. Your project in France is hit by strikes, which means additional costs, and penalties for late completion. This will create a loss for the project, though the 4 other projects will make enough profits to cover the loss. You must still recognise the loss on the French project immediately.

The percentage of completion method is calculated on a cumulative basis in each period. It is based on current estimates. A change in estimates of final revenue or costs, are recognised in the period that the change is made. A PRACTICAL APPROACH TO IFRS

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Disclosure An enterprise should disclose: 1. the amount of contract revenue recognised as revenue in the period; 2. the methods used to determine the contract revenue recognised in the period; and 3. the methods used to determine the stage of completion of contracts in progress. An enterprise should disclose each of the following for contracts in progress at the balance sheet date: 1. the aggregate amount of costs incurred and recognised (less recognised losses to date) 2. the amount of advances received; and 3. the amount of retentions Retentions are amounts of progress billings, which are not paid until the satisfaction of conditions specified in the contract for the payment of such amounts or until defects have been rectified. Progress billings are amounts billed for work performed on a contract whether or not they have been paid by the customer. Advances are amounts received by the contractor before the related work is performed. An enterprise should disclose: a.

the gross amount due from customers for contract work as an asset; and

b. the gross amount due to customers for contract work as a liability. The gross amount due from customers for contract work is the net amount of: a.

costs incurred plus recognised profits; less

b. the sum of recognised losses and progress billings for all contracts in progress for which costs incurred plus recognised profits (less recognised losses. exceeds progress billings. The gross amount due to customers for contract work is the net amount of: a.

costs incurred plus recognised profits; less

b. the sum of recognised losses and progress billings for all contracts in progress for which progress billings exceed costs incurred plus recognised profits (less recognised losses). An enterprise discloses any contingent liabilities and contingent assets in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets. Contingent liabilities and contingent assets may arise from such items as warranty costs, claims, penalties or possible losses.

STUDENT CORNER Since, big projects take around 2-3 years to get completed and its imperative for the contractor to know the year end results. Therefore, according to IAS 11 this can be worked out on the basis of calculating % of work completed till the year end and comparing it with the amount received from the client at the year end.

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% of work completed can be calculated on the basis of : (a)

Work Certified Method.

(b)

Cost Incurred Method.

The income statement will include : Turnover

% completion * Contract price

Profit

% completion * Expected profit ( or 100% of loss)

Cost of sales

Balancing figure

Now what is the difference between Work certified and Cost incurred approach......a little confusing!!! Don't Worry…. This is simple to understand and remember……..one has a positive outlook and other negative. Create a project that you have quoted a price to build. Imagine it 3/4th built. Now think of the money you are due to get at the year end!!!! You already have a smile on your face. The work certified method conjures a positive image in your mind – a building nearing completion and loads of money to be earned. On the other hand, Cost incurred method creates a negative picture in your mind – cash going out of your bank for undertaking the project and even more cash to be paid out resulting in sad face.

And the really important stuff……accounting practice K Revenue and costs on contracts should be recognized over the period of the contract.

Profit should also be recognized over the period of the contract as long as it can be assessed with reasonable certainty. K Losses on contracts must be recognized in full as soon as they are foreseen. If we are

expecting a loss then instead of bringing in a percentage , we should bring in the full loss (Remember the Framework document and the need to present 'reliable' information). Losses are therefore easier to account for.

A common mistake that students generally commit is to account for only a proportion of foreseen losses when they should be recognized in full as soon as they come to our knowledge.

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WORKSHEET 1. The start and finish of Construction Contracts normally fall in to: (a) the same accounting period. (b) different accounting periods. 2. A key issue of the standard is: (a) The timing of recognition of contract revenue and contract costs. (b) Selection of reporting currency. (c) Balance sheet structure. 3. An effective internal financial budgeting and reporting system to control construction contracts is: (a) Helpful. (b) Unnecessary. (c) Required. 4. Cost-escalation clauses may be a feature of fixed-price contracts: (a) True. (b) False. 5. In a cost-plus contract, you can charge: (a) All costs plus a profit margin. (b) Costs agreed under the contract, plus an agreed profit. 6. You can combine and segment construction contracts: (a) To reduce work. (b) To reflect economic reality, under specified conditions. 7. A contract may provide for an additional asset at the client's option, or by way of an amendment. Can this be treated as an additional contract? (a) No. (b) Maybe. 8. Contract revenue should comprise: (a) All cash flows. (b) Initial revenue agreed, plus variations, claims and incentive payments. 9. Variations can only increase revenue. (a) True. (b) False. 10. Claims relate to costs included in the contract price. (a) True. (b) False. 11. Incentive payments can be included in the revenue at the start of the contract. (a) True. (b) False. 12. Contract estimates may be revised. (a) True. (b) False.

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13. Contract costs only include costs that relate specifically to the contract. (a) True. (b) False. 14. Incidental income, such as from the sale of scrap materials, should be shown as: (A) Revenue. (b) A deduction from costs. 15. Development costs can be charged to contract costs. (a) True. (a) False. 16. Borrowing costs can be charged to contract costs. (a) True. (b) False. 17. Costs incurred in securing contracts may be included in contract costs. (a) True. (b) False. 18. Any expected loss on the contract should be: (a) Ignored. (b) Recognised at the end of the contract. (c) Spread over the life of the contract. (d) Recognised immediately. 19. Contract costs that relate to future work on the contract: (a) Can be ignored. (b) Should be expensed immediately. (c) May be treated as an asset. 20. Advances paid to subcontractors: (a) Can be ignored. (b) Should be expensed immediately. (c) May be treated as an asset. 21. If revenue, that has already been recognised, may not be paid, the uncollectible amount: (a) Is deducted from revenue. (b) Is recognised as an expense. 22. Stage of completion calculation: the main reference is: (a) The client. (b) Internal records. (c) The contract. 23. When the outcome of a contract cannot be estimated: (a) Revenue should not be recognised. (b) Some revenue may be recognised. (c) All revenue can be recognised. 24. Changes in estimates are: (a) Recognised in the period that the change is made.

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(b) Recognised at the end of the contract. (c) Ignored. 25. Creations Construct Inc. is executing a project of constructing the tallest building in the country. The project is expected to take three years to complete. The company has signed a fixed price contract of `12,000,000 for the construction of this prestigious tower. The details of the costs incurred to date in the first year are: Site labor costs `1,000,000 Cost of construction material `3,000,000 Depreciation of special plant and equipment used in contracting to build the tallest building `500,000 Marketing and selling costs to get the tallest building in the country the right exposure `1,000,000 Total contract cost estimated to complete `5,500,000 Calculate the percentage of completion and the amounts of revenue, costs, and profits to be recognized under IAS 11. 26. Global Builders Inc. is well known for its expertise in building flyovers and maintaining these structures. Impressed with Global's track record, the local municipal authorities have invited them to submit a tender for a two-year contract to build a super flyover in the heart of the city (the largest in the region) and another tender for maintenance of the flyover for 10 years after completion of the construction. Evaluate whether these two contracts should be segmented or combined into one contract for the purposes of IAS 11. 27. XYZ, Inc. is negotiating with the local government to build a new bridge after demolishing the existing bridge in downtown near the city center. At the initial meeting, it was indicated that the government would not be willing to pay for both components of the contract an amount exceeding `100,000. The government representatives insisted that separate proposals would need to be submitted and negotiated and that the contractor should maintain separate records for each component of the contract and upon re quest furnish details of the contract costs incurred to date by component. After submission of the separate proposals, it was agreed that the split of the contract price of `100,000 would be in the ratio of 70% for construction of the new bridge and 30% for demolishing the existing bridge. Evaluate in light of the provisions of IAS 11 whether the contract for the construction of the new bridge and the contract for demolishing the existing bridge should be segmented and treated as separate contracts or be combined and treated as a single contract.

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ANSWER 1. 5. 9. 13. 17. 21.

(b) (b) (b) (b) (a) (b)

25.

Solution

2. 6. 10. 14. 18. 22.

(a) (b) (b) (b) (d) (c)

3. 7. 11. 15. 19. 23.

(c) (b) (b) (a) (c) (b)

4. 8. 12. 16. 20. 24.

(a) (b) (a) (a) (c) (a)

(a)Contract cost incurred to date Site labor cost `1,000,000 Material cost `3,000,000 Depreciation of special plant and equipment `500,000 Total cost incurred `4,500,000 NOTE: IAS 11 does not allow 'marketing and selling costs' to be considered contract costs. (b) Cost to complete = `5,500,000 (c) Percentage of completion = 4,500,000 / (4,500,000 + 5,500,000) = 4,500,000 / 10,000,000 = 45% (d) Revenue, costs, and profits to be recognized in the first year: Revenue = 12,000,000 × 0.45 = `5,400,000 Costs = 10.000,000 × 0.45 = `4,500,000 Profit = `900,000 26. Solution The two contracts should be combined and treated as a single contract because The two contracts are very closely related to each other and, in fact, are part of a single contract with an overall profit margin. The contracts have been negotiated as a single package. The contracts are performed in a continuous sequence. 27. Solution The two contracts should be segmented and treated as separate contracts because Separate proposals were submitted for the two contracts. The two contracts were negotiated separately. Costs and revenues of each contract can be identified separately 25. A construction contractor has a fixed-price contract for `30,000 to build a tunnel. The contractor's initial estimate of contract costs is `22,500. It will take 3 years to build the tunnel. By the end of year 1, the contractor's estimate of contract costs has increased to `25,200. In year 3, the client approves a variation resulting in an increase in contract revenue of `1,500 and estimated additional contract costs of `750. At the end of year 2, costs incurred include `900 for materials to be used in year 3. The stage of completion is determined by calculating the proportion that costs incurred for work done so far bear to the estimated total costs. A summary of the financial data during the construction period is as follows:

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CHAPTER 11 PROPERTY, PLANT AND EQUIPMENT 'If you count all your assets, you always show a profit.'

CHAPTER 11 PROPERTY, PLANT AND EQUIPMENT Accounting for property, plant and equipment is a very important issue. We also should also remember that accrual concept is considered as a 'bedrock' for preparing financial statements. Clearly, purchase of property or equipment involves a large The principal issues associated with accounting for PP&E are : amount of cash. It would be wrong to show this as an K recognition of the assets expense immediately in the income statement of the year when they are acquired. of purchase. Since the equipment is going to be of use for a K determination of the long period of time; hitting the earnings only in the year of carrying amounts of these purchase will fail to give the correct picture. Earnings, assets in subsequent therefore would look terrible in the year of purchase and periods. determination of particularly good in the remaining years in which income K depreciation charges and is generated from the equipment with no expense being any impairment losses to be reflected. recognized in relation to And so the big amount of cash spent on PPE should not be these assets. immediately expensed but instead should be capitalized – put in the balance sheet initially – with depreciation being the accounting mechanism that, spreads the cost of a capitalized purchase over the useful economic life of an asset. The amount of cash appears in the cash flow statement, the asset on the balance sheet and the depreciation expense appears in the income statement. Simple, then what's the worry about? The problem is to identify what kinds of expenditure should be considered as a part of plant, property and equipment.

OBJECTIVE

K The

objective of IAS 16 is to prescribe the accounting treatment for property, plant and equipment (PP&E) so that users of the financial statements can discern information about the entity's investment in its PP&E and any changes in those investments.

K The general principle underlying IAS 16 is that, first, an entity accounts for all costs

of property, plant, and equipment at the time these costs are incurred and, second, it then allocates the costs over the useful life of the asset.

Scope K IAS

16 will be applied in accounting for property, plant and equipment, except when another Standard requires, or permits, a different accounting treatment.

Practical Insight

Leases Other Standards may require recognition based on a A PRACTICAL APPROACH TO IFRS

IAS 16 does not apply to: K biological assets related to agricultural activity (see IAS 41 Agriculture); nor K property, plant and equipment classified as held for sale in accordance with IFRS 5; K the recognition and measurement of O Pg. 299

different approach from that in IAS 16. For example, IAS 17 Leases requires you to evaluate recognition of a leased item on the basis of the transfer of risks and rewards. Other aspects of the accounting treatment for these assets, including depreciation, are prescribed by IAS 16.

exploration and evaluation assets (see IFRS 6; or K mineral rights and mineral reserves such as oil, natural gas and similar nonregenerative resources.

Investment Property An undertaking will apply IAS 16 to property that is being constructed, or developed, for future use as investment property. Once the construction or development is complete, the property becomes investment property, and you are required to apply IAS 40. IAS 40 also applies to property that is being redeveloped for continued future use as investment property. An undertaking, using the cost model for investment property under IAS 40, will use the cost model in IAS 16.

KEY DEFINITIONS Carrying amount It is the amount at which an asset is recorded in the balance sheet, after deducting any accumulated depreciation and accumulated impairment losses. Cost It is the amount of cash (or cash equivalents) paid and the fair value of any other consideration, given to acquire an asset at the time of its acquisition, or construction. Depreciable amount It is the cost of an asset, or valuation, less its residual value. Depreciation It is the spreading of the depreciable amount of an asset over its useful life. Fair value It is the amount for which an asset could be exchanged between knowledgeable, independent parties. Impairment loss It is the amount by which the carrying amount of an asset exceeds its recoverable amount. Carrying Amount – Recoverable Amount = Impairment Loss Property, plant and equipment ('PPE') are tangible items that: K are held for use in the production, or supply, of goods or services, for rental to others,

or for administrative purposes; and K are expected to be used during more than one reporting period.

Recoverable amount It is the higher of an asset's net selling price, and its value in use.

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Residual value It is the estimated amount that you would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age, and in the condition expected at the end of its useful life. Useful life K the period over which an asset is expected to be available for use by an undertaking; or K the number of production, or similar units expected to be obtained from the asset by an undertaking. Specific Value It is the present value of the cash flows that an entity expects to receive by the continued use of an asset and the sale and other disposition at the end of its useful life. Incase of liabilities, it's the present value of cash flows that are expected to incur to pay off the liabilities.

EXAMPLE The policy of ABC Ltd. is to keep company vehicles for 4 years. It has just bought a new vehicle for `40,000. Today's market price, less selling costs, of a similar vehicle that is 4 years old is `12,000, which is a reasonable estimate of the residual value of the new vehicle. In this case, the depreciable amount will be `40,000 - `12,000= `28,000, and the annual depreciation charge will be `28,000 / 4 years = `7,000. At the end of the 4 years, the company sold the vehicle for `8,000. Every year the company will Debit income statement and Credit accumulated depreciation by `7,000. The PPE will be shown at `20000 in the Balance Sheet. At the end of the life of vehicle (after 4 years), the total accumulated depreciation is `28,000 (7,000*4).The value of the vehicle on the date of sale is `12,000(`40,000 – `28,000). The vehicle is sold for `8,000 which means that the co. has incurred a loss of `40,00(`12,000 – ` 8,000).

Type of PPE and its Valuation Property type - different accounting treatment applied to properties under IFRS depending on their current and future uses and their ownership.

Standard Standard Name Number

Owner-occupied Property

IAS 16

Property, Plant and Cost or Equipment (see also IAS 20 Revaluation Government grants)

Property Under Construction (including investment property under construction)

IAS 16

Property, Plant and Equipment (See also IAS 12 Borrowing costs)

Cost.

Property acquired in an Exchange of Assets

IAS 16

Property, Plant and Equipment

Fair value or the carrying amount of the assets given up.

Investment Property

IAS 40

Investment Property

Cost or Fair Value

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Valuation

Investment property being redeveloped for continuing use as investment property

IAS 40

Investment Property

Cost or Fair Value

Investment property held for sale without development (unless it meets the criteria of IFRS 5 - see below).

IAS 40

Investment Property

Cost or Fair Value

Property held under an operating lease classified as an investment property

IAS 40

Investment Property

Fair Value (accounted for as a finance lease under IAS 17).

Property held under a finance lease

IAS 17

Lease Owner-occupied IAS 16, Investment

The lower of fair and the present value of the minimum lease payments.

Property held under an operating lease-owner-occupied

IAS 17

Leases

Leasing costs expensed.

Property held to another party under a finance lease

IAS 17

Leases

Account receivable equal to the net investment in the lease

Property sale and leaseback

IAS 17

Leases

As operating lease of finance lease, as appropriate

Trading properties property (including investment property) intended for sale in the normal course of business or being built or developed for that purpose

IAS 2

Investment (Properties Lower of cost and held for sale that meet net realisable the criteria of IFRS 5 should value be recorded according to IFRS 5 - see below. These are generally not in the normal course of business)

Property held for sale, or included in a disposal group that is held for sale

IAS 5

Non-current Assets held for sale and Discontinued Operations

Lower of carrying amount and Fair Value Less Cost to sell

Assets received in exchange for loans (taking possession of and collateral)

IFRS 5 & IFRS 16

Non-current assets held for sale and discontinued operations Property, Plant and Equipment Property acquired in an (see exchange of assets above)

Lower of fair value less costs to sell carrying amount of the loan net of impairment at the date of exchange.

Property provided as part of a construction contract

IAS 11

Construction Contracts

Stage of contract completion or cost.

Future costs of dismantling, removal and site restoration.

IAS 37

Provision, Contingent Liabilities and Contingent Assets

Present value of the expected costs, using a pre-tax discount rate.

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Recognition Items of property, plant, and equipment should be recognised as assets when it is probable that: K the

future economic benefits associated with the asset will flow to the entity, and

K the cost of the asset can be measured reliably.

The specific cases are as follows: (A) SPARE PARTS AND SERVICING EQUIPMENT

This recognition principle is applied to all property, plant, and equipment costs at the time they are incurred. These costs include costs incurred initially to acquire or construct an item of property, plant and equipment and costs incurred subsequently to add to, replace part of, or service it.

These are usually carried as inventory, and recorded in the income statement as consumed. However, major spare parts and stand-by equipment qualify as property, plant and equipment, if they will be used during more than one period. Also, if the parts and servicing equipment can be used only in connection with an item of property, plant and equipment, they are accounted for as property, plant and equipment. IAS 16 does not specify what constitutes an item of property, plant and equipment. It may be appropriate to aggregate individually-insignificant items, such as moulds, tools and dies as one asset. (B) SAFETY AND ENVIRONMENTAL COSTS Items may be acquired for safety, or environmental reasons. The benefit is the undertaking's continuance in business, as a result of their use. (c ) REPAIRS AND MAINTENANCE COSTS The costs of the day-to-day servicing ('repairs and maintenance') are recorded in the income statement as incurred. Parts of some items may require replacement at regular intervals. For example, a furnace may require relining after a specified number of hours of use, or aircraft interiors such as seats and galleys, may require replacement several times during the life of the airframe. Items may also be acquired to make a less-frequently recurring replacement, such as replacing the interior walls of a building, or to make a non-recurring replacement. The carrying amount of property, plant and equipment the cost of replacing part of such an item is recorded when that cost is incurred. New Carrying Cost = Old Carrying Cost + New Part Cost - Old Part Cost

EXAMPLE A building has a carrying amount of `1 crore. New interior walls cost will `20,000. The original walls have a carrying amount of `1,00,000. Add the cost of the new walls, and remove the carrying amount of the old walls: `1crore + `2,00,000 – `10,000 = `1,00,000 is the new carrying amount.

