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F7 Knowledge Summary- Dec 2016

THE CONCEPTUAL AND REGULATORY FRAMEWORK FOR FINANCIAL REPORTING

CONCEPTUAL FRAMEWORK
The IFRS Framework describes the basic concepts that underlie the preparation and presentation of financial statements
for external users. A conceptual framework can be seen as a statement of generally accepted accounting principles
(GAAP) that form a frame of reference for the evaluation of existing practices and the development of new ones.

Purpose of framework

Assist in the development of future IFRS and the review of existing standards by setting out the underlying
concepts
Promote harmonisation of accounting regulation and standards
Assist the preparers of financial statements in the application of IFRS and dealing with accounting transaction s
for which there is not (yet ) an accounting standard

Advantages of a conceptual framework


Financial statements are more consistent with each other
Avoids firefighting approach and a has a proactive approach in determining best policy
Less open to criticism of political/external pressure
Has a principles based approach
Some standards may concentrate on effect on statement of financial position; others on statement of profit or
loss

Disadvantages of a conceptual framework


A single conceptual framework cannot be devised which will suit all users
Need for a variety of standards for different purposes
Preparing and implementing standards may still be difficult with a framework

The purpose of financial reporting is to provide useful information as a basis for economic decision making.

Qualitative characteristics of useful financial information


They identify the types of information likely to be most useful to users in making decisions about the reporting
entity on the basis of information in its financial report.

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Fundamental qualitative characteristics
Relevance
Relevant financial information is capable of making a difference in the decisions made by users if it has predictive
value, confirmatory value, or both.
Materiality is an entity-specific aspect of relevance based on the nature or magnitude (or both) of the items to
which the information relates in the context of an individual entity's financial report

Faithful representation
Information must be complete, neutral and free from material error

Enhancing qualitative characteristics


Comparability
Comparison with similar information about other entities and with similar information about the same entity for
another period or another date.
Verifiability
It helps to assure users that information represents faithfully the economic phenomena it purports to represent.
Verifiability means that different knowledgeable and independent observers could reach consensus, although
not necessarily complete agreement
Timeliness
It means that information is available to decision-makers in time to be capable of influencing their decisions.
Understandability
Classifying, characterising and presenting information clearly and concisely. Information should not be excluded
on the grounds that it may be too complex/difficult for some users to understand

The IFRS framework states that going concern assumption is the basic underlying assumption

The five elements of financial statements


Asset: 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.

Liability: A liability is a present obligation of the entity arising from past events, the settlement of which is
expected to result in an outflow from the entity of resources embodying economic benefits.

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

Income: Income is increases 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.

Expense: Expenses are decreases 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.

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Recognition of the elements of financial statements
Recognition is the process of incorporating in the statement of financial position or statement of profit or loss an item
that satisfies the following criteria for recognition:
The item that meets the definition of an element
It is probable that any future economic benefit associated with the item will flow to or from the entity and
The items cost or value can be measured with reliability.

Application of recognition criteria

An asset is recognised in the statement of financial position when it is probable that the future economic
benefits will flow to the entity and the asset has a cost or value that can be measured reliably.
A liability is recognised in the statement of financial position when it is probable that an outflow of resources
embodying economic benefits will result from the settlement of a present obligation and the amount at which
the settlement will take place can be measured reliably.
Income is recognised in the income statement when an increase in future economic benefits related to an
increase in an asset or a decrease of a liability has arisen that can be measured reliably.
Expenses are recognised when a decrease in future economic benefits related to a decrease in an asset or an
increase of a liability has arisen that can be measured reliably.

Measurements of elements in financial statements

The IFRS Framework acknowledges that a variety of measurement bases:

Historical cost
Current cost (Assets are carried at the amount of cash or cash equivalents that would have to be paid if the
same or an equivalent asset was acquired currently)
Net realisable value (The amount of cash or cash equivalents that could currently be obtained by selling an asset
in an orderly disposal)
Present value (A current estimate of the present discounted value of the future net cash flows in the normal
course of business)
Fair value (As per IFRS 13)

HISTORICAL COST ACCOUNTING


The application of historical cost accounting means that assets are recorded at the amount they originally cost, and
liabilities are recorded at the proceeds received in exchange for the obligation.

Advantages
Simple to understand
Figures are objective, reliable and verifiable
Results in comparable financial statements
There is less possibility for manipulation by using 'creative accounting' in asset valuation.