Following will be the journal entries in the above example: (1)

Building

a/c

Dr

2,00,000

To Bank a/c

2,00,000

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(2)

Depreciation a/c

Dr

1,00,000

To Building a/c

1,00,000

(Being the carrying cost of old walls w/o as depreciation) (d) Some equipment may need regular major inspections for faults, regardless of whether parts of the item are replaced. e.g. aircraft, bridges, dams. When each major inspection is performed, its cost is recorded in the carrying amount. Any remaining carrying amount of the cost of the previous inspection (as distinct from physical parts) is written off.

EXAMPLE Your aircraft has a carrying amount of `1crore. The latest inspection cost was `20lakh. The original inspection has a carrying amount of `10lakh. Add the cost of the new inspection, and remove the carrying amount of the old inspection: `1,00,00,000 + `20,00,000 - `10,00,000 = `1,10,00,000. This is the new amount of PPE as shown in the Balance Sheet after the inspection. The journal entries are: (a)

Aircraft a/c

Dr

20,00,000

To Bank a/c

20,00,000

(Being the cost of new inspection capitalized) (b)

Depreciation a/c

Dr

10,00,000

To Aircraft a/c

10,00,000

(Being the old inspection cost w/o as depreciation)

Measurement At Recognition Property, plant and equipment will be measured at cost. BUT, then what does cost include…………?

Elements of Cost The cost comprises: K Buying

price, including import duties and nonrefundable taxes, after deducting trade discounts and rebates;

K Any costs directly attributable to bringing the asset

to the location, and condition, necessary for it to be capable of operating in the manner intended by management. K The initial estimate of the costs of dismantling, and

removing the item, and restoring the site on which it is located.

A PRACTICAL APPROACH TO IFRS

Examples of directly attributable costs are: K staff costs arising directly from the construction, or acquisition, of the item of property, plant and equipment; K site preparation costs; K initial delivery and handling costs; K installation and assembly costs; and K costs of testing whether the asset is functioning properly, after deducting the net proceeds from any samples, or sundry income; and K professional fees. O Pg. 304

Activity 1 Problem ABC & Co., is installing a new plant at its production facility. It has incurred these costs: -

Cost of the plant `2,50,000.

-

Initial delivery and handling cost `20,000.

-

Cost of site preparation `60,000.

-

Consultants used to advice on the acquisition `70,000.

-

Interest charges paid to supplier for deferred credit `20,000.

-

Estimated dismantling cost to be incurred after 7 years `30,000.

-

Operating losses before commercial production `40,000.

Find out the costs to be capitalized as per IAS-16? Solution -

Cost to be capitalized include:

-

Cost of the plant `2,50,000.

-

Initial delivery and handling cost `20,000.

-

Cost of site preparation `60,000.

-

Consultants used to advice on the acquisition `70,000.

-

Estimated dismantling cost to be incurred after 7 years `30,000.

-

Total Cost = (2,50,000 + 20,000 + 60,000 + 70,000 + 30,000) = `4,30,000.

-

Interest charges can be capitalized as per allowed alternative treatment of IAS-23 Borrowing Cost.

An undertaking applies IAS 2 Inventories to the costs of obligations for dismantling, removing and restoring the site on which an item is located, having used the item to produce inventories during that period. The obligations for costs accounted for in accordance with IAS 2 or IAS 16 are recorded and measured in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets.

Expensed Costs Costs that should be expensed in the income statement (and not capitalised), include: K costs of opening a new facility; K costs

of introducing a new product, or service (including advertising and promotional activities);

K costs

of running a business in a new location, or with a new class of customer (including staff training); and

K administration and other general overhead costs.

Stopping Cost Recognition Recognition of costs ceases when the item is in the location, and capable of operating in the manner intended by management. Therefore, costs incurred in using, relocating, or redeploying are not included in the carrying amount of the item. A PRACTICAL APPROACH TO IFRS

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Incidental Costs / Income Some incidental operations may occur before, or during the construction, or development activities. For example, income may be generated by using a building site as a car park, until construction starts. The income and related expenses of incidental operations are recorded in the income statement, and included in their respective classifications of income and expense.

Self Constructed Assets The cost of a self-constructed asset is determined by using the same principles as if a tangible fixed asset is acquired. If an undertaking makes similar assets for sale in the normal course of business, the cost of the asset is usually the same as the cost of constructing an asset for sale. Any internal profits are eliminated from such costs.

The following costs are not included in the carrying amount. K costs incurred on an item, capable of operating in the manner intended by management, but, yet to be brought into use, or is operated at less than full capacity; K initial operating losses, such as those incurred while demand for an item builds up; and K costs of relocating, or reorganising part, or all, of an undertaking's operations.

Similarly, the cost of abnormal amounts of wasted material, labour, or other resources incurred in selfconstructing an asset, is not included in the cost of the asset. IAS 23 Borrowing Costs details the criteria for the recognition of interest as a component of the carrying amount of a selfconstructed asset.

Measurement of Cost The cost is the cash price equivalent as on the recognition date. If payment is deferred beyond normal credit terms, the difference between the cash price equivalent and the total payment is recorded as interest over the period of credit, unless such interest is recorded as a borrowing cost in the carrying amount of the item, in accordance with IAS 23.

EXAMPLE MNO Ltd. wants to purchase a Building. It can pay can pay `2 crore cash down payment, or pay for it over 3 years for a total cost of `2,03 crores. Using either payment method, the cost will be ` 2 crores and `0.3 crores will be treated as interest. He journal entries as per IAS 16 will be: (i) Building a/c Dr 2,00,00,000 To Creditors a/c 2,00,000 (Being building bought on credit) (ii) Interest a/c Dr 10,00,000 To Interest payable account 10,00,000 (Being interest charged annually at the end of the first year) One, or more, items may be acquired in exchange for a non-monetary asset or assets, or a combination of monetary and non-monetary assets. This system of accounting would be used for barter transactions involving PPE. The cost of such an item is measured at fair value unless: A PRACTICAL APPROACH TO IFRS

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the exchange transaction lacks commercial substance or K K the fair value of neither the asset received nor the asset given up is reliably measurable..

If the acquired item is not measured at fair value, its cost is measured at the carrying amount of the asset given up plus extra cash payment (or minus payment by another company, which gives your company an asset).

Measurement after Recognition An undertaking will choose either the cost model, or the revaluation model, as its accounting policy, and will apply that policy to an entire class of property, plant and equipment.

Cost Model An item will be carried at its cost, less any accumulated depreciation, and any accumulated impairment losses. Value of an asset = Cost at initial recognition – Accumulated Depreciation – Impairment Loss

Revaluation Model K An item

whose fair value can be measured reliably may be carried at revalued amount (fair value) less subsequent accumulated depreciation and accumulated impairment losses.

Value of an asset = Fair Value – Accumulated Depreciation-Impairment Loss K Revaluations will be made with sufficient frequency to ensure that the carrying amount

does not differ materially from fair value at the balance sheet date. K The

fair value of land and buildings is usually determined by professionally-qualified valuers, from market-based evidence. The fair value of plant and equipment is usually their market value, determined by appraisal. If there is no market-based evidence of fair value, estimate the fair value. For example: present value of future income or replacement cost less depreciation.

K The higher the market volatility, the greater the frequency of revaluations. If there is a big

difference between the carrying amount and fair value then a revaluation should be made. Some items necessitate annual revaluation due to frequent changes in fair value. K Frequent revaluations are usually unnecessary for property, plant and equipment. They

are usually revalued every 3-5 years unless investment property is involved (see IAS 40) when more-frequent valuations are common.

Revaluation in Classes If an item is revalued, the entire class to which that asset belongs will also be revalued. A class is a grouping of assets of a similar nature and use. The following are examples of common separate classes: (1) land; A PRACTICAL APPROACH TO IFRS

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(2) land and buildings; (3) machinery;

The items within a class are revalued simultaneously (or not at all) to avoid selective revaluation of assets, and the reporting of amounts that are a mixture of costs and values as at different dates. A class of assets may be revalued on a rolling basis, provided revaluation of the class of assets is completed within a short period, and provided the revaluations are kept up to date.

(4) ships; (5) aircraft; (6) motor vehicles; (7) furniture and fixtures; and (8) office equipment.

EXAMPLE Rahul owns various offices. He decides to revalue them every 3 years. The revaluations may be done at the same time, or one third of the properties may be revalued each year.

Initial Revaluation The revaluation model revalues property, plant, and equipment to its fair value. PPE is carried on the balance sheet at its fair value less accumulated depreciation (revalued) and any impairment losses. Revaluation can result in either increase or decrease in carrying cost. (a) Increase in carrying amount due to revaluation If an asset's carrying amount is increased as a result of a revaluation, the increase will be credited directly to equity under the heading of Equity - Revaluation Reserve. The journal entry will be: PPE

a/c

Dr

To Equity Revaluation Reserve a/c (Being increase in the carrying amount recorded)

EXAMPLE The carrying value of a factory of `15 crore has been revalued at `17 crore. The `2 crore surplus will be credited to the revaluation surplus reserve within equity. The journal entry will be : Building a/c

Dr

2,00,00,000

To Equity Revaluation Reserve a/c

2,00,00,000

(Being revaluation of the factory recorded) (a) Decrease in carrying amount due to revaluation If an asset's carrying amount is decreased as a result of a revaluation, the decrease will be recorded in income statement. The journal entry will be: Loss on Revaluation a/c

Dr

To PPE a/c (Being decrease in the carrying amount recorded)

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EXAMPLE Carrying amount increase following decrease A factory had a carrying value of `10 crore. It has been revalued at `8 crore. The `2 crore loss on revaluation is debited to the income statement as an expense. The journal entry will be: Loss on revaluation(Building ) a/c Dr 2,00,00,000 To Building a/c 2,00,00,000 (Being loss on revaluation of factory recorded)

Subsequent Revaluation (a) A major area of difference between IFRS and GAAP relates to reporting the value of property, plant, and equipment. According to IAS 16 Property, Plant and Equipment, entities can follow the cost model or the revaluation model. The cost model carries an item of property, plant and equipment at its cost less any accumulated depreciation and any accumulated impairment losses. (b) Subsequent decreases in value of an asset should first be charged against any previous revaluation surplus in respect to that asset, and the excess should be expensed.

The revaluation model carries an i te m o f p ro p e r t y, p l a n t a n d equipment at a revalued amount, which is its fair value at the date of the revaluation less any subsequent accumulated depreciation and subsequent accumulated impairment losses. Reporting PPE at cost is the benchmark treatment but revaluation is a permitted alternative. This is a significant departure from GAAP, which requires entities to use the cost model.

EXAMPLE During the current year, Piazza Company elected to measure property, plant, and equipment at revalued amounts. Assume Piazza owns a building with a cost of `1,90,000 and a current fair value of `2,00,000. The journal entry to increase the carrying amount of the building to its fair value follows. Building a/c Dr 10,000 To Revaluation reserve-Building 10,000 (Being increase in the carrying amount due to revaluation recorded) In the following year, Piazza Company determines that the fair value of the building is no longer `2,00,000. Assuming the fair value has decreased to `1,60,000. The following entry should be made. Revaluation reserve- building a/c Dr 10,000 Loss on Revaluation- building(expense) a/c Dr 30,000 To Buildings a/c 40,000 (Being Loss on revaluation adjusted against the amount of previous year's gain and the balance expensed to the income statement.) ( c ) If previous revaluations resulted in an expense, subsequent increases in value should be charged to income to the extent of the previous expense. The excess should be credited to equity. A PRACTICAL APPROACH TO IFRS

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EXAMPLE The factory of XYZ Ltd. had a carrying value of `20 crore. It has been revalued at `19 crore. The `1 crore shortfall is debited to the income statement account. Next year the factory is revalued again at `25 crore. The increase in the carrying amount on account of revaluation is `6 crore. Out of this increase, `1 crore will be credited to income statement account and the balance will be credited to Revaluation surplus account. The following would be the journal entries for the two years: FIRST YEAR Loss on Revaluation(Building) a/c Dr 1,00,00,000 To Building a/c 1,00,00,000 (Being loss on account of revaluation expensed to income statement.) SECOND YEAR Building a/c Dr 60000000 To Loss on revaluation-Building(expense) a/c 1,00,00,000 To Revaluation reserve (Building) a/c 5,00,00,000 (Being gain on revaluation adjusted against previous year's loss and the balance credited to Revaluation reserve account.) ( d ) Once an asset has been revalued, its value on the balance sheet must represent its current fair value. At each year end, management should consider whether the asset's fair value differs from its carrying value. The carrying value should not differ materially from the asset's fair value.

Accumulated Depreciation When an item is revalued, any accumulated depreciation is treated in one of the following ways, both of which result in the net carrying amount being equal to the revaluation figure: (1) Depreciation restated proportionately, with the change in the gross carrying amount of the asset. The carrying amount of the asset after revaluation equals its revalued amount. This method is often used when an asset is revalued by means of applying an index to its depreciated replacement cost. (2) Depreciation eliminated against the gross carrying amount of the asset. The net amount is restated to the revalued amount of the asset. This method is often used for buildings.

EXAMPLE A machine cost `12,000 and has been depreciated by `2,000, leaving a net book value of `10,000. It has been revalued using a general price index. The index has risen by 25% since the machine was bought. The new cost is therefore `15,000 (12,000 x 125%). Depreciation would also increase to `2,500 (2,000 x 125%) and the carrying amount based on this would be: New Cost – New Depreciation = `12,500 (15,000-2,500)

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EXAMPLE Clark Company owns a building that cost `8,00,000. The building has accumulated depreciation of `2,00,000 so the carrying value is `6,00,000. Assume Clark revalues the building to its current fair value of `10,00,000. Under treatment 2, Clark would eliminate accumulated depreciation of `2,00,000 and then increase the buildings account by `4,00,000. (a)

Accumulated depreciation a/c Dr

2,00,000

To Buildings a/c

2,00,000

(Being the amount of accumulated depreciation written off against Buildings) (b)

Buildings a/c

Dr

4,00,000

To Revaluation Surplus

4,00,000

(Being the value of Buildings increased on account of Revaluation)

Asset Written Off When the asset is written out of the balance sheet, the revaluation surplus included in equity may be transferred directly to retained earnings. The journal being:

EXAMPLE A factory had a cost of `22 crores. It has been revalued at `28 crores. The `6 crore surplus has been credited to the revaluation surplus reserve within equity. It is sold for `30 crores.The profit of `2 crore is shown as a gain in the income statement. The `6 crores is transferred directly from the revaluation surplus to retained earnings, with no impact on the income statement. The journal entries will be: (a)

Buildings a/c

Dr

6,00,00, 000

To Revaluation Surplus

6,00,00, 000

(Being the value of Buildings increased on account of Revaluation) (b)

Bank a/c

Dr

30,00,00,000

To Buildings a/c

28,00,00,000

To Profit on sale of Building

2,00,00,000

(Being Building sold at a profit) (c)

Revaluation Surplus a/c

Dr

6,00,00, 000

To Retained Earnings

6,00,00, 000

(Being the Revaluation surplus transferred to Retained Earnings on account of disposal of the asset)

Asset used – Transfer Part to Retained Earnings As the asset is used some of the Equity - Revaluation Reserve may be transferred to retained earnings. The amount transferred is the difference between depreciation on revalued carrying amount and depreciation on original cost. Transfers from Equity - Revaluation Reserve to retained earnings are not made through income statement. A PRACTICAL APPROACH TO IFRS

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Depreciation K IAS 16 requires that each part of an item of PP&E with a cost that is significant in relation

to the total cost of the item be depreciated separately. Significant parts of an item of PP&E that have the same useful lives and depreciation methods may be grouped in determining depreciation. This is also known as 'COMPONENT ACCOUNTING'.

EXAMPLE Aircraft: Airframe and engines of an aircraft are depreciated separately.

For depreciation, parts with the same life may be grouped.

EXAMPLE If the airframe and engines of an aircraft have the same useful life, it may be appropriate to depreciate them grouped as one asset. If a part is depreciated separately then the remaining parts must also be depreciated. Parts, individually not significant may be aggregated before being depreciated.

EXAMPLE An airline accounts for the airframe, engines, mechanics and seating as separate items. Other items are considered as the 'remainder' of the aircraft and are aggregated and depreciated over their useful lives.

K Depreciation shall be applied to the depreciable amount of an asset on a systematic basis

over its expected useful life. Expected useful life is the period used, not the asset's economic life, which could be appreciably longer. K The depreciable amount takes account of the expected residual value of the assets. Both

the useful life and the residual value shall be reviewed annually and the estimates revised as necessary in accordance with IAS 8. K Depreciation commences when an asset is in the location and condition that enables it to

be used in the manner intended by management. Depreciation shall cease at the earlier of its derecognition (sale or scrapping) or its reclassification as 'held for sale' (see IFRS 5). Temporary idle activity does not preclude depreciating the asset, as future economic benefits are consumed not only through usage but also through wear and tear and obsolescence. Useful life, therefore needs to be carefully determined based on use, maintenance programs, expected capacity, expected output, expected wear and tear, technical or commercial innovations, and legal limits.

EXAMPLE XYZ Ltd. owns an asset with an original cost of `2,00,000. On acquisition, it was estimated that the useful life was 10 years and the residual value would be

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`20,000. During the last 8 years, there have been no revisions to the assessed residual value. At the end of 8th year, management has reviewed the useful life and residual value and has extended the useful life to 12 years in view of the maintenance program adopted by the company. As a result, the residual value is also reduced to `10,000. The changes in estimates would be effected in this way: The asset has a carrying amount of `56,000 at the end of 8th year : `2,00,000 (cost) less `1,44,000 (accumulated depreciation). Accumulated depreciation is calculated as: Depreciable amount equals cost less residual value = `2,00,000 – `20,000 = `1,80,000. Annual depreciation = depreciable amount divided by useful life : = `1,80,000 / 10 = `18,000 p.a. Accumulated depreciation = `18,000 × no. of years (8) = `1,44,000. Revision of the useful life to 12 years results in a remaining useful life of 4 years (12 – 8). The revised depreciable amount is `46,000: carrying amount of `56,000 – the revised residual amount of `10,000). Thus depreciation should be charged in future at `11,500 per annum (`46,000 divided by 4 years).

Assets Producing Other Assets Sometimes asset are used to produce other assets. In this case, the depreciation charge constitutes part of the cost of the other asset, and is included in its carrying amount. For example, the depreciation of manufacturing plant and equipment is included in the costs of conversion of inventories (see IAS 2).

EXAMPLE Sam buys a product-testing machine for `4,00,000. You estimate that it will be able to test 20,000 units over its life. No residual value is anticipated. Every time a unit is tested, depreciate the machine by `20. This depreciation is debited to inventories. It is then transferred to cost of sales when the goods are sold. Assuming that 500 units are sold, following would be the journal entries; (a)

Inventory(testing) depreciation a/c

Dr

20

To accumulated depreciation

20

(Being depreciation transferred to accumulated depreciation on each unit tested) (b)

Cost of Sales a/c

Dr 10,000

To Inventory

10,000

(Being the testing cost of 500 units transferred to cost of sales) Similarly, depreciation of items used for development activities may be included in the cost of an intangible asset, recorded under IAS 38 Intangible Assets.

Depreciable Amount and Depreciation Period K The depreciable amount of an asset will be allocated on a systematic basis over its useful

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The residual value, and the useful life, of an asset will be reviewed at least at each financial year-end and, any changes will be accounted for as a change in an accounting estimate in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.

EXAMPLE An aircraft is being depreciated over 10 years. It has a residual value of `2 crore. Industry practice recommends 12 years of useful life, but reduces residual value to `0.8 crore. The management takes expert advice, and agrees to follow industry practice with regard to both the depreciation period, and the residual value. These changes should be accounted for under IAS 8.

K Depreciation is recorded, even if the fair value of the asset exceeds its carrying amount,

as long as the asset's residual value does not exceed its carrying amount.

EXAMPLE The carrying amount of your asset is `4 crore. The fair value is `5 crore. The asset will continue to be depreciated. (It may be revalued to fair value, if all assets in its class are revalued.)

EXAMPLE Fair Value = Carrying Amount The carrying amount of your asset is `3 crore. The residual value is also `3crore. No further depreciation will be charged.

EXAMPLE Fair Value = Carrying Amount The carrying amount of your asset is `3 crore. The residual value is also `3crore. No further depreciation will be charged. K Repair and maintenance of an asset do not negate the need to depreciate it.

EXAMPLE Maintenance Your hotel has a program of upgrading and maintenance to sustain its value. Nevertheless, it must be depreciated. (The hotel may be revalued to take account of value of the improvements, but only if they cause an increase in the fair value of the hotel.)

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Residual Value The depreciable amount of an asset is determined after deducting its residual value.

The residual value is the net value of the asset at the end of its useful life. The initial residual value is determined at the start of the asset's life using judgment.

EXAMPLE

A vehicle costs `20,000. Its estimated life is 4 years. The residual value is `8,000. The depreciable amount is `12,000 (`20,000 - `8,000). The depreciation charge is `3,000 (`12,000/4) per year Vehicle a/c

DR

20,000

To Cash a/c ( Being purchase of vehicle) Depreciation a/c

20,000 DR

3,000

To Accumulated depreciation (Being depreciation charged)

3,000

The residual value of an asset is often insignificant, and therefore immaterial in the calculation of the depreciable amount. The residual value of an asset may increase to an amount equal to, or greater than, the asset's carrying amount. If it does, the asset's depreciation charge is zero until its residual value subsequently decreases to an amount below the asset's carrying amount.

EXAMPLE A vehicle costs `20,000. Its estimated life is 4 years. The estimated residual value is `8,000. The depreciation charge is `3,000 per year. At the end of year 3, the carrying amount is `11,000. The residual value has increased to `9,000, due to increases in the prices of second hand vehicles. The depreciation charge for year 4 is reduced from `3,000 to `2,000, so the carrying value is the same as the residual value of `9,000. Depreciation a/c

DR

2,000

To Accumulated depreciation (Being depreciation charged for the 4th year)

2,000

Unless the residual value of an asset is guaranteed, the residual value will only be an estimate of the amount that the undertaking will receive when it sheds the asset. A PRACTICAL APPROACH TO IFRS

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The higher the residual value, the lower will the cost to the undertaking in depreciation charges. If the estimated residual value is too high, this will result in a loss on disposal and inflated profits in the periods before disposal.

Where PPE represents a material part of the asset structure, such as undertakings that lease PPE, the accuracy of residual values is the key to the accuracy of results.

Depreciation - Start and End Depreciation of an asset starts when it is available for use, ie when it is in the location and condition necessary for it to be capable of operating in the manner intended by management. Depreciation of an asset ceases at the earlier of the date that:

Depreciation does not cease when the asset becomes idle, or is retired from active use, and held for disposal, unless the asset is fully-depreciated.

(1) the asset is classified as held for sale (or included in a disposal group that is classified as held for sale) - see IFRS 5 and (2) the date that the asset is derecognised (written out of the balance sheet) or is fully depreciated..

Methods of Depreciation Straight-line depreciation results in a constant charge over the useful life.

EXAMPLE TIME METHOD An air-conditioning machine costs `2,00,000. It is estimated to have a life of 5 years, with no residual value. It is depreciated it at the rate of `40,000 per year. The factory is closed for 4 months for the installation of new machines. Depreciation of the air-conditioning machines continues through this period Property, plant & equipment a/c

DR

2,00,000

To Cash

2,00,000

(Being machinery purchased) Depreciation a/c

DR

40,000

To Accumulated depreciation

40,000

(Being annual depreciation charged)

Diminishing Balance Method The diminishing balance method results in a decreasing charge over the useful life and loads the early years with a much higher charge.

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EXAMPLE You buy a machine for `10.000. It has high risk of technical obsolescence. You depreciate it at 50% as follows: Year 1 `5.000 (50% of 10.000) Year 2 `2.500 (50% of 5.000) (`10000- `5000) Year 3 `1.250 (50% of 2.500) Year 4 `625 (50% of 1.250)

(`5000- `2500) (`2500- `1250)

EXAMPLE UNITS OF PRODUCTION METHOD A product-testing machine is purchased for `1,00,000 for a seasonal product. An estimate is that it will be able to test 20,000 units over its life. No residual value is anticipated. Every time a unit is tested, depreciate the machine by `5. In the reporting period 3,200 units are tested, Property, plant & equipment a/c

DR

1,00,000

To Cash

1,00,000

(Being machinery purchased) Depreciation a/c

DR

16,000

To Accumulated depreciation

16,000

(Being annual depreciation charged)

EXAMPLE UNITS OF PRODUCTION METHOD For safety reasons the factory had a 4 month shutdown. No production took place so no depreciation is charged

Units of Production Method However, units of production method of depreciation the depreciation charge can be zero, when there is no production.

Asset Useful Life Factors, such as technical, or commercial obsolescence, and wear and tear (even when the asset is idle), often reduce life.

The estimation of the useful life of the asset is a matter of judgement, based on the experience of the undertaking with similar assets.

Consequently, all of the following are considered in determining the useful life of an asset: 1. expected usage of the asset. (Usage = production). A PRACTICAL APPROACH TO IFRS

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2.

expected physical wear and tear, which depends on operational factors, such as the number of hours for which the asset is to be used, the repair and maintenance. 3. technical, or commercial obsolescence, arising from changes or improvements in production, or from a change in the market demand for the product, or service output, of the asset. 4. the asset management policy may involve the disposal of assets after a specified time The longer the life of an asset, the more years it will be depreciated, and the less each year's depreciation charge will be. If the estimated life is too long, this will result in a loss on disposal and inflated profits in the periods before disposal.

Land and Buildings Land and buildings are separable assets, and are accounted for separately, even when they are acquired together. Though there are some exceptions, such as quarries and sites used for landfill, land has an unlimited useful life and therefore is not depreciated. Buildings have a limited useful life, and therefore are depreciable assets. An increase in the value of the land on which a building stands does not affect the determination of the depreciable amount of the building.

EXAMPLE LAND AND BUILDING A building is purchased including the land. The price is split between the land `1 crore and the building `0.2 crore. The building is depreciated over 20 years, at `10.000 per year. The land is not depreciated. 4 years later, the land is revalued at `1.4 crore. The building continues to be depreciated, despite the land's revaluation surplus Property, plant & equipment a/c (land)

DR

1 crore

Property, plant & equipment a/c (building)

DR

0.2 crore

To Cash a/c

1.2crore

(Being property purchased) Depreciation a/c

DR

10,000

To Accumulated depreciation a/c

10,000

(Being annual depreciation charged)

EXAMPLE USEFUL LIFE A vehicle costs `20,000. Its estimated life is 4 years, or after 1,50,000 km., whichever is sooner. The residual value is estimated at `8,000. The vehicle will have an economic life longer than its useful life to the firm. This is reflected in the residual value.

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NON-DEPRECIATION OF LAND A piece of land is purchased for mining. The price is `1 crore. Property, plant & equipment (land) a/c

DR

1 crore

To Cash a/c

1 crore

(Being land purchased)

Land Cost If the cost of land includes the costs of site dismantlement, removal and restoration, the restoration cost portion of the land asset is depreciated over the period of benefits obtained by incurring those costs. The preparation for the mine costs `0.1 crore, and the restoration at the end of the project will cost `0.3 crore.

Property, plant & equipment (land) a/c

DR

0.4 crore

To Cash a/c

0.1 crore

To Provision for restoration a/c

0.3 crore

(Being the preparation and provision for restoration of the property)

The mine will have an economic life of 20 years, after which the land will be redeveloped for other purposes. The preparation and restoration costs totaling `0.4 crore should be depreciated over the 20 year life of the mine.

Depreciation a/c

DR

5,000

Provision for restoration a/c

DR

15,000

To Accumulated depreciation a/c

20,000

(Being the annual depreciation of the preparation and provision for restoration of the property)

The `1 crore cost of the mine should not be depreciated, if its value is sustained over that period, and it will be worth `1 crore at the end of the period, after restoration. In some cases, the land itself may have a limited useful life, in which case it is depreciated in a manner that reflects the benefits to be derived from it. If the land is leased, under a finance lease, its useful life is limited to that of the lease.

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EXAMPLE A piece of land is purchased for mining. The cost price is `1 crore. The mine will have an economic life of 10 years, after which the land will be reduced in value to `0,0 as the restoration costs will be equal to the value of the land. The `1crore depreciable amount of the land should be written off over the 10 year life of the mine. Property, plant & equipment (land) a/c

DR

`1 crore

To Cash a/c

`1 crore

(Being property purchased) Depreciation a/c

DR

`0.1 crore

To Accumulated depreciation a/c

`0.1 crore

(Being annual depreciation charged)

STUDENT CORNER IAS 16 makes it clear that an item of property, plant and equipment should be recognized as an asset if and only if it is probable that future economic benefits associated with the asset will flow to the entity and the cost of the asset can be measured reliably. Also, purchase of an asset would involve huge amount of cash. Showing it as an expense in the year of purchase would not give the correct picture of an entity. Also what to do in case of revaluations, subsequent measurement of assets etc?

And the really important stuff…….. accounting practice The cost of an item of PPE should only be recognized when its probable future benefits will flow to the enterprise and the cost can be measured reliably. Assets should initially be measured at cost. These include the directly attributable costs incurred in bringing the asses into working condition for its intended use. Subsequent expenditure should be capitalized if the expenditure meets the criteria for initial recognition. For example, a replacement of a major part of an asset should be capitalized and the old part replaced should be derecognized. Companies can adopt a policy of revaluing assets if the wish………BUT …..they must: K revalue full class of assets K revalue sufficiently often that the asset is retained at an up-to-date value on the balance

sheet. The gains on revaluation should be recognized in the revaluation reserve and losses on

IAS 16 prescribes the accounting treatments for PPE where the principal issues are recognition of assets, the determination of their carrying value and the depreciation and the impairment charges recognized in relation to them.

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revaluation are treated consistently with impairments in value. The depreciable amount of a fixed asset (other than land) should be allocated on a systematic basis over its useful economic life in a manner that reflects the consumption of economic benefits. The residual value of assets should be reviewed each year and based on year-end price levels. A change in the method of depreciation is only allowed on the grounds of truth and fairness and does not constitute a change of accounting policy. The depreciation rate should be reviewed at the end of each reporting period.

Owned assets…… How are they accounted for?

Capitalised at cost (include any directly attributable costs incurred in bringing the asset into working condition. Land…….no depreciation Other property, plant and equipment items – Depreciate Cost – Residual value Expected useful life

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Do not confuse the accumulated depreciation account with the current year depreciation expense. The accumulated Depreciation should NOT appear in the income statement!! ………. It is the accumulated depreciation to date which is shown netted against cost in the balance sheet. The income statement should just show the current (one year) effect of depreciation. A common pitfall is to forget to transfer revaluation reserve to retained earnings over the useful economic life of an asset ie, when the asset is fully depreciated the revaluation reserve should be written down to zero too. Incase of sale of revalued asset, the revaluation reserve should be transferred to retained earnings on the date of sale.

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WORKSHEET 1. Residual value is specifically: (a) Scrap value. (b) The net cash amount that you will receive from the ultimate sale of the asset, at the end of its life (c) The gross cash amount that you will receive from the ultimate sale of the asset, at the end of its life. 2. Useful life of an asset refers to the life: (a) Of the asset throughout its life, in the hands of any number of owners. (b) Of the asset whilst it is available for use in the firm. (c) The average of 1 & 2. 3. Spare parts and servicing equipment are usually accounted for as: (a) Expenses written off to the income statement on buy. (b) Inventory. (c) A separate class of fixed assets. 4. Major spare parts and stand-by equipment qualify as property, plant and equipment when: (a) They are expected to be used during more than one period. (b) The firm is in the oil industry. (c) The parts cost more than 20% of the equipment they are supporting. 5. Individually-insignificant items, such as moulds, tools and dies may be: (a) Ignored. (b) Expensed on purchase. (c) Aggregated as one asset. 6. Repairs and maintenance costs are normally: (a) Capitalised. (b) Expensed in the income statement as incurred. (c) Recorded as deferred expenses. 7. If the costs of a major inspection (for example, aircraft) are capitalised: (a) They must be shown as a separate asset. (b) Any remaining costs of a previous inspection must be written off. (c) The board of directors must be notified immediately. 8. If the costs of a major inspection (for example, aircraft) are capitalised, and there was no cost for the initial major inspection in the asset cost: (a) No cost should be deducted from the asset. (b) An estimate of the initial inspection cost should be made. (c) The cost of the new inspection must be expensed. 9. Elements of cost are: i. The purchase price ii. Any costs directly attributable to bringing the asset to the location. iii. The initial estimate of the costs of dismantling, and removing the item. A PRACTICAL APPROACH TO IFRS

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iv. Overheads of the purchasing department relating to the buy of the asset. (a) i-iv (b) i-iii (c) i-ii (d) i 10. Directly attributable costs include: i. staff costs of arising directly from the construction, or acquisition, of the item of property, plant and equipment; ii. site preparation costs; iii. initial delivery and handling costs; iv. installation and assembly costs; and v. costs of testing whether the asset is functioning properly, after deducting the net proceeds from any samples, or sundry income; and vi. professional fees. vii. costs of opening a new facility; viii. costs of introducing a new product, or service (including costs of advertising and promotional activities); ix. costs of running a business in a new location, or with a new class of customer (including costs of staff training); and x. administration and other general overhead costs. (a) i-x (b) i-vii (c) v-x (d) i-vi 11. Recognition of costs (to be capitalised) ceases when: (a) The accounting period ends. (b) The item is in the location and capable of operating. (c) Full production capacity has been reached. 12. The following costs (i) costs incurred while an item, capable of operating in the manner intended by management, has yet to be brought into use, or is operated at less than full capacity; (ii) initial operating losses, such as those incurred while demand for the item's output builds up; and (iii) costs of relocating, or reorganising part, or all, of an undertaking's operations. should be accounted for as: (a) Extraordinary items. (b) (Capitalised as) fixed assets. (c) Expenses. 13. Incidental income and expenses (such as using a site as a temporary car park) should be:

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(a) Capitalised into the asset. (b) Taken to the income statement. (c) Ignored. 14. Internal profits generated, when creating a self-constructed asset, should be: (a) Eliminated from the asset cost. (b) Depreciated over the life of the asset. (c) Included from the asset cost. 15. The cost of abnormal amounts of wasted material, labour, or other resources incurred in self-constructing an asset should be: (a) Capitalised. (b) Expensed. (c) Deferred. 16. If payment for a fixed asset is deferred beyond normal credit terms, any additional payment above the cash cost of the asset will be accounted for as: (a) Cost of fixed asset. (b) Borrowing cost. (c) Repairs and maintenance. 17. If one or more assets are exchanged for a new asset, the new asset is valued at: (a) Replacement cost. (b) Fair value. (c) Residual value. 18. In the case of an exchange of assets, if the acquired asset cannot be valued: (a) The cost of the asset given up is used. (b) The residual value is used. (c) The asset cannot be capitalised. 19. An undertaking can choose either the cost model or the revaluation model, as its accounting policy. It must apply the chosen model to: (a) All fixed assets. (b) An entire class of fixed assets. (c) Major assets. 20. Using the cost model, the asset in accounted for at: (a) Cost. (b) Cost less accumulated depreciation. (c) Cost less accumulated depreciation and any impairment losses. 21. Using the revaluation model, can fair values be estimated, if there is no marketbased evidence? (a) No. (b) Yes, if the asset is specialized, and rarely sold, by using an income, or a depreciated replacement cost approach. (c) Yes, if the asset is specialized, and rarely sold, by using indexation. 22. Revaluations are required: (a) Annually.

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(b) Every 3-5 years. (c) When fair values change, or are expected to change. 23. When an item is revalued, any accumulated depreciation at the date of the revaluation is treated in which of the following ways: (a) Restated proportionately, with the change in the gross carrying amount of the asset, so that the carrying amount of the asset after revaluation equals its revalued amount. (b) Eliminated against the gross carrying amount of the asset and the net amount restated to the revalued amount of the asset. (c) Either (a) or (b). 24. Examples of separate classes of fixed assets are: (i) land. (ii) land and buildings. (iii) machinery. (iv) ships. (v) aircraft. (vi) motor vehicles. (vii) furniture and fixtures. (viii) office equipment. (ix ) stationery (a) i-v (b) vi-ix (c) i-viii (d) i-ix 25. A class of assets may be revalued on a rolling basis, provided: (a) The revaluation is completed in a short period, and the revaluations are kept up to date. (b) Only one class of assets is involved. (c) It is noted on the face of the balance sheet. 26. If an asset's carrying amount is increased by revaluation, the increase is; (a) Shown as a gain in the income statement. (b) Taken to revaluation surplus, via the income statement. (c) Taken to revaluation surplus, directly, without being recorded in the income statement. 27. If an asset's carrying amount is decreased by revaluation and there is no revaluation reserve, the decrease should be: (a) Capitalised. (b) Expensed. (c) An extraordinary item. 28. Transfers of amounts between Equity - Revaluation Reserve and retained earnings are allowed: (a) Only on asset disposal.

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(b) On asset disposal, and in each period, being the difference between the depreciation charged on a revalued amount and the depreciation of the cost amount. (c) When retained earnings are negative. 29. Depreciation charges for a period are recorded: (a) Only in the income statement. (b) As an exceptional item. (c) In the income statement, or as part of the cost another asset (such as inventories). 30. Changes in the estimated useful life should: (a) Be accounted for under IAS 8. (b) Be expensed immediately. (c) Be noted on the face of the balance sheet. 31. The carrying value of your asset is `10. Its fair value is `12 . Do you continue depreciation? (a) No. (b) Yes, until the end of its useful life. (c) Yes, but at half the previous rate. 32. The carrying value of your asset equals the residual value. Do you continue to depreciate it? (a) No. (b) Yes, until the end of its useful life. (c) Yes, but at half the previous rate. 33. Regular repair and maintenance preserves the value of your hotel. Do you continue to depreciate it? (a) No. (b) Yes, until the end of its useful life. (c) Yes, but at half the previous rate. 34. Your asset has a residual value. Do you continue to depreciate it? (a) No. (b) Yes, until the end of its useful life, but deduct the amount of the residual value from the amount to be depreciated. (c) Yes, but at half the previous rate. 35. Depreciation can cease when an asset is idle. (a) False. (b) Only due to factory closure. (c) Only under a units of production method. 36. In determining the useful life of an asset, consider: (i) Expected usage of the asset. (ii) Expected physical wear and tear. (iii) Technical, or commercial obsolescence.

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(iv) Legal, or similar, limits on the use of the asset. (v) Interest rates. (a) i-ii (b) i-iii (c) i-iv (d) i-v 37. Land and buildings are separate assets, as: (a) They can always be sold separately. (b) Land usually has an unlimited life, but buildings do not. (c) Buildings can be revalued, but land cannot. 38. You buy land and building. The land is revalued at double its cost. Do you continue to depreciate the building? (a) No. (b) Yes, until the end of its useful life. (c) Yes, but at half the previous rate. 39. If your land is leased under a finance lease, do you depreciate it? (a) No. (b) Yes, until the end of the lease. (c) Only if it has a building on it. 40. A variety of depreciation methods can be used. These methods include the straight-line method, the diminishing balance method and the units of production method. The choice of depreciation method is governed by: (a) Tax laws. (b) The lowest cost option. (c) The expected pattern of consumption of the asset. 41. Compensation from third parties for items impaired, lost or sequestrated should be recorded as income: (a) When the item is lost. (b) When the compensation is receivable. (c) When the cash is received. 42. The carrying amount will be derecognised (written out of the balance sheet): (a) On disposal. (b) When no future benefits are expected from its use. (c) Either. 43. A gain on the sale of an asset should be recorded as: (a) A capital gain in equity. (b) A gain in the income statement. (c) Revenue. 44. The gain, or loss, arising on the sale of an asset is: (a) The cash proceeds. (b) The net proceeds minus the carrying value of the asset. (c) The net proceeds minus the residual value of the asset.

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Numerical Questions 1. An asset costs `80000. Its life is 5 years. (Straight line) depreciation of `14000 per year is charged. What is the residual value? 2. The asset costs `500,000. It will produce 25000 units. What is the unit depreciation charge? 3. Gupta Ltd. is installing a new plant at its production facility. It has incurred these costs: (a) Cost of the plant (cost per supplier's invoice plus taxes) `2,500,000 (b) Initial delivery and handling costs `2,00,000 (c) Cost of site preparation `6,00,000 (d) Consultants used for advice on the acquisition of the plant `7,00,000 (e) Interest charges paid to supplier of plant for deferred credit `2,00,000 (f) Estimated dismantling costs to be incurred after 7 years `3,00,000 (g) Operating losses before commercial production `4,00,000 4. You buy a vehicle for `40,000. You depreciate it at `6,000 per year. You sell it after 5 years for `8,000. What is the profit, or loss, on disposal? 5. Bricks Ltd owns an asset with an original cost of `200,000. On acquisition, management determined that the useful life was 10 years and the residual value would be `20,000. The asset is now 8 years old, and during this time there have been no revisions to the assessed residual value. At the end of year 8, management has reviewed the useful life and residual value and has determined that the useful life can be extended to 12 years in view of the maintenance program adopted by the company. As a result, the residual value will reduce to `10,000. How would these changes in estimates be recorded?

ANSWER 1. 5. 9. 13. 17. 21. 25. 29. 33. 37. 41.

(b) (c) (b) (b) (b) (b) (a) (c) (b) (b) (b)

2. 6. 10. 14. 18. 22. 26. 30. 34. 38. 42.

(b) (b) (d) (a) (a) (c) (c) (a) (b) (b) (c)

3. 7. 11. 15. 19. 23. 27. 31. 35. 39. 43.

(b) (b) (b) (b) (b) (c) (b) (b) (c) (b) (b)

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4. 8. 12. 16. 20. 24. 28. 32. 36. 40. 44.

(a) (b) (c) (b) (c) (c) (b) (a) (c) (c) (b)

Numerical Questions 1. 2. 3. 4. 5.

Ans: `10000 Ans: `2000 per unit Ans: `43,00000 Ans: Loss; `2000 Ans; The asset has a carrying amount of `56,000 at the end of year 8: `200,000 (cost) less `144,000 (accumulated depreciation). Accumulated depreciation is calculated as Depreciable amount equals cost less residual value = `200,000 – `20,000 = `180,000. Annual depreciation = depreciable amount divided by useful life = `180,000 / 10 = `18,000. Accumulated depreciation = `18,000 × No. of years (8) = `144,000. Revision of the useful life to 12 years results in a remaining useful life of 4 years (12 – 8). The revised depreciable amount is `46,000: carrying amount of `56,000 – the revised residual amount of `10,000). Thus depreciation should be charged in future at `11,500 per annum (` 46,000 divided by 4 years).

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CHAPTER 12 REVENUE RECOGNITION (IAS 18) 'Even a slight reduction in revenue can have a significant impact.'

CHAPTER 12 REVENUE RECOGNITION (IAS 18) Revenue manipulation is one of the most common ways of creative accounting ………. Be it Enron or the most recent example of Satyam. And, therefore we need an accounting standard on Revenue Recognition. All accountancy students need to be clear when revenue can be recognized and that revenue is same as 'Gains'.

Excluded from revenue are amounts collected on behalf of others, such as sales taxes, value added tax and money collected on behalf of a principal, in an agency relationship.

OBJECTIVE

K Income is defined in the Framework for the Preparation and Presentation of Financial Statements as increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities. Income encompasses both revenue and gains. K Revenue is income that arises in the course of ordinary activities of an entity and is referred to by a variety of different names including sales, fees, interest, dividends and royalties. The objective of this Standard is to prescribe the accounting treatment of revenue arising from certain types of transactions and events.

This standard must be applied to accounting for revenue from the following transactions and events: (a) the sale of products; (b) the provision of services; and (c) the use by others, of c o r p o ra t e a s s e t s t h a t generate interest, royalties and dividends. This standard supersedes IAS 18, recognition of revenue, adopted in 1982.

K The

primary issue in accounting for revenue is determining when to recognise revenue. Revenue is recognised when it is probable that future economic benefits will flow to the entity and these benefits can be measured reliably. This Standard identifies the circumstances in which these criteria will be met and, therefore, revenue will be recognised. It also provides practical guidance on the application of these criteria.

KEY DEFINITIONS K Revenue

Other than increases from contributions by investors, Revenue is the gross inflow of benefits from ordinary activities, when those inflows result in increases in equity. K Fair value Fair value is the value for which an asset could be sold, or a liability extinguished, between willing, independent traders. K Product The term 'product' includes both those produced by the company to be sold and those acquired for resale to third parties.

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K Service delivery

Service delivery means, a set of tasks agreed on a contract for a fixed in time. The services can be provided in the course of one year or over several years. Some contracts for the provision of services are directly related to construction contracts, including those undertaken by architects or management of projects. Revenue from such contracts is not covered in this standard, but is recorded in accordance with the requirements for construction contracts, is specified in IAS 11, construction contracts. The Standard does not deal with revenue coming from: K Leases (IAS 17) K Dividends

from investments accounted under the equity method (IAS 28)

K Insurance contracts (IF` 4) K Changes

in fair values of financial instruments (IAS 39)

Examples of items not included within the definition of 'Revenue' for the purpose of this standard are: K Realised gains resulting from the disposal of, and unrealized gains resulting from holding of non-current assets. E.g., appreciation in the value of Fixed Assets. K Realised or unrealized gains resulting from changes in Foreign Exchange rates. K Realised gains resulting from the discharge of an obligation at less than its carrying value. K Unrealised gains resulting from the restatement of the carrying amount of an obligation.

K Changes in the values of current assets K Initial recognition and changes in value of biological assets (IAS 41) K Initial recognition of agricultural produce (IAS 41) K Extraction of minerals

Practical Insight Revenue includes only the gross inflows of economic benefits received and receivable by the entity on its own account. Amounts collected on behalf of third parties such as sales taxes, goods and services taxes and value added taxes are not economic benefits which flow to the entity and do not result in increases in equity. Therefore, they are excluded from revenue. Similarly, in an agency relationship, the gross inflows of economic benefits include amounts collected on behalf of the principal and which do not result in increases in equity for the entity. The amounts collected on behalf of the principal are not revenue. Instead, revenue is the amount of commission.

Measurement of Revenue K Revenue is to be measured at the fair value of the consideration received or receivable.

The amount of revenue arising on a transaction is usually determined by agreement between the entity and the buyer or user of the asset. It is measured at the fair value of the consideration received or receivable taking into account the amount of any trade discounts and volume rebates allowed by the entity. A PRACTICAL APPROACH TO IFRS

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Activity 1 PQR Ltd. has arrangements with its customers that, in any 12-month period ending March 31, if they purchased goods for a value of at least ` 1 lakh, they will receive a retrospective discount of 2%. PQR Ltd. closes its books on December 31st every year. It has made sales to a customer during the period April 1 to December 31st of ` 90,000. Required How much revenue should PQR Ltd. recognize? Solution Sales for the period of April to December : ` 90,000 Prospective sales for a period of 12 months ending 31st March : ` 90,000 * 12/9 = ` 1,20,000. Since sales is more than ` 1,00,000, a reterospective rebate of 2% is to be given back to the customers. Therefore, the amount of Revenue to be recognized : 1,20,000 - 1,20,000*2/100 = ` 1,17,600 Activity 2 Nice Guy Inc. sells goods with a cost of ` 1,00,000 to Yellow & Co. for ` 1,40,000 for a credit period of six months, ` 1,25,000 with a credit period of one month or with ` 5,000 discount for cash on delivery. Required How should Nice Guy Inc. measure the income from the transaction? Solution The revenue for this transaction would be the interest income which the company is generating for 6 months. The company is selling goods at `1,40,000 for a credit of 6 months as compared to ` 1,20,000( `1,25,000 – `5,000) for cash down payment. Therefore, the difference between the credit price and the normal price would be the revenue. `1,40,000 - `1,20,000 = `20,000 K What if cash flow from revenue is deferred?

If the inflow of cash or cash equivalents is deferred, the fair value of the consideration may be less than the nominal amount of cash received or receivable. For example, an entity may provide interest free credit to the buyer or accept a note receivable bearing a below-market interest rate from the buyer as consideration for the sale of goods. When the arrangement effectively constitutes a financing transaction, the fair value of the consideration is determined by discounting all future receipts using an imputed rate of interest. K What if transaction is barter?

Only when goods are sold or services are rendered in exchange for dissimilar goods or services, the exchange is regarded as a transaction which generates revenue. A PRACTICAL APPROACH TO IFRS

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K What if revenue is having more than one component?

(a) Recognition criteria are applied to the separately identifiable components of a single transaction in order to reflect the substance of the transaction. Example, when the selling price of a product includes an identifiable amount for subsequent servicing, that amount is deferred and recognised as revenue over the period during which the service is performed. (b) Conversely, the recognition criteria are applied to two or more transactions together. For example, an entity may sell goods and, at the same time, enter into a separate agreement to repurchase the goods at a later date, thus negating the substantive effect of the transaction; in such a case, the two transactions are dealt with together. Identification of a transaction The recognition criteria in this Standard are usually applied separately to each transaction. However, in certain circumstances, it is necessary to apply the recognition criteria to the separately identifiable components of a single transaction in order to reflect the substance of the transaction. Activity 3 Euphoria Ltd. sells equipment of `1,00,000 for `1,50,000 with a guarantee of providing service free of charge. What is the amount of revenue to be recognized? Solution The company would recognize revenue of `1,00,000 for the sale. The balance of `50,000 would be recognized as service revenue over the next two years. Revenue from Sale of Goods Revenue from sale of goods would be recognized on the fulfillment of the following conditions; (a) Entity has transferred to the buyer the significant risks and rewards of ownership of the goods; (b) Entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold; (c) Amount of revenue can be measured reliably; (d) It is probable that the economic benefits associated with the transaction will flow to the entity; and (e) Costs incurred or to be incurred in respect of the transaction can be measured reliably. Retention of significant risks means that the sale will not be recognised. For example: (a) If the contract allows the goods to be returned and you cannot reasonably estimate the probability of return, the sale cannot be recognised until customer acceptance is clear. (b) If installation has not been completed and it is an important part of the contract, recognition does not take place until installation is complete. (c) If the sale is contingent on the buyer deriving revenue from resale of the goods, recognition is deferred. (d) If the seller provides exceptional cover against unsatisfactory performance of the goods (more than is covered by normal warranty provisions). A PRACTICAL APPROACH TO IFRS

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Activity 4 Which of the following situations signify that 'risks and rewards' have not been transferred to the buyer? (a) XYZ Inc. sells goods to ABC Inc. In the sales contract, there is a clause that the seller has an obligation for unsatisfactory performance, which is not governed by normal warranty provisions. (b) Zeta Inc. shipped machinery to a destination specified by the buyer. A significant part of the transaction involves installation that has not yet been fulfilled by Zeta Inc. (c) The buyer has the right to cancel the purchase for a reason not specified in the contract of sale (duly signed by both parties) and the seller is uncertain about the outcome. Solution (a) According to the clause in the sales contract, XYZ Inc. has an obligation beyond the normal warranty provision. Thus 'risks and rewards of ownership' have not been transferred to the buyer on the date of the sale. (b) 'Risks and rewards of ownership' have not been transferred to the buyer on the date of the delivery of the machinery because a significant part of the transaction (i.e., Revenues recognized and the installation) is yet to be done. costs (expenses) associated (c) 'Risks and rewards of ownership' will not be transferred to the buyer due to the 'unspecified uncertainty' arising from the terms of the contract of sale (duly signed by both parties), which allow the buyer to retain the right of cancellation of the sale due to which the seller is uncertain of the outcome.

with them should be matched and recognized simultaneously—this is essential because if costs cannot be measured reliably, then the related revenue should not be recognized. In such a situation, any consideration received from such transactions is booked as a liability.

A transaction is not deemed a sale until it is probable that the future economic benefits will flow to the entity. In some of the cases, the receipt of consideration may be doubtful. Until the uncertainty is removed, the sale should not be recognized. For e.g.: Incase of uncertainty about collectability of revenue booked in an earlier period, then that amount is to be recognized as an expense as opposed to adjusting the previously recognized revenue.

Rendering of Services Revenue from the provision of services should be recognised by referring to the stage of completion at the balance sheet date. The stage of completion, the costs to date, and the costs to complete the transaction should be reliably measurable. For e.g.: K Installation fees are recognized over the period of installation by reference to the stage of completion. K Subscriptions usually are recognized on a straight-line basis over the subscription period. K Insurance agency commissions would be recognized on commencement of the insurance unless the agent is likely to have to provide further services, in which case A PRACTICAL APPROACH TO IFRS

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a portion of the revenue would be deferred to cover the cost of providing that service. K Fees from development of customized software are recognized by reference to stage of completion, including post-delivery support. K Event admission fees are recognized when the event occurs. If subscription to a number of events is sold, the fee is allocated to each event. K Tuition fees would be recognized over the period in which tuition is provided. K Financial

service fees depend on the services that are being rendered. Very often they are treated as an adjustment to the effective interest rate on the financial instrument that is being created. This would be the case for origination and commitment fees. Investment management fees would be recognized over the period of management.

Activity 5 A contractor is constructing a building for a client. Project revenue is `20crore. Costs to date are `6crore, and its estimated that additional costs to completion are `10crore . The client has, so far, only approved `4 crore of the expenditure, as his staff is on holiday for the month. The contractor believes that the `2crore (`6 crore – `4 crore ) will be approved. No payment has been received. Recognise: `4 crore as expense (the amount approved) `5 crore as (accrued) revenue (4/16* `20crore). `2m is left as work in progress. (`6 crore - `4 crore = `2 crore) Cost of sales a/c

DR

`4crore

To work in progress

`4crore

(Being approved amount recorded as expenditure) Accounts receivable a/c

DR

`5crore

To revenue a/c

`5crore

(Being proportionate amount of revenue recognised in accordance with the project revenue and approved expenditure) Revisions to estimates do not mean that the financial outcome of the transaction cannot be reliably measured. Advances and progress payments received from clients may not reflect the stage of completion.

Interest, Royalties and Dividends Revenue arising from the use by others of entity assets yielding interest, royalties and dividends shall be recognised when: A PRACTICAL APPROACH TO IFRS

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(a) It is probable that the economic benefits associated with the transaction will flow to the entity; and (b) Amount of the revenue can be measured reliably.

Disclosure Disclosure includes: Accounting policies used for revenue recognition, including methods of determining the stage of completion of transactions for services. Revenue should be split, to show separately, revenue arising from: 1. Sale of goods. 2. Provision of services. 3. Interest. 4. Royalties. 5. Dividends. 6. Revenue from the exchange of goods, or services, should be identified in each category. 7. Any contingent liabilities, or assets, such as warranty claims should be identified in each category.

Specific Examples of sale of Goods 1.

'Bill and Hold' Buyer takes title but delivery is delayed. The seller recognises Revenue when the buyer takes title, if: 1. delivery will be made 2. the product is identified and ready for delivery 3. delayed delivery is agreed 4. usual payment terms apply.

EXAMPLE You are about to deliver your monthly consignment of goods, when your client's warehouse burns down. He asks you to store them, at his risk, until he can find alternative storage. The title to the good and risk has passed to the customer. Revenue is recognised immediately.

2.

Installation and inspection. Where the contract specifies delivery, installation and inspection, all must be completed to recognise revenue. Exceptionally revenue may be recognised on delivery, if installation and inspection are short and straightforward. A PRACTICAL APPROACH TO IFRS

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EXAMPLE You sell domestic refrigerators to a retail chain.They must be inspected prior to acceptance, but the inspector is ill. None have been rejected in the last 2 years. Revenue can be recognised immediately.

3.

On approval, with a limited right of return. Revenue is recognised upon the buyer's acceptance, or the time for rejection has passed.

EXAMPLE You sell curtains to a retailer.Written notification of rejection must be made within 10 days. At the end of 10 days, if none have been rejected, revenue can be recognised.

4.

Consignment sales and sales using agents. The agent resells the goods before paying the seller. Revenue is recognised when the goods are resold.

STUDENT CORNER It is vital that the point of recognition of revenue is properly determined. There are multiple possibilities even for a single transaction such as sale of goods. Is it revenue when a customer places an order? Is it revenue when the goods are shipped to the customer? Is it revenue when customer receives the goods? Is it revenue when the customer pays? The decision made about when and how revenues are recognized will have a direct impact on the income statement and is therefore a major aspect in determining a company's earnings.

And the really important stuff……..accounting practice (a) Revenue should be measured at the fair value of the consideration received or receivable (b) If the revenue is deferred, it should be measured at present value (c) In a barter transaction, the revenue should be the fair value of the goods received and if incase the fair value cannot be determined reliably, then the fair value of the goods given up should be considered (d) Revenue should be recognized for the sale of goods when a number of criteria are met: K The enterprise has transferred to the buyer the significant risks & rewards of ownership of goods K The enterprise retains no control over the goods sold K The amount of revenue can be measured reliably A PRACTICAL APPROACH TO IFRS

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K It is probable that the economic benefits associated with the transaction will flow to

the enterprise incurred or to be incurred in respect of the transaction can be measured reliably

K The costs

Risks and rewards transferred to the buyer

No control over the goods

When should revenue be recognized in sale of goods?

Probable economic benefits will flow

Costs incurred can be measured reliably

(e) Revenue from services should be recognised over the period of the service provided the following criteria are met: K The amount of revenue can be measured reliably K It is probable that the economic benefits associated with the transaction will flow to

the enterprise K The stage of completion of the transaction at the reporting period can be measured

reliably K The costs incurred and to be incurred to complete the transaction can be measured

reliably

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Can be measured reliably

Probable economic benefits will flow

When should revenue be recognized on provision of a service?

The costs to complete the transaction can be measured reliably

The stage of completion can be measured objectively

(f) Revenue from interest, dividends and royalties should be recognised as follows: Interest

: Time proportion basis reflecting the effective yield on the asset

Royalties

: Accrual basis

Dividends

: Right to receive the payments is established

A typical error made by the students is to take the revenue figure from the trial balance to the income statement without deducting the amount w.r.t sale-or-return basis as this amount should be treated as the cost of goods in inventory

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WORKSHEET The answer closest to that you believe to be correct. 1. Revenue: a) Includes gains. b) Is the gross inflow of economic benefits of the ordinary activities, when those inflows result in increases in equity, other than increases relating to contributions from investors. c) Includes sales taxes and value added tax. 2. Fair Value a) Is the value for which an asset could be sold, or a liability extinguished, between willing, independent traders. b) Is the value agreed between related parties. c) Is based on historical cost. 3. Trade discounts and volume rebates should: a) Be ignored. b) Be subtracted from revenue. c) Be shown in the balance sheet under equity. 4. Where interest-free, long-term credit is given, a) Revenue should not be recognised until cash is received. b) Future receipts should be discounted to net present value. c) A bad debt provision should be created. 5. Where goods are exchanged: a) No bookkeeping is necessary. b) Cash is never involved. c) Revenue is created. 6. A Transaction involves after sales service: a) It is no longer regarded as revenue. b) The revenue relating to the service is spread over the period of the service. c) It is always a credit transaction. 7. Combined transactions, such as a sale and repurchase agreement: a) Are dealt with as one transaction. b) Must be shown separately. c) Are illegal. 8. When is a sale recognised? a) Whenever the seller decides to recognise it. b) At the end of each accounting period. c) When certain conditions have been satisfied. 9. Normal credit risk derived from sales is: a) The best reason to defer revenue recognition. b) Not a reason to defer revenue recognition. c) Detailed in the audit report.

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10. Retention of significant risks means that: a) The sale will not be recognised. b) There is no problem with revenue recognition. c) Insurance is mandatory. 11. If the sale is contingent on the buyer deriving revenue from resale of the goods: a) It should never be recognised as a sale. b) It should receive shareholder approval. c) Recognition is deferred. 12. Where foreign exchange control jeopardises the transfer of the sales proceeds: a) Recognition cannot take place until permission to transfer funds is granted. b) The sale is cancelled. c) A bad debt provision should be created. 13. Once an amount has been recognised in revenue, any risk of non-payment is treated as: a) A reduction in revenue b) A bad, or doubtful debt expense. c) A charge to accounts payable. 14. Where warranties are given to the buyer, the cost of these will be recognised: a) As an expense. b) As a reduction in revenue. c) In the following period. 15. Revenue from the provision of services should be recognised by referring to the: a) Original estimates. b) Payments received in advance. c) Stage of completion at the balance sheet date. 16. The stage of completion, the costs to date, and the costs to complete the transaction should be: a) Ignored. b) Listed in the accounts. c) Reliably measurable. 17. Revisions to estimates: a) Mean that the financial outcome of the transaction cannot be reliably measured. b) Mean that the financial outcome of the transaction can be reliably measured. c) Cancel the transaction. 18. Advances and progress payments received from clients: a) Is proof of the stage of completion. b) May not reflect the stage of completion. c) Should be booked to accounts payable. 19. If the costs will probably be recovered, recognise: a) All revenue. b) Only that amount of revenue, equal to the costs. c) No revenue. A PRACTICAL APPROACH TO IFRS

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20. Interest revenue should be recognised on a: a) Time-proportion basis, reflecting the effective yield of the asset. b) Cash basis. c) Time-proportion basis, reflecting collection periods. 21. Royalties should be recognised on: a) A cash basis. b) An accruals basis. c) An actual basis. 22. Dividends should be recognised: a) On a cash basis. b) On an accruals basis. c) When the shareholder has a legal right to receive payment.

EXERCISE QUESTIONS Decide when, and how much, revenue can be recognised in each of the following situations. Provide debits and credits for your answer, where revenue is recognized. 1.

You are about to deliver your monthly consignment of goods, when your client's delivery service ceases business. He asks you to store them, at his risk, until he can find alternative transport.

2.

You sell carpets to a retail chain. They must be inspected prior to acceptance, but the inspector is ill. None have been rejected in the last 3 years.

3.

You sell radiators to a wholesaler. Written notification of rejection must be made within 30 days.

4.

In April, you supply 40 computers to your agent. The contract is a consignment contract. In November, the agent sells the computers, but you do not receive the money until December.

5.

You sell software via the Internet. Clients can pay on receipt of the software.

6.

You build warehouses. You accept deposits and progress payments, prior to the warehouse being finished. When it is finished, 2% of the total payment remains unpaid, but is likely to be paid soon.

7.

A buyer pays for your goods on the 5th of each month. They are shipped on the 10th of the month, and he accepts delivery on the 15th of each month.

8.

You sell a portfolio of shares in January for `10,000, with a contract to repurchase them for `10,500 in March.

9.

You sell a 5-year subscription to your hardware support service, payable in advance.

10. You sell a machine for `1,00,000, payable in instalments over one year. The rate of interest is 10%. Interest is included in the price.

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11. You sell a hotel, but have committed your firm to repair the drains. Your repairer is away for 2 months. 12. You are installing a telephone network in 20 identical buildings for a client, under a single contract. 13. You sell a photocopier for `30,000, including a year's warranty. The fair value of the warranty is `2,400. The copier will require quarterly services. 14. In July, as an agent, you book a band to appear once in March and once in May at a dance hall. Your commission is `4,000. 15. A client signs an insurance policy, which will give your firm a commission of `5,000. Payments will be made monthly over 2 years. The payments will be collected at the client's home. The commission element of each collection will be `100. 16. You provide a `1,00,000 loan at 12% for 3 years. Interest is paid at the end of each year. Your administration fee is `3,600 and paid in advance. 17. You offer a `1,00,000 loan facility at 15% for 4 years. Interest is paid at the end of each year. Your commitment fee is `4,800 and paid in advance. The loan is drawn down on the 1st day of year 3. 18. You provide a loan for 4 years. You have a service fee of `32,000, payable in advance. Each quarter, you will audit your client's accounts, and review the results, to confirm that there has been no breach of covenant (the loan contract). 19. You organise a syndicated loan for `2,000 million. You provide 5% of the funds. You receive 8% interest, while the other syndicate members receive only 6%. 20. In October, you sell tickets for an exhibition that will take place in December. 21. To become a member of a car club, you have to pay `100 registration fee and `600 annual membership. How does the car club recognise its revenue? 22. As part of the contract, your car service franchisee must buy equipment for the service bays from you. Title passes when the equipment has been installed and has been inspected by the local authorities.

Solutions Answers to Multiple Choice Questions: 1. b) 10. 2. a) 11. 3. b) 12. 4. b) 13. 5. c) 14. 6. b) 15. 7. a) 16. 8. c) 17. 9. b) 18.

a) c) a) b) a) c) c) b) b)

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b) a) b) c)

Answers to Exercise Questions: 1.

Revenue can be recognised immediately. Debit: Account receivable. Credit: Revenue. 2. Revenue can be recognised immediately. Debit: Account receivable. Credit: Revenue. 3. At the end of 30 days, if none have been rejected, revenue can be recognised. Debit: Account receivable. Credit: Revenue (after 30 days) 4. Revenue is recognised in November, when the computers are sold by the agent. Debit: Account receivable. Credit: Revenue (in November). 5. When your agent has received the cash, having delivered the software, the revenue can be recognised. Debit: Cash. Credit: Revenue. 6. If the work is complete, revenue may be recognised. Debit: Account receivable, deferred revenue. Credit: Revenue. 7. Recognise revenue when the goods are accepted. Debit: Deferred revenue. Credit: Revenue. 8. This is primarily a finance transaction, and no revenue should be recognised. 9. Divide the revenue by 60 and recognise 1/60 of the revenue each month. Debit: Cash. Credit: Deferred revenue (on day 1). Debit deferred revenue. Credit Revenue (monthly). 10. Recognise immediately revenue of `90,909 (100,000/110%) and interest receivable of `9,091, matched by an accounts receivable of `100,000. Debit: Accounts receivable `100,000. Credit: Revenue `90,909, Interest receivable `9,091. 11. Defer recognition of the sale until the drains are repaired. Debit: Cash. Credit: Deferred revenue. 12. Recognise 5% of revenue on completion of installation in each building. Debit: Account receivable. Credit: Revenue (for each installation). 13. Recognise `27,600 as revenue for the sale immediately, and `600 as service revenue when the photocopier has each service. Debit: Cash `30,000. Credit: Revenue `27,600, Deferred revenue `2,400. Recognise `2,000 each time the band appears. Debit: Account receivable `2,000. Credit: Deferred revenue `2,000 each time. 15. Recognise commission of `2,600 now, and `100 each time payment is collected. Debit: Account receivable `5,000. Credit: Revenue `2,600, Deferred revenue `2,400. 16. Accrue interest monthly, and recognise the fees monthly ( `100 each month). Debit: Loan receivable `100,000, Cash `3,600. Credit: Cash `100,000, Deferred revenue `3,600 (on day 1). Debit: Account receivable `1,000, deferred revenue `100. Credit: Interest receivable `1,000, fee income `100 (monthly).

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17. Accrue interest monthly in years 3 and 4 and recognise `200 of fees each month in years 3 and 4. Debit Account receivable `4,800, Credit: Deferred revenue `4,800 (on day1). Debit: Loan receivable `1,00,000, Credit: Cash `1,00,000 (on drawdown). Debit: Account receivable `1,250, deferred revenue `200. Credit: Interest receivable `1,250, fee income `200 (monthly after drawdown). 18. Recognise `2,000 of fee income on completion of each review. Debit: Cash `32,000, Credit: Deferred revenue `32,000 (on day1). Debit: Deferred revenue `2,000. Credit: Fee Income `2,000 (after review). 19. Each year, you record `6 million as interest receivable and `2 million as syndication fees. Debit: Loan receivable `100 million. Credit: Cash `100 million(on day1). Debit: Cash `8 million. Credit: Interest receivable `6 million, fees `2 million (when interest is received) 20. Revenue will be recognised after the exhibition in December. Debit: Cash. Credit: Deferred revenue (in October). 21. The `100 can be recognised as the car club's revenue when you are registered. The membership fee will be recognised at the rate of `50 per month. Debit: Cash `700, Credit: Revenue `100, Deferred revenue `600. 22. Recognise the sale when the inspection has been satisfactorily completed. Debit: Account receivable. Credit: Deferred revenue (on day1). Debit: Deferred revenue. Credit: Revenue (after inspection).

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CHAPTER 13 PROVISIONS, CONTINGENT ASSETS AND CONTINGENT LIABILITIES (IAS 37) 'The prudent businessmen often sets up reserves to create provisions and cover contingent liabilities.'

CHAPTER 13 PROVISIONS, CONTINGENT ASSETS AND CONTINGENT LIABILITIES Traditionally, there were no rules w.r.t accounting for provisions and contingencies. The rule followed by the accountants was that of 'Prudence',ie To make provisions for all known liabilities and expected losses and ignore all probable gains and profits. This concept was used by the accountants as one of the most powerful weapons in the manipulation of profits. Maybe what the accounting profession needs is the concept of 'unfudgeability'!!!- a reminder that accounts are meant to fairly report profit as it is, rather than a 'fudged, figure. Well, we haven't got a concept of unfudgeability but what we have is an accounting standard covering provision accounting.

OBJECTIVE

So……………………what are the key objectives?

The objective of IAS 37 is to provide recognition criteria and measurement bases for provisions, contingent liabilities and contingent assets, and to specify the information to be disclosed in the notes to the financial statements to enable users to understand the provisions made. And, this standard is applicable to: All undertakings in accounting for provisions, contingent liabilities and contingent assets, except: i those resulting from financial instruments, that are carried at fair value; ii those arising in insurance undertakings from contracts with policyholders (IFRS 4); and iii those covered by another Standard.

KEY DEFINITIONS The following terms are used in IAS 37: A provision is a liability of uncertain timing, or amount. A liability is an obligation arising from past events. An obligating event is an event that creates a legal, or constructive obligation. A legal obligation is an obligation that derives from: i a contract through its explicit, or implicit terms; or ii legislation. A constructive obligation is an obligation where: i by practice, policies or a statement, the undertaking has indicated that it will accept certain responsibilities; and ii the undertaking has created an expectation that it will discharge those responsibilities. A contingent liability is: i a possible obligation that arises from past events, and whose existence will be confirmed by the occurrence, or non-occurrence, of uncertain future events; or ii a present obligation that arises from past events, but is not recorded because:

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a. it is not probable that payment will be required to settle the obligation; or b the amount of the obligation cannot be measured A contingent asset is a possible asset, that arises from past events, and whose existence will be confirmed by the occurrence or non-occurrence of uncertain future events. An onerous contract is a contract in which the costs of the obligations exceed the benefits to be received. A restructuring is a programme that is planned, and controlled, by management, and significantly changes either: i the scope of a business; or ii the manner in which that business is conducted Now, when should the provision be recognised… (The Three Conditions) Provisions should be recognized if, and only if, all of these conditions are met: (a) An entity has a present obligation-legal or constructive resulting from a past event; (b) It is probable that an outflow of resources embodying economic benefits would be required to settle the obligation; and (c) A reliable estimate can be made of the amount of the obligation.

Important Considerations: (a) Present obligation from past event Financial statements deal with the financial position at the end of a reporting period, and not its possible position in the future. No provision is recorded for costs that need to be incurred to operate in the future. The only liabilities recorded are those that exist at the balance sheet date.

A constructive obligation is an obligation where: i by past practice, policies or statements, the undertaking has indicated that it will accept certain responsibilities; and ii as a result, the undertaking has created an expectation that it will discharge those responsibilities. EXAMPLE A company has a written policy to meet proven environmental claims, without going to court. This is a constructive obligation. Here, the written policy of the company creates an expectation that the company will pay and not the legal laws.

EXAMPLE (i) You buy a school, and plan to open10 more schools. No provision is made for these new schools, as there is no obligation arising from past events.

EXAMPLE ii) XYZ Co. has been sued for `25 lakhs for environmental damage and will have to pay this amount in full. It will also have to pay `10 lakhs to retrain staff, and buy new machines, to avoid incurring further legal action. In this case, only the `25 lakhs should be included as provision because `10 lakhs relates to future operating costs. The journal entry would be: A PRACTICAL APPROACH TO IFRS

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Environmental damage a/c Dr

25,00,000

To Provision for Environmental a/c 25,00,000 (Being provision created on account of settlement as against environmental damage a/c)

iii) PQR Ltd. has been told that new regulations will require it to install ventilation equipment in the factory, in the next period, for the products that the company is currently making. Here, record the expenditure when it is incurred, not make a provision in advance.

Future operating expenditure is not an obligation. It should be accounted for in future periods.

iv) Kumar sells mobile phones. He has set up a warranty provision for claims, generated from the sale of mobile phones. He does not know who will make a claim, only that around 10% of claims will be made, relating to goods already sold. The sale of mobiles during last year were `20,00,000. In this case, the provision would be created on `20,00,000 @10%. The journal entry will be: Warranty Costs a/c

Dr

2,00,000

To Provision for product warranties

2,00,000

(Being provision created on account of warranties given at the time of sale. )

v) In December, your board decided to close your book distribution division. In January, the plans were announced to the staff concerned. No provision should be made in the December accounts, as no start had been made at or before the balance sheet date, nor had any announcement been made. However, this may be considered to be a postbalance sheet event and disclosures may be needed to comply with IAS 10.

b)

At what amounts the provisions be recorded? The amount to be recognized as a provision is the best estimate of the expenditure required to settle the present obligation at the balance sheet date. While a reliable

A management, or board, decision does not give rise to a constructive obligation at the balance sheet date, unless the decision has been communicated before the balance sheet date to those affected by it, in order to raise an expectation that the undertaking will discharge its responsibilities.

'Best estimate' is a matter of judgment and is usually based on past experience with similar transactions, evidence provided by technical or legal experts, or additional evidence provided by events after the balance sheet date.

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estimate is usually possible, in rare circumstances, it may not be possible to obtain a reliable estimate. In such cases, the liability is to be disclosed as a contingent liability (and not recognized as a provision).

EXAMPLE Krishna sells car batteries. He wants to set up a warranty provision for claims, generated from the sale of car batteries. History tells that the claims generated by last year's sales will cost between `5 lakh and `10 lakh. The most likely figure will be `8 lakh. This should be recorded as the provision. The journal entry will be; Warranty Costs a/c

Dr

8,00,000

To Provision for product warranties 8,00,000 (Being provision created on account of warranty given on sale of batteries.)

EXAMPLE An undertaking sells goods, with a warranty for the cost of repairs of any manufacturing defects that become apparent within the first six months after purchase. If minor defects were detected in all products sold, repair costs of `1 lakh would be incurred. If major defects were detected in all products sold, repair costs of `4 lakh would be incurred. The undertaking's past experience and future expectations indicate that, for the coming year, 75 per cent of the goods sold will have no defects, 20 per cent of the goods sold will have minor defects and 5 per cent of the goods sold will have major defects. The undertaking assesses the probability of the warranty obligations as a whole. The expected value of the cost of repairs is: (75% of nil )+ (20% of `1,00,000)+ (5% of `4,00,000) = `40,000 The journal entry will be: Warranty costs a/c Dr

40,000

To Provision for product warranties 40,000 (Being provision created on account of warranty given on sale of goods)

c)

Can the amount of provisions be changed? The answer is YES. Changes in provisions has to be reviewed at each balance sheet date, and the amount of the provision should be adjusted accordingly to reflect the current best estimate. When it is no longer probable that outflow of resources would be required to settle the obligation, the provision should be reversed. A provision

In the past, entities used to rationalize a shortfall in a provision based on the premise that for the same time period, there were more than required amounts provided as provisions in other cases. In other words, a shortfall in one provision was justified (and not adjusted) because it was balanced by excess in another provision. This practice would not be possible now

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should be used only for the purpose for which it was originally recognized or set up.

Provisions – Specific Situations (a) Onerous Contracts An onerous contract is one in which the unavoidable costs of meeting the obligations under the contract, exceed the benefits expected to be received under it.

since IAS 37 categorically states that a provision should be used for the purpose for which it was initially created or recognized. Furthermore, IAS 37 also mandates that changes in provisions shall be reviewed at each balance sheet date and the amount of p rov i s i o n s h o u l d b e a d j u s t e d accordingly to reflect the current best estimate.

If an undertaking has a contract that is onerous, the present obligation under the contract should be recorded and measured as a provision.

EXAMPLE M&N co. provide electricity to commercial and domestic clients. The government has instructed the company to cut domestic charges by 5% and fix the price for 2 years. This will cost `20 lakh, as the cost of your supplies cannot be reduced. This is an onerous contract, and a provision should be made for the loss of `20lakh. (b) Restructuring A restructuring is a program that is planned and controlled by management, and significantly changes either the scope of a business or the manner in which that business is conducted. For e.g.: K Sale or termination of a line of business. K Closure

In the past, entities used to accrue lump-sum provisions for restructuring, because there were no Standards governing this important area. In some cases, this led to abusive practices of manipulation and creative accounting. In order to control the practice of dumping of all kinds of provisions under the banner of provision for restructuring, IAS 37 prescribed rules to regulate it.

of business locations in a region or relocation of business activities from one location to another. K Changes in management structure, such as elimination of a layer of management. K Fundamental reorganization of the entity such that it has a material and a significant impact on its operations. A decision taken by the board of A restructuring provision can be created only on d i re c t o r s c o n t e m p l a t i n g o n a the fulfillment of the following conditions; restructuring program which is not communicated to the parties affected (i) The entity has a detailed formal plan for by the decision would not by itself give the restructuring. rise to a constructive obligation. Thus (ii) Has raised valid expectations in the communication of the decision to minds of those affected that the entity parties affected is a prerequisite if an will carry out restructuring by starting entity wants to make a provision for to implement that plan or announcing 'restructuring' on the basis of a constructive obligation. its main features to those affected by it. A PRACTICAL APPROACH TO IFRS

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EXAMPLE Grey is a food and drink manufacturer. Due to some operational problems he decides to dispose of the food manufacturing at a net cost of `10lakh. This reduces the scope of his business. Is there a need to create a provision? The provision would be created on satisfying the following conditions; (a) There should be a detailed formal plan of restructuring. (b) This should have raised valid expectations in the minds of those affected that the entity would carry out the restructuring by announcing the main features of its plans to restructure. If the above conditions are met, then provision should be recorded as follows; Restructuring costs a/c Dr 1,00,0000 To Provision for restructuring 1,00,000 (Being provision created on account of restructuring)

Disclosures Incase of Provisions For each class of provision, an entity should disclose: G The carrying amount at the beginning and the end of the period. G Additional provisions made in the period, including increases to existing provisions. G Amounts utilized during the period. G Unused amounts reversed during the period. G A brief

description of the nature of the obligation and the expected timing of any resulting outflows of economic benefits.

Contingent Liabilities A contingent liability is: i

a possible obligation that arises from past events, and whose existence will be confirmed by the occurrence, or non-occurrence, of uncertain future events;

EXAMPLE Brown has given a performance guarantee of his agent, that services will be successfully supplied to his client, for one year. While he hopes that there will be no claim, there is a risk that the agent will not perform satisfactorily, and a claim will be made. He will not know until either a claim is made, or a year has elapsed. This will create a contingent liability based on the risk assessment. or ii

a present obligation that arises from past events, but is not recorded because: A PRACTICAL APPROACH TO IFRS

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a. it is not probable that payment will be required to settle the obligation; or b. the amount of the obligation cannot be measured.

EXAMPLE You are being sued for `30 lakh for damages that were claimed to have been caused by your aircraft components. You dispute the claim. It is unclear whether, or not you will be liable. If you are found liable, it is unlikely that you would have to pay the claim in full. The uncertainties make the claim a contingent liability.

You should not record a contingent liability in the balance sheet. You should disclose a contingent liability in the notes, unless the possibility of payment is remote.

EXAMPLE Every year, for the last 5 years, the government has said that it will levy a 'windfall' tax on banks. It has yet to do so. Unless the government takes further steps to enact the tax collection, no contingent liability should be recorded, based on the anticipation that the government is unlikely to act.

Relationship between Provisions and Contingent Liabilities All provisions are contingent, as they are uncertain in timing or amount. Here, the term 'contingent' is used for liabilities, and assets, that are not recorded in the balance sheet, as their existence will be confirmed only by the occurrence or non-occurrence of uncertain future events. In addition, the term 'contingent liability' is used for liabilities that do not meet the recognition criteria.

IAS 37 distinguishes between: i

provisions - which are recorded as liabilities because they are present obligations, and it is probable that payment will be made to settle them

ii

contingent liabilities - which are not recorded on balance sheet as liabilities, as they are either: i

possible obligations, as it has yet to be confirmed whether there is an obligation; or

ii

obligations that do not meet the criteria in IAS 37 as either it is not probable that payment will be required, or an estimate of the obligation cannot be made.

Contingent liabilities are assessed continually to determine whether settlement has become probable. If it becomes probable that payment will be required for an item previously dealt with as a contingent liability, a provision is recorded in the financial statements of the period in which the change in probability occurs.

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EXAMPLE Contingent Liability which becomes a provision You are being sued for `40 million, for product liability. In 2XX8, you recognise a contingent liability, as you believe that the there is only a remote chance that you will have to pay. In 2XX9, the court decides the case against you, and the `40 million is changed to a provision.

Contingent Assets Contingent assets arise from unplanned events that give rise to the possibility of an inflow of benefits. A contingent asset is disclosed where an inflow of benefits is probable. An example is a claim being pursued through legal processes, where the outcome is uncertain but likely to be in favour of the entity. Contingent asset are recorded off balance sheet as the income that may never be realised.

EXAMPLE You have made a claim for `50 million compensation against your insurance company. The claim has gone to court. Similar claims against the same company have also gone to court, and then been paid. Treat this as a contingent asset. When the realisation of income is virtually certain, the related asset is not a contingent asset, and income should be recorded.

EXAMPLE Your claim for `50 lakh compensation against your insurance company has been successful. The company has asked for time to pay, but you do not believe there is any serious risk of a bad debt. Treat this as income. Account receivables a/c Dr 50,00,000 To P & L a/c 5,00,000 (Being income recognized) The requirements in relation to contingent assets and liabilities as summarized in the following table: Degree of Probability

Liability of Uncertain Timing or Amount

Asset of Uncertain Timing or Amount

Virtually certain (therefore not contingent)

Make provision (receivable)

Recognise

Probable

Make Provision

Disclose by note (contingent asset)

Possible

Disclose by note (contingent liability)

No disclosure

Remote

No disclosure

No disclosure

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When there is the possibility of the recovery from a third party of all or part of a contingent liability, this must be treated as a separate matter, and a contingent asset is only recognized if its receipt is virtually certain as shown in the above table.

Disclosure Key disclosures include: K The movements in all classes of provision over the period K The

nature of the provision and any uncertainties and assumptions used in recognizing and measuring it

K For

contingent liabilities, the nature of the liability, the uncertainties surrounding it and the possible financial effect

STUDENT CORNER Ideally companies like to present a pattern of 'earnings' showing that in this period the company actually did a little better than in the previous period. This gives an impression of 'quality earnings', ie. the management is doing a great job. Although, it creates a good image but also generates additional pressure on the companies to deliver a better performance in the next year. Instead of reporting such profits it is normal for companies to start to forsee 'future costs'. Under the guise of 'prudence', they were able to 'slush' these excess profits on the balance sheet using a general provision. These non-specific provisions are often referred as 'big bath' provisions, are now outlawed by IAS 37. Once these provisions were created on the balance sheet, companies used them to create endless periods of 'good news'. Instead of starting income statements at the top with revenue and deducting costs to calculate profit, it was possible to decide from the bottom, what you wanted profit to be. By releasing some of the provision it was easy to directly manipulate profit.

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And the really important stuff…….accounting practice K Provisions should be recognized when:

(a) An entity has a present obligation ( either legal or constructive) arising as a result of past events (b) It is probable that a transfer of economic benefits will be required to settle the obligation and (c) The obligation can be measured reliably K If material to the amount of the provision, the amount should be deducted from it K Contingent liabilities should not be recognized in the financial statements, however disclosure should be made unless the possibility of the transfer of economic benefits is remote K Contingent assets should not be recognized, and disclosure is only allowed if the possible profit is considered probable. Virtually certain profits could be recognized in the financial statements.

When deciding if a provision should be recognized, an entity should determine whether the future expenditure should be avoided. If the future expenditure can be avoided no provision should be made.

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WORKSHEET 1. 'Profit smoothing' often involves: (a) Contingent assets. (b) Contingent liabilities. (c) Provisions. 2. Product service warrantees are: (a) Contingent assets. (b) Contingent liabilities. (c) Provisions. 3. IAS 37 provisions include: (a) Depreciation. (b) Impairment of assets. (c) Doubtful debts. (d) Environmental provisions. 4. A provision is : (a) A liability of uncertain timing, or amount. (b) An obligation arising from past events. (c) An event that creates a legal, or constructive obligation. 5. A liability is: (a) A liability of uncertain timing, or amount. (b) An obligation arising from past events. (c) An event that creates a legal, or constructive obligation. 6. An obligating event is: (a) A liability of uncertain timing, or amount. (b) An obligation arising from past events. (c) An event that creates a legal, or constructive obligation. 7. A contract in which the costs exceed the benefits is: (a) An onerous contract. (b) A contingent liability. (c) A contingent asset. 8. Provisions are reported: (a) As part of trade payables. (b) As part of accruals. (c) Separately. 9. A constructive obligation: (a) Only relates to construction contracts. (b) Arises when you indicate that you accept certain responsibilities. (c) Arises from a legal duty. 10. A provision is recorded: (a) For a present obligation. (b) For a future obligation.

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(c) For a future obligation, if the possibility of a penalty is remote. 11. If the possibility of a penalty is remote: (a) Do nothing. (b) Record a contingent liability. (c) Record a provision. 12. The cost of transfer of a liability to a third party is used to: (a) Value a contingent liability. (b) Value a contingent asset. (c) Value a provision. 13. Discount rates should be: (a) Pre-tax. (b) Post-tax. (c) Changed annually. 14. Gains from disposal of assets should: (a) Be taken into account in provisions. (b) Be taken into account in provisions, only if closely linked to the event giving rise to the provision. (c) Not be taken into account in provisions. 15. If it is no longer probable that payment relating to a provision will be required: (a) The provision should be used for other liabilities. (b) The provision should be reversed. (c) The provision should be replaced by a contingent liability. 16. Future operating losses indicate a need to: (a) Test for impairment. (b) Consider making a provision. (c) Consider making a contingent liability. 17. Onerous contracts indicate a need to: (a) Test for impairment. (b) Consider making a contingent asset. (c) Consider making a contingent liability. 18. Examples of restructuring are: i sale, or termination, of a line of business; ii the closure of business locations in a country or region, or the relocation of business activities from one country or region to another; iii changes in management structure; iv fundamental reorganisations, that have a material impact on the nature, and focus, of the undertaking's operations; v change of company name. (a) i+iii+iv (b) i – iii (c) i – iv (d) i-v A PRACTICAL APPROACH TO IFRS

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19. A constructive obligation to restructure only arises when: (a) There is a formal plan. (b) There is an expectation that there will be restructuring. (c) Both 1 +2. 20. In November, your board decides to restructure the group. In December, the plan is finalised. In January it is announced. The group has a constructive obligation in: (a) November. (b) December. (c) January. 21. In November, your board decides to restructure the group. In December, the plan is finalised. In January it is announced. A provision can be considered in: (a) November. (b) December. (c) January. 22. When a sale is only part of a restructuring, but there is no binding sale agreement: (a) No constructive obligation arises. (b) A constructive obligation can arise for the other parts of the restructuring. (c) A constructive obligation arises from the decision to sell the business. 23. A restructuring provision covers: (a) Retraining, or relocating continuing staff. (b) Marketing. (c) Investment in new systems and distribution networks. (d) Redundancy costs. 24. A restructuring provision: (a) Does not cover future operating losses. (b) Covers reasonable future operating losses. (c) Does not cover future operating losses, unless they relate to an onerous contract. 25. A provision should be recorded when: (a) An undertaking has a present obligation legal, or constructive. (b ) It is probable that payment will be required. (c) An estimate can be made of the obligation. (d) 1-3 are all present. 26. If there is a present obligation to pay money, you should record a: (a) Contingent asset. (b) Contingent liability. (c) Provision. 27. If there is no present obligation, but one is highly likely, you should record: (a) Nothing. (b) A contingent liability. A PRACTICAL APPROACH TO IFRS

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(c) A provision. 28. If there is no present obligation, but one is highly unlikely, you should record: (a) Nothing. (b) A contingent liability. (c) A provision. 29. Warranty claims normally generate a: (a) Contingent asset. (b) Contingent liability. (c) Provision. 30. Provisions should be: (a) Exact amounts only. (b) Estimates only. (c) Either exact amounts or estimates. 31. Provisions are stated: (a) Before tax. (b) After tax. (c) Both before and after tax. 32. Future events will impact the size of provision if: (a) They involve anticipated completely new technology. (b) They involve cost reductions supported by experts. (c) They are normal trading losses. 33. Reimbursements should be booked when: (a) Notified. (b) When it is virtually certain that the money will be received. (c) When you receive the cash. 34. Reimbursements should be recorded as: (a) A reduction of the provision liability. (b) An expense. (c) A separate asset. 35. A contingent liability is: (a) A possible obligation that arises from past events. (b) A specific obligation that arises from past events. (c) A possible obligation that arises from future events. 36. Joint and several liability. You and your partners are liable for `100 million of environmental damages. The case has been brought against you, but your partners will reimburse you for `60 million. You record: (a) A provision of `100 million. (b) A contingent liability for `100 million. (c) You make a provision for `40 million, and a contingent liability for `60 million.

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37. Contingent asset is recorded when cash inflows are: (a) Received. (b) Virtually certain. (c) Probable. 38. When can a 'provision' be recognized in accordance with IAS 37? (a) When there is a legal obligation arising from a past (obligating) event, the probability of the outflow of resources is more than remote (but less than probable), and a reliable estimate can be made of the amount of the obligation. (b) When there is a constructive obligation as a result of a past (obligating) event, the outflow of resources is probable, and a reliable estimate can be made of the amount of the obligation. (c) When there is a possible obligation arising from a past event, the outflow of resources is probable, and an approximate amount can be set aside toward the obligation. (d) When management decides that it is essential that a provision be made for unforeseen circumstances and keeping in mind this year the profits were enough but next year there may be losses. 39. A competitor has sued an entity for unauthorized use of its patented technology. The amount that the entity may be required to pay to the competitor if the competitor succeeds in the lawsuit is determinable with reliability, and according to the legal counsel it is less than probable (but more than remote) that an outflow of the resources would be needed to meet the obligation. The entity that was sued should at yearend: (a) Recognize a provision for this possible obligation. (b) Make a disclosure of the possible obligation in footnotes to the financial statements. (c) Make no provision or disclosure and wait until the lawsuit is finally decided and then expense the amount paid on settlement, if any. (d) Set aside, as an appropriation, a contingency reserve, an amount based on the best estimate of the possible liability. 40. A factory owned by XYZ Inc. was destroyed by fire. XYZ Inc. lodged an insurance claim for the value of the factory building, plant, and an amount equal to one year's net profit. During the year there were a number of meetings with the representatives of the insurance company. Finally, before year-end, it was decided that XYZ Inc. would receive compensation for 90% of its claim. XYZ Inc. received a letter that the settlement check for that amount had been mailed, but it was not received before year-end. How should XYZ Inc. treat this in its financial statements? (a) Disclose the contingent asset in the footnotes. (b) Wait until next year when the settlement check is actually received and not recognize or disclose this receivable at all since at year-end it is a contingent asset. (c) Because the settlement of the claim was conveyed by a letter from the

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insurance company that also stated that the settlement check was in the mail for 90% of the claim, record 90% of the claim as a receivable as it is virtually certain that the contingent asset will be received. (d) Because the settlement of the claim was conveyed by a letter from the insurance company that also stated that the settlement check was in the mail for 90% of the claim, record 100% of the claim as a receivable at year-end as it is virtually certain that the contingent asset will be received, and adjust the 10% next year when the settlement check is actually received. 41. The board of directors of ABC Inc. decided on December 15, 20XX, to wind up international operations in the Far East and move them to Australia. The decision was based on a detailed formal plan of restructuring as required by IAS 37. This decision was conveyed to all workers and management personnel at the headquarters in Europe. The cost of restructuring the operations in the Far East as per this detailed plan was `2 million. How should ABC Inc. treat this restructuring in its financial statements for the year-end December 31, 20XX? (a) Because ABC Inc. has not announced the restructuring to those affected by the decision and thus has not raised an expectation that ABC Inc. will actually carry out the restructuring (and as no constructive obligation has arisen), only disclose the restructuring decision and the cost of restructuring of `2 million in footnotes to the financial statements. (b) Recognize a provision for restructuring since the board of directors has approved it and it has been announced in the headquarters of ABC Inc. in Europe. (c) Mention the decision to restructure and the cost involved in the chairman's statement in the annual report since it a decision of the board of directors. (d) Because the restructuring has not commenced before year-end, based on prudence, wait until next year and do nothing in this year's financial statements.

ANSWER 1. (c) 5. (b) 9. (b) 13. (a) 17. (a) 21. (c) 25. (d) 29. (c) 33. (b) 37. (c) 41. (a)

2. 6. 10. 14. 18. 22. 26. 30. 34. 38.

(b) (c) (a) (b) (c) (b) (c) (c) (c) (b)

3. 7. 11. 15. 19. 23. 27. 31. 35. 39.

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(d) (a) (a) (b) (c) (d) (b) (a) (a) (b)

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4. 8. 12. 16. 20. 24. 28. 32. 36. 40.

(a) (c) (c) (a) (c) (c) (a) (b) (c) (c)

CHAPTER 14 INTANGIBLE ASSETS (IAS 38) 'There are far many more assets in a company than those that come up on the financial statement. Managing a company successfully involves much more than just managing the stuff on the balance sheet.'

CHAPTER 14 INTANGIBLE ASSETS ( IAS 38) All successful companies will have assets that are classified as intangibles ie, without physical substance. Initially, way back in 1988 a new trend started...... to capitalise internally generated brands onto the balance sheet. As a result, the net asset value of the companies as per the balance sheet was much higher than the actual value which was many a times used as an eye wash for the investors and general public to increase the reputation of the companies. To prevent such a practice and regulate intangible assets IAS 38 was created. IAS 38 does not apply to: (i) intangible assets held for sale, in the ordinary course of business . (ii) deferred tax assets (iii) leases that fall within the scope of IAS 17 Leases (iv) assets arising from employee benefits (v) goodwill arising on a business combination (vi) financial assets, as defined in IAS 27, IAS 28, IAS 31, IAS 39 (vii) the recognition and measurement of exploration and evaluation assets, mineral rights and expenditure on the exploration for, or development and extraction of, minerals, oil, natural gas and similar non-regenerative resources (viii) non-current intangible assets classified as held for sale (or included in a disposal group that is classified as held for sale) in accordance with IFRS 5 (ix) deferred acquisition costs, and intangible assets arising in insurance undertakings, from contracts with policyholders.

OBJECTIVE

The objective of this standard is to prescribe the accounting treatment for intangible assets that are not dealt with specifically in another standard. This standard requires an entity to recognise an intangible asset if, and only if, specified criteria are met. The standard also specifies how to measure the carrying amount of intangible assets and requires specified disclosures about intangible assets. Common examples of intangible assets are computer software, patents, copyrights, motion picture films, customer lists, mortgage servicing rights, fishing licenses, import quotas, franchises, customer or supplier relationships, customer loyalty, market share, and marketing rights. IAS 38 defines the criteria for asset recognition, specifies how carrying amounts should be measured in subsequent periods, and provides guidance on required disclosures.

KEY DEFINITIONS The following terms are used in IAS 38: An intangible asset is an identifiable non-monetary asset, without physical substance.

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An active market is a market where all the following conditions exist: (i) the items traded within the market are homogeneous (ii) willing buyers and sellers can normally be found at any time (iii) prices are available to the public. The agreement date for a business combination is the date when a substantive agreement between the parties is reached and in the case of publicly listed undertakings, announced to the public. In the case of a hostile takeover, the earliest date that a substantive agreement is reached is on the date when a sufficient number of the acquiree's owners have accepted the acquirer's offer for the acquirer to obtain control of the acquiree. Amortisation is the systematic allocation of the depreciable amount of an intangible asset over its useful life. An asset is a resource: (i) controlled by an undertaking (ii) from which future benefits are expected to flow. Carrying amount is the amount at which an asset is recorded in the balance sheet, after deducting any accumulated amortisation and accumulated impairment losses. Cost is the amount of money paid to acquire an asset. Depreciable amount is the cost, or valuation of an asset, less its residual value. Development is the application of research findings, or other knowledge, to a plan, or design, for the production of new (or substantially improved) materials, devices, products, processes, systems or services, prior to the start of commercial production, or use. Fair value is the amount for which an asset could be exchanged between knowledgeable, independent parties. An impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable amount. Monetary assets are money held and assets to be received, in fixed or determinable amounts of cash or cash equivalents. Research is original and planned investigation, undertaken with the prospect of gaining new scientific, or technical knowledge and understanding. Residual value is the net amount that an undertaking expects to obtain for an asset at the end of its useful life, after deducting the expected costs of disposal.

Recognition and measurement The recognition of an item as an intangible asset requires an entity to demonstrate that the item meets: (a) the definition of an intangible asset; and (b) the recognition criteria. This requirement applies to costs incurred initially to acquire or internally generate an intangible asset and those incurred subsequently to add to, replace part of, or service it. An asset is identifiable if it either: (a) is separable, ie.is capable of being separated or A PRACTICAL APPROACH TO IFRS

If an intangible asset is acquired in a business combination, the cost of that intangible asset is its fair value at the acquisition date. If an asset acquired in a business combination is separable or arises from contractual or other legal rights, sufficient information exists to measure reliably the fair value of the asset. In accordance with this Standard and IFRS 3 (as

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divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, identifiable asset or liability, regardless of whether the entity intends to do so; or (b) arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations. An intangible asset shall be recognised if, and only if: (a) it is probable that the expected future economic benefits that are attributable to the asset will flow to the entity; and

revised in 2008), an acquirer recognises at the acquisition date, separately from goodwill, an intangible asset of the acquiree, irrespective of whether the asset had been recognised by the acquiree before the business combination. This means that the acquirer recognises as an asset separately from goodwill an in-process research and development project of the acquiree if the project meets the definition of an intangible asset.

(b) the cost of the asset can be measured reliably. The probability recognition criterion is always considered to be satisfied for intangible assets that are acquired separately or in a business combination. An intangible asset shall be measured initially at cost. The cost of a separately acquired intangible asset comprises: (a) its purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates; and (b) any directly attributable cost of preparing the asset for its intended use.

Internally generated intangible assets Internally generated goodwill shall not be recognised as an asset. No intangible asset arising from research (or from the research phase of an internal project) shall be recognised. Expenditure on research (or on the research phase of an internal project) shall be recognised as an expense when it is incurred. An intangible asset arising from development (or from the development phase of an internal project) shall be recognised if, and only if, an entity can demonstrate all of the following: (a) the technical feasibility of completing the intangible asset so that it will be available for use or sale. (b) its intention to complete the intangible asset and use or sell it. A PRACTICAL APPROACH TO IFRS

No intangible asset arising from research (or from the research phase of an internal project) shall be recognised. Expenditure on research (or on the research phase of an internal project) shall be recognised as an expense when it is incurred.

The cost of an internally generated asset comprises all expenditure creating, producing and preparing the asset for its intended use including: (i) expenditure on materials and services used in generating the asset (ii) the employment costs of personnel directly engaged in producing the asset (iii) any expenditure that is directly attributable to the asset, such as fees to register a legal right and the amortisation of patents and licences (iv) o v e r h e a d s t h a t a r e necessary to generate the asset (v) interest.

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(c) its ability to use or sell the intangible asset. (d) how the intangible asset will generate probable future economic benefits. Among other things, the entity can demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset. (e) the availability of adequate technical, financial and other resources to complete the development and to use or sell the intangible asset. (f) its ability to measure reliably the expenditure attributable to the intangible asset during its development. Internally generated brands, mastheads, publishing titles, customer lists and items similar in substance shall not be recognised as intangible assets. The cost of an internally generated intangible asset is the sum of expenditure incurred from the date when the intangible asset first meets the recognition criteria. Reinstatement of expenditure previously recognised as an expense is prohibited. Expenditure on an intangible item shall be recognised as an expense when it is incurred unless: (a) it forms part of the cost of an intangible asset that meets the recognition criteria; or (b) the item is acquired in a business combination and cannot be recognised as an intangible asset. If this is the case, it forms part of the amount recognised as goodwill at the acquisition date (see IFRS 3).

Measurement after Initial Recognition An entity shall choose either the cost model or the revaluation model as its accounting policy. If an intangible asset is accounted for using the revaluation model, all the other assets in its class shall also be accounted for using the same model, unless there The revaluation treatment does not allow : is no active market for those assets. (i) t h e r e v a l u a t i o n o f Cost model: After initial recognition, an intangible asset intangible assets that shall be carried at its cost less any accumulated have not previously been amortisation and any accumulated impairment losses. recorded as assets or Revaluation model: After initial recognition, an (ii) initial recognition of intangible asset shall be carried at a revalued amount, intangible assets, at being its fair value at the date of the revaluation less any amounts other than cost. subsequent accumulated amortisation and any The revaluation treatment is subsequent accumulated impairment losses. For the applied after an asset has been initially recorded at purpose of revaluations under this Standard, fair value cost. shall be determined by reference to an active market. However, if only part of the Revaluations shall be made with such regularity that at cost of an intangible asset is the end of the reporting period the carrying amount of recorded as an asset, because the asset does not differ materially from its fair value. the asset did not meet the An active market is a market in which all the following criteria for recognition, the conditions exist: revaluation may be applied to the whole of that asset. (a) the items traded in the market are homogeneous; A PRACTICAL APPROACH TO IFRS

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(b) willing buyers and sellers can normally be found at any time; and (c) prices are available to the public. If an intangible asset's carrying amount is increased as a result of a revaluation, the increase shall be recognised in other comprehensive income and accumulated in equity under the heading of revaluation reserve.

EXAMPLE A franchise had a carrying value of `15 lakh. It has been revalued at `17 lakh. The `2 lakh surplus will be credited to the revaluation reserve within equity. Intangible assets a/c Dr 2,00,000 To Revaluation reserve a/c 2,00,000 (Being increase in revaluation of intangible asset recorded) However, the increase shall be recognised in profit or loss to the extent that it reverses a revaluation decrease of the same asset previously recognised in profit or loss.

EXAMPLE A franchise had a carrying value of `20 lakh. It has been revalued at `19 lakh. The `1lakh shortfall is expensed to the income statement. Profit & loss a/c Dr 1,00,000 To Accumulated amortisation a/c 1,00,000 ( Being loss on revaluation of intangible asset expensed to income statement) At the next valuation, it is revalued at `23 lakh. `1lakh of the surplus will be credited to the income statement. The remaining `3 lakh surplus will be credited directly to the revaluation surplus reserve within equity, without appearing on the income statement. Accumulated amortisation a/c Dr 1,00,000 To Profit & Loss a/c 1,00,000 (Being increase in revaluation of intangible asset adjusted with previous time's loss on revaluation) Intangible Asset a/c Dr 3,00,000 To Revaluation reserve a/c 3,00,000 (Being increase in revaluation of intangible asset recorded)

If an intangible asset's carrying amount is decreased as a result of a revaluation, the decrease shall be recognised in profit or loss.

EXAMPLE A franchise had a carrying value of `20 lakh. It has been revalued at `19lakh. The `1lakh shortfall is expensed to the income statement. Profit & Loss a/c Dr 1,00,000 To Accumulated amortization

a/c 1,00,000

(Being loss on revaluation of intangible assets expensed to P & L a/c)

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However, the decrease shall be recognised in other comprehensive income to the extent of any credit balance in the revaluation surplus in respect of that asset.

EXAMPLE A franchise had a carrying value of `10 lakh. It has been revalued at `12 lakh. The `2 lakh surplus is credited to the revaluation reserve within equity. Intangible asset a/c Dr

2,00,000

To Revaluation reserve a/c

2,00,000

(Being increase in revaluation of intangible assets recorded) At the next valuation, it is revalued at `7 lakh. `2lakh of the shortfall will be charged to the revaluation reserve. The remaining `3 lakh shortfall will be charged to the income statement. Revaluation reserve a/c Dr 2,00,000 To intangible assets 2,00,000 (Being loss on revaluation of intangibles adjusted with the existing revaluation reserve) Profit & Loss a/c Dr 3,00,000 To accumulated amortisation a/c 3,00,000 (Being the balance of loss on revaluation of intangibles expensed to P & L a/c after adjusting with existing revaluation reserve.) If an intangible asset is revalued, any accumulated amortisation at the date of the revaluation is either: (i) restated proportionately, with the change in the gross carrying amount of the asset, so that the carrying amount of the asset after revaluation equals its revalued amount or (ii) eliminated against the gross carrying amount of the asset and the net amount restated to the revalued amount of the asset.

EXAMPLE 1. A copyright cost `6,000 and has been amortised by `1,000, leaving a net book value of `5,000. It has been revalued by a 25% increase. Both cost and amortisation will be increased by 25%, to `7.500 and `1,250 respectively. Net book value rises to `6,250. Intangible assets a/c Dr 1,500 To Accumulated amortisation a/c 250 To Revaluation reserve a/c 1250 (Being revaluation of the copyright recorded) 2. A franchise cost `5 lakh and has been amortised by `2 lakh, leaving a net book value of `3 lakh. It is revalued to `6 lakh. This can be shown either as: a) Valuation `10 lakh, Amortisation `4 lakh or b) Net book value `6 lakh A PRACTICAL APPROACH TO IFRS

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Intangible assets a/c To Accumulated Amortisation To Revaluation reserve (Being revaluation of intangibles recorded)

Dr

5,00,000 2,00,000 3,00,000

This records the revaluation of the franchise or it may be shown as: a) Valuation `6 lakh, b) Amortisation nil c ) Net book value `6 lakh Intangible assets a/c Dr 1 ,00,000 Accumulated amortisation Dr 2,00,000 To Revaluation reserve 3,00,000 (Being revaluation of intangibles recorded and cancelling accumulated amortisation)

Amortisation Amortisation Period The depreciable amount of an asset should be allocated, over its useful life. Amortisation should commence when the asset is available for use.

Useful Life Useful life is: (a) the period over which an asset is expected to be available for use by an entity; or (b) the number of production or similar units expected to be obtained from the asset by an entity. An entity shall assess whether the useful life of an intangible asset is finite or indefinite and, if finite, the length of, or number of production or similar units constituting, that useful life. An intangible asset shall be regarded by the entity as having an indefinite useful life when, based on an analysis of all of the relevant factors, there is no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity. The useful life of an intangible asset that arises from contractual or other legal rights shall not exceed the period of the contractual or other legal rights, but may be shorter depending on the period over which the entity expects to use the asset. If the contractual or other legal rights are conveyed for a limited term that can be renewed, the useful life of the intangible asset shall include the renewal period(s) only if there is evidence to support renewal by the entity without significant cost. To determine whether an intangible asset is impaired, an entity applies IAS 36 Impairment of Assets. A PRACTICAL APPROACH TO IFRS

Many factors need to be considered in determining the useful life of an intangible asset including: (i) the expected usage of the asset and whether the asset could be efficiently managed by another management team (ii) typical product life cycles for the asset (iii) technical, technological or other types of obsolescence (iv) t h e s t a b i l i t y o f t h e industry in which the asset operates and changes in the market demand for the products, or services, produced by the asset (v) e x p e c t e d a c t i o n s b y competitors (vi) the cost of maintenance required to obtain the future benefits from the asset and the company's ability and intent to reach such a level (vii) the period of control over the asset and legal or similar limits on the use of the asset, such as the expiry dates of related leases

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EXAMPLE A company has purchased an exclusive right to generate hydro-electric power for forty years at a cost of `80 lakh. The costs of this power are much lower than those from alternative sources. It is expected that there will be sufficient demand for at least forty years. Therefore, it is required to amortise the right to generate power, over forty years.

Intangible Assets with Finite Useful Lives The depreciable amount of an intangible asset with a finite useful life shall be allocated on a systematic basis over its useful life. Depreciable amount is the cost of an asset, or other amount substituted for cost, less its residual value. Amortisation shall begin when the asset is available for use, ie when it is in the location and condition necessary for it to be capable of operating in the manner intended by management. Amortisation shall cease at the earlier of the date that the asset is classified as held for sale (or included in a disposal group that is classified as held for sale) in accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations and the date that the asset is derecognised. The amortisation method used shall reflect the pattern in which the asset's future economic benefits are expected to be consumed by the entity. If that pattern cannot be determined reliably, the straight-line method shall be used. The amortisation charge for each period shall be recognised in profit or loss unless this or another Standard permits or requires it to be included in the carrying amount of another asset. The residual value of an intangible asset is the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life. The residual value of an intangible asset with a finite useful life shall be assumed to be zero unless: (a) there is a commitment by a third party to purchase the asset at the end of its useful life; or (b) there is an active market for the asset and: (i) residual value can be determined by reference to that market; and (ii) it is probable that such a market will exist at the end of the asset's useful life. The amortisation period and the amortisation method for an intangible asset with a finite useful life shall be reviewed at least at each financial year-end. If the expected useful life of the asset is different from previous estimates, the amortisation period shall be changed accordingly. If there has been a change in the expected pattern of consumption of the future economic benefits embodied in the asset, the amortisation method shall be changed to reflect the changed pattern. Such changes shall be accounted for as changes in accounting estimates in accordance with IAS 8.

Intangible Assets with Indefinite Useful Lives An intangible asset with an indefinite useful life shall not be amortised. In accordance with IAS 36 Impairment of Assets, an entity is required to test an intangible asset with an indefinite useful life for impairment by comparing its recoverable amount with its carrying amount A PRACTICAL APPROACH TO IFRS

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(a) annually, and (b) whenever there is an indication that the intangible asset may be impaired. The useful life of an intangible asset that is not being amortised shall be reviewed each period to determine whether events and circumstances continue to support an indefinite useful life assessment for that asset. If they do not, the change in the useful life assessment from indefinite to finite shall be accounted for as a change in an accounting estimate in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.

Disclosure General You should disclose the following for each class of intangible assets, distinguishing between internally-generated intangible assets and other intangible assets: 1. useful lives, or the amortisation rates used 2. amortisation methods used 3. gross carrying amount and the accumulated amortisation (aggregated with accumulated impairment losses) at the beginning and end of the period 4. line item(s) of the income statement in which the amortisation of intangible assets is included 5. reconciliation of the carrying amount at the beginning and end, of the period showing: (i) additions, indicating separately, those from internal development and through business combinations (ii) assets classified as held for sale or included in a disposal group classified as held for sale in accordance with IFRS 5 and other disposals; (iii) increases, or decreases, during the period resulting from revaluations and from impairment losses recorded, or reversed directly in equity (iv) impairment losses recorded in the income statement during the period (v) impairment losses reversed in the income statement during the period (vi) amortisation recorded during the period (vii) net exchange differences arising on the translation of the financial statements of a foreign undertaking (viii) other changes in the carrying amount, during the period. Comparative information is not required. A class of intangible assets is a grouping of assets of a similar nature and use. Examples of separate classes may include: (i) brand names (ii) mastheads and publishing titles (iii) computer software (iv) licences and franchises (v) copyrights, patents and other industrial property rights, service and operating rights (vi) recipes, formulae, models, designs and prototypes intangible assets under development. Intangible assets under development. The classes mentioned above may be shown disaggregated / aggregated into smaller / larger classes if this is clearer. Disclosure of information on impaired intangible assets under IAS 36 is in addition to the A PRACTICAL APPROACH TO IFRS

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information above. Disclosure of the nature and impact, of a material change in an accounting estimates must be made under IAS 8. Such disclosure may arise from changes in: (i) the amortisation period (ii) the amortisation method or (iii)residual values. The financial statements should also disclose: (1) the reasons for an asset having an indefinite life and its carrying amount (2) a description, the carrying amount and remaining amortisation period of any individual intangible asset that is material to the financial statements of the undertaking as a whole (3) intangible assets acquired by way of a government grant and initially recorded at fair value: (i)

the fair value initially recorded for these assets

(ii) their carrying amount (iii) whether they are carried under the cost, or the revaluation treatment for subsequent measurement (iv) the existence and carrying amounts of intangible assets, whose title is restricted and the carrying amounts of intangible assets pledged as security for liabilities (v) the amount of commitments for the acquisition of intangible assets.

STUDENT CORNER K The most

common of all intangible assets is Goodwill – the difference between the value of a business as a whole and the aggregate of the fair value of its separable net assets. BUT......... PURCHASED GOODWILL IS NOT DEALT WITH IN IAS 38. Internally generated Goodwill is dealt in IAS 38. However, it is not to be shown as an asset on the balance sheet as per the standard. This is the most common mistake students make ....... When asked about intangibles, they talk about purchased goodwill in their answer. Well yes, purchased goodwill is an intangible asset and the title of the standard is also 'Intangible Assets', but the issue of purchased goodwill is covered by IFRS 3. K IAS 38 deals with expenditure incurred on stuff like patents, brands, advertising,

training, software, licences etc.... assets you have purchased without physical existence. The cost incurred cannot be shown on the balance sheet and have to be expensed immediately.

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And the really important stuff…………. Accounting practice (i) Intangibles should be recognized if, and only if, the following criteria are met: K It is probable that future economic benefits will flow to the enterprise; and K The cost of the asset can be measured reliably. It is important to recognize the difference between internally generated intangibles and purchased intangibles. (i) Intangible assets should be amortised over their useful economic lives. If no amortization is charged because the life is indefinite, the asset must be subject to an annual impairment review. (ii) Intangibles can be revalued only if an active market exists for the asset which is very rare.

Intangible Assets

Purchased Intangible Assets

it is difficult to identify a probable future economic benefit and to reliably determine its cost, the standard does not allow internally generated goodwill to go on to the balance sheet as an asset. K All internally generated intangibles must be treated as either research or development costs. Costs for assets in the research phase must be charged to the income statement while those in the developmental phase must be capitalised if following criteria are met: (a) technically feasible. (b) intention to complete and use or sell the asset. (c) E x i s t e n c e o f a m a r k e t o r demonstration of usefulness of intangibles. (d) Availability of technical, financial and other resources to complete the asset. (e) Measure the cost reliability.

Internally Generated Intangible Assets

K Since,

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These are considered in IFRS 3. But, for them the probability criterion is always met and therefore they are recognised on the balance sheet subject to an impairment review.

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WORKSHEET 1. Residual value is specifically: (a) Scrap value. (b) The estimated amount that you would currently obtain from disposal of the asset, net of disposal costs. (c) The gross cash amount that you will receive from the ultimate sale of the asset, at the end of its life. 2. Useful life of an asset refers to the life: (a) In the hands of any number of owners. (b) Whilst it is available for use in the firm. (c) The average of 1 & 2. 3. Elements of cost are: (i) Purchase price (ii) Import duties. (iii) Non-refundable purchase taxes. (iv) Overheads of the purchasing department relating to the purchase of the asset. (a) i-iv (b) i-iii (c) i-ii (d) i 4. Directly attributable costs include: (i) profession fees (ii) legal services (iii) administration and other general overhead costs. (a) i (b) i-ii (c) i-iii 5. The following costs (i) start-up costs (ii) training costs (iii) costs of relocating, or reorganising operations. should be accounted for as: (a) Extraordinary items. (b) Capitalised as fixed assets. (c) Expenses. 6. If payment for an asset is deferred beyond normal credit terms, any additional payment above the cash cost of the asset will be accounted for as: (a) Cost of fixed asset. (b) Borrowing cost. (c) Repairs and maintenance. A PRACTICAL APPROACH TO IFRS

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7. If one or more assets are exchanged for a new asset, the new asset is valued at: (a) Replacement cost. (b) Fair value. (c) Residual value. 8. In the case of an exchange of assets, if the acquired asset cannot be valued: (a) The cost of the asset given up is used. (b) The residual value is used. (c) The asset cannot be capitalised. 9. An undertaking can choose either the cost option or the revaluation option, as its accounting policy. It must apply the chosen model to: (a) All fixed assets. (b) An entire class of fixed assets. (c) Major assets. 10. Using the cost option, the asset in accounted for at: (a) Cost. (b) Cost less accumulated depreciation. (c) Cost less accumulated depreciation and any impairment losses. 11. Using the revaluation option, can fair values be estimated, if there is no market-based evidence? (a) No. (b) Yes, if the asset is specialised and rarely sold, by using an income, or a depreciated replacement cost approach. (c) Yes, if the asset is specialised and rarely sold, by using indexation. 12. Revaluations are required: (a) Annually. (b) Every 3-5 years. (c) When fair values change, or are expected to change. 13. When an item is revalued, any accumulated amortisation at the date of the revaluation is treated in which of the following ways: (a) Restated proportionately, with the change in the gross carrying amount of the asset, so that the carrying amount of the asset after revaluation equals its revalued amount. (b) Eliminated against the gross carrying amount of the asset and the net amount restated to the revalued amount of the asset. (c) Either (a) or (b). 14. Examples of separate classes of intangible assets are: (i) brand names (ii) mastheads and publishing titles (iii) computer software (iv) licences and franchises

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(v)

copyrights, patents and other industrial property rights, service and operating rights (vi) recipes, formulae, models, designs and prototypes (vii) intangible assets under development. (viii) office equipment. (ix) canteen equipment. (a) i-v (b) vi-ix (c) i-vii (d) i-ix 15. May a class of assets may be revalued on a rolling basis? (a) Only if the revaluation is completed in a short period and the revaluations are kept up to date. (b) Only one class of assets is involved. (c) No. 16. If an asset's carrying amount is increased by revaluation, the increase is (a) Shown as a gain in the income statement. (b) Taken to revaluation surplus, via the income statement. (c) Taken to revaluation surplus, directly, without being recorded in the income statement. 17. If an asset's carrying amount is decreased by revaluation, the decrease should be: (a) Capitalised. (b) Expensed. (c) An extraordinary item. 18. Transfers of amounts between revaluation reserve and retained earnings are allowed: (a) Only on asset disposal. (b) On asset disposal and in each period, being the difference between the depreciation charged on a revalued amount and the depreciation of the cost amount. (c) When retained earnings are negative. 19. Amortisation charges for a period are recorded: (a) Only in the income statement. (b) As an exceptional item. (c) In the income statement, or as part of the cost another asset (such as inventories). 20. Changes in the estimated useful life should: (a) Be accounted for under IAS 8. (b) Be expensed immediately. (c) Be noted on the face of the balance sheet.

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21. The carrying value of your asset is `10 m. Its fair value is `12 m. Do you continue amortisation? (a) No. (b) Yes, until the end of its useful life. (c) Yes, but at half the previous rate. 22. The carrying value of your asset equals the residual value. Do you continue to amortise it? (a) No. (b) Yes, until the end of its useful life. (c) Yes, but at half the previous rate. 23. Your asset has a residual value. Do you continue to amortise it? (a) No. (b) Yes, until the end of its useful life, but deduct the amount of the residual value from the amount to be amortised. (c) Yes, but at half the previous rate. 24. In determining the useful life of an asset, consider: (i) Expected usage of the asset. (ii) Public information on similar types of assets. (iii) Technical, or commercial obsolescence. (iv) Legal, or similar, limits on the use of the asset. (v) The level of knowledge of operators of the asset. (a) i-ii (b) i-iii (c) i-iv (d) i-v 25. A variety of amortisation methods can be used. These methods include the straight-line method, the diminishing balance method and the units of production method. The choice of depreciation method is governed by: (a) Tax laws. (b) The lowest cost option. (c) The expected pattern of consumption of the asset. 26. The carrying amount of an item shall be derecognised (written out of the balance sheet): (a) On disposal. (b) When no future benefits are expected from its use. (c) Either. 27. Research costs can be capitalised: (a) Never. (b) When the development stage has begun. (c) When the development stage is complete.

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28. If there is a third party willing to buy your asset at the end of its useful life, but no active market for the asset. (a) The residual value is nil. (b) The residual value is halved. (c) The residual value is fully valued. 29. The definition of an intangible asset comprises: i Identifiability ii Control over a resource. iii Existence of future benefits. iv Residual value. (a) i-ii (b) i-iii (c) i-iv (d) iii 30. Separability: (a) Requires distinction from goodwill. (b) Is necessary for identifiability. (c) Requires separate ownership. 31. Control is: (a) Power to obtain benefits from a resource. (b) Power to restrict access of others to the resource. (c) Both 1 & 2 are required. 32. Future benefits include: I Revenue ii Cost savings iii Residual value (a) i-ii (b) i-iii (c) i 33. The cost of an internally-generated asset includes,: (i) expenditure on materials and services used in generating the asset (ii) the employment costs of personnel directly engaged in producing the asset (iii) any expenditure that is directly attributable to the asset, such as fees to register a legal right and the amortisation of patents and licences (iv) overheads that are necessary to generate the asset, (v) profit margin. (a) i-ii (b) i-iii (c) i-iv (d) i-v

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34. Expenditure on an intangible item that was initially recorded as an expense, in previous interim, or annual financial statements: (a) Should not be recorded as part of the cost of an asset. (b) Can be added to the residual value. (c) May be added to the next revaluation. 35. Intangible assets are initially recorded at: (a) Cost. (b) Revalued amount. (c) Either.

ANSWER 1. 5.

(b) (c)

2. 6.

(b) (b)

9. 13. 17. 21. 25. 29. 33.

(b) (c) (b) (b) (c) (b) (c)

10. 14. 18. 22. 26. 30. 34.

(c) (c) (b) (a) (c) (a) (a)

3. (b) 7. (b) 11. 15. 19. 23. 27. 31. 35.

(a) (c) (c) (b) (a) (c) (a)

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4. (b) 8. (a) 12. 16. 20. 24. 28. 32.

(c) (c) (a) (c) (c) (a)

GLOSSARY A Accounting Policies (Page-5, 11, 28, 29, 39, 40, 63, 87, 93, 94, 113, 163, 165, 175, 179, 180, 182, 192, 194, 243, 245, 246, 247, 252, 254, 256, 257, 331, 369) Accounting Estimates (Page-39, 40, 127, 182, 243, 245, 249, 254, 257, 306, 369) Accounting Year (Page-13), Agricultural Activity (Page-31, 139, 140), Asset Written Off (Page-303), Asset Useful Life (Page-309), Associates (Page-16, 84, 89, 90, 92, 93, 94, 95, 98, 99, 171, 187, 197, 233) Assets (Page-5, 8, 10, 15, 16, 19, 20, 22, 23, 28, 29, 30, 31, 35, 41, 46, 47, 49, 50, 52, 54, 59, 61, 67, 210, 213, 222) Accounting Standards (Page-3, 161, 179, 252), Assumptions (Page-19, 20, 351), Accrual Basis (Page-20, 35, 181, 182), Adjusting Events (Page-262, 263, 264, 265, 267 ), Allocation (Page-50, 53), Amortization (Page-129, 362, 365, 366, 367), Active Market (Page-129, 140, 376) , Authorization Date (Page-262), Accumulated Depreciation (Page-237)

B Borrowing Costs (Page-79), Benefit Plans (Page-67), Balance Sheet (Page-12, 30, 38, 44, 69, 105, 111, 129), Basic Earnings Per Share (Page-107), Biological Asset (Page139), Business Combinations (Page-144)

C Capital Disclosures (Page-193), Cash Flow Statements (Page-34, 165 ), Construction Contracts (Page-31), Contingent Liabilities (Page-122), Contingent Assets (Page-121, 122, 172, 343, 350, 352), Convergence (Page-11, 12, 13), Comparability (Page-21), Cost (Page10), Contract Price (Page-280, 282, 285, 287,), Contract Revenue (Page-46), Current

Tax (Page-37), Cost Model (Page-53), Consolidated Financial Statements (Page88), Consolidated Accounts (Page-91), Control (Page-83), Compound Financial Instruments (Page-103), Cash Settled Transactions (Page-146), Comprehensive Income (Page-187), Cost Of Conversion (Page-204), Constructive Obligation (Page343)

D Deferred Tax Liability (Page-0), Disclosure (Page-14), Deferred Tax (Page37), Deferred Tax Asset (Page-51), Depreciation (Page-38), Dividend (Page62), Defined Contribution Plans (Page-67), Defined Benefit Plans (Page-86), Diluted Earnings Per Share (Page-107), Discontinued Operation (Page-174), Disposal Group (Page-361), Direct Method (Page-35), Depreciation (Page-38)

E Earning Per Share (Page-5, 188, 189), Employee Benefits (Page-66), Errors (Page-40), Expenses (Page-28), Equity Method (Page-92), Equity Accounting (Page-95), Equity (Page-30), Earnings (Page-30), EU (Page-3), Exemptions (Page143)

F First-time Adoption (Page-7, 142), Finite Useful Life (Page-127, 128, 368) Financial Statements (Page-12, 16, 19, 21, 28, 42, 57), Foreign Exchange Rates (Page169), Financial Instruments (Page-16), Framework (Page-19), Financial Reporting (Page-3), FIFO (Page-182), Financing Activities (Page-36), Fair Value (Page-31), Finance Lease (Page-57), Functional Currency (Page-75), Foreign Currency

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(Page-75), Financial Asset (Page-104), Financial Liabilities (Page-105), Fair Presentation (Page-144), Finished Goods (Page-32)

(Page-31, 208, 212, 247,), Liabilities (Page-22, 28, 30, 69), Lessor (Page-57, 58), Lesse (Page-57, 59, )

M G Government Grants (Page-73), GAAP (Page-144), Globalization (Page-9), Capital (Page-10), Going Concern (Page-21), Government Assistance (Page-140), Goodwill (Page-93), Guidelines (Page-3), General Purpose Financial Statements (Page-179)

Measurement (Page-16, 41, 49, ), Minority Interest (Page-89, 108, 195)

N

Harmonization (Page-10), Held For Sale (Page-32), Hedging (Page-75, 132, 133),

Net Relisable Value (Page-98, 212, 214), Non-adjusting Events (Page-262, 264, 265, 267), Negative Goodwill (Page-93), Non-current Assets (Page-30, 38, 74, 117, 152, 153, 174, 186), Notes (Page-27, 28, 45, 113, 180, 181, 192, 194, 212, 225, 236, 261, 267, 343), Non-cash Transactions (Page-35)

I

O

Indefinite Useful Life (Page-114, 127, 367, 368, 369), Inventories (Page-31), Income Tax (Page-35), Investments (Page-92), Interim Financial Reporting (Page-111), Impairment (Page-114), Intangible Assets (Page-123), IFRS (Page-3), IAS (Page-3), IASB (Page-179), IASC (Page-3), ICAI (Page-15), Investing Activities (Page-36), Impairment (Page-5, 15, 53, 98, 114), Interest (Page-13), Interim Period (Page113), Interim Report (Page-112, 113), Impairment Loss (Page-98), Investment Property (Page-114), Income Statement (Page-29), Indirect Method (Page-35), Interest Paid (Page-35),

Operating Segments (Page-158), Offsetting (Page-28, 103, 182, 183), Operating Activities (Page-34, 35, 36, 37, 218, 220, 223, 224, 225, 226, 236, 238, 240, 241), Operating Lease (Page-57, 58, 59, 60),

H

J Joint Ventures (Page-96, 171), Jointly Controlled Operations (Page-96, 97), Jointly Controlled Assets (Page-96), Joint Venture (Page-83)

Q Qualifying Asset (Page-80, 81)

L Leases (Page-57, 58, 60, 167, 266), LIFO

P Property, Plant & Equipment (Page-308, 309, 310, 311, 312), Public Interest Entity (Page-13), Prior-period Items (Page-165), Post-employment Benefits (Page-67, 77,), Pension Schemes (Page-69), Presentation Currency (Page-76), Potential Ordinary Shares (Page-107, ), Provisions (Page-42, 119, 122, 135, 137, 172, 186, 193, 246, 247, 287, 341, 343, 345, 346, 347, 348, 349, 351, 352, 353, 356, ), Proposed Dividends (Page-166, 224, 226, 229),

R Revenue (Page-41, 46, 47, 61, 64, 65, 97, 100, 104, 157, 158, 168, 187, 252, 254, 266, 278, 279, 282, 285, 286, 287, 288, 323, 325, 326, 327, 328, 330, 331, 332, 333, 334, 335, 336, 337, 351), Recognition

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(Page-16, 43, 44, 45, 69, 113, 144, 166, 195, 201, 212, 262, 266, 267, 292, 309, 333), Reporting Period (Page-16), Reporting (Page-3,9, 10, 12, 16, 19, 43, 44, 69, 75, 76, 111, 113, 144, 148, 150, 156, 163, 166, 170, 171, 172, 175, 179, 183, 195, 201, 212, 223, 227, 262, 266, 267, 285, 292, 309, 333, 351), Relevance (Page-21), Reliability (Page-21, 22, 357), Replacement (Page-52, 167, 295, ), Revaluation Model (Page-53, 299, 317), Residual Value (Page-56, 292, 293, 304, 305, 306, 307, 308, 309, 313, 315, 319, 321, 362, 372, 375), Restating (Page-194, 251, 252), Revaluation Surplus (Page-300, 302, 303, 310, 365), Royalties (Page-62, 63, 325, 330, 337), Related Parties (Page-84, 85), Related Party Disclosures (Page-82, 169), Rights Issue (Page-109, 110,), Reporting Period (Page-16, 43, 44, 45, 69, 113, 144, 166, 195, 201, 212, 262, 266, 267, 292, 309, 333,), Raw Materials (Page-33, 201, 206, 212), Restructuring (Page-344, 347, 348, 354, 355, 358),

S SIC (Page-8), Self Constructed Assets (Page-317), Selling Costs (Page-31, 203, 206, 212, 288, 293), Selling & Distribution Costs (Page-221), Subsidiary (Page-84, 85, 88, 89, 90, 91, 92, 97, 150, 151), Significant Influence (Page-84, 92, 95), Separate Financial Statements (Page-97, 98, 170), Shares (Page-103, 104, 105, 106, 107, 108, 109, 110, 147, 179, 220, 221, 222, 239), Segment Reporting (Page-156), Statement Of Changes In Equity (Page-113, 192, 194), Subsequent Revaluation (Page-0)

T Taxes (Page-35), Termination Benefits (Page-68), Tax Paid (Page-37, 221, 226, 231, 232, 238), True & Fair (Page-162),

W Weighted Average (Page-107, 108, 109, 110, 182, 208, 212, 246, 247, 249, 253, 254, 255), Work Certified (Page-47, 280, 284), Work-in-progress (Page-201, 212)

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