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Disadvantages
The carrying value of assets is often substantially different to market value
No account is taken of inflation meaning that profits are overstated and assets understated
Financial capital is maintained but not physical capital
Ratios like Return on capital employed are distorted
It does not measure any gain/loss of inflation on monetary items arising from the impact
Comparability of figures is not accurate as past figures are not restated for the effects of inflation

STANDARD SETTING PROCESS


The due process for developing an IFRS comprises of six stages:
1. Setting the agenda
2. Planning the project
3. Development and publication of Discussion Paper
4. Development and publication of Exposure Draft
5. Development and publication of an IFRS Standard
6. Procedures after a Standard is issued

REGULATORY FRAMEWORK

International Financial Reporting Standards Foundation (IFRS Foundation)

Responsible for governance of standard setting process. It oversees, funds, appoints and monitors the operational
effectiveness of:

IFRS Advisory Council (IFRS International Accounting International Financial Reporting


AC) Standards Board (IASB) Standards Interpretations Committee
(IFRS IC)
Provide advice to IASB on: Develop new accounting
standards Assist the IASB to establish and
their agenda and work Liaise with national improve
prioritization standard-setting bodies to standards
the impact of proposed promote convergence of
standards international and national Issues Interpretations
Provides strategic advice accounting standards (known as IFRICs) which provide
timely guidance on emerging
accounting issues not addressed in
full standards

Assist in the international/national


convergence process

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Principles vs rules-based approach

Rules-based accounting system


Likely to be very descriptive
Relies on a series of detailed rules or accounting requirements that prescribe how financial statements should
be prepared
Considered less flexible, but often more comparable and consistent, than a principles-based system
Can lead to looking for loopholes

Principles-based accounting system


It relies on generally accepted accounting principles that are conceptually based and are normally underpinned
by a set of key objectives
More flexible than a rules-based system
Require judgement and interpretation which could lead to inconsistencies between reporting entities and can
sometimes lead to the manipulation of financial statements

Because IFRSs are based on The Conceptual Framework for Financial Reporting, they are often regarded as being a
principles-based system.

PAST EXAMS ANALYSIS

Topic Exam Attempt Question


Spec. exam Sept. 16 MCQ.4, 13
June 15 MCQ.1,6
Dec. 14 MCQ.3,5,7,20
Framework Dec. 13 Q.4 (a)
Dec. 12 Q.4(a)
June 12 Q.5
June 11 Q.4 (a)

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PREPARATION OF FINANCIAL STATEMENTS FOR COMPANIES
IAS 1 Presentation of financial statements

A complete set of financial statements comprises:

A statement of financial position


either
A statement of comprehensive income, or
A statement of profit or loss and other comprehensive income
A statement of changes in equity
A statement of cash flows
Accounting policies and explanatory notes

The statement of financial position

A recommended format is as follows:


XYZ Group Statement of Financial Position as at 31 December 20X6

Assets $ $
Non-current assets:
Property, plant and equipment X
Goodwill X
Other intangible assets X
X
Current assets:
Inventories X
Trade receivables X
Cash and cash equivalents X
X
Total assets X

Equity and liabilities

Capital and reserves:


Share capital X
Retained earnings X
Other components of equity X
X
Total equity X

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Non-current liabilities:
Long-term borrowings X
Deferred tax X
X

Current liabilities:
Trade and other payables X
Short-term borrowings X
Current tax payable X
Short-term provisions X
X
Total equity and liabilities X
Current assets include all items which:
Will be settled within 12 months of the reporting date, or
Are part of the entity's normal operating cycle.

Within the capital and reserves section of the statement of financial position, other components of equity include:
Revaluation reserve
General reserve

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Statement of changes in equity
The statement of changes in equity provides a summary of all changes in equity arising from transactions with owners in
their capacity as owners.

This includes the effect of share issues and dividends.

XYZ Group
Statement of changes in equity for the year ended 31 December 20X6

Share Share Revaluation Retained Total


capital premium surplus earnings equity
$ $ $ $ $
Balance at 31 X X X X X
December 20X1
Change in (X) (X)
accounting policy __ __ __ __
Restated balance X X X X X
Dividends (X) (X)
Issue of share X X X
capital
Total X X X
comprehensive
income for the year
Transfer to (X) X -
retained earnings __ __ __ __
Balance at 31 X X X X X
December 20X6

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Statement of profit or loss and comprehensive income
A recommended format for the statement of profit or loss and other comprehensive income is as follows:
XYZ Group
Statement of profit or loss and other comprehensive income
for the year ended 31 December 20X6
$
Revenue X
Cost of sales (X)
Gross profit X
Distribution costs (X)
Administrative expenses (X)
Profit from operations X
Finance costs (X)
Profit before tax X
Income tax expense (X)
Net Profit for the period X

$
Profit for the year X
Other comprehensive income
Gain on property revaluation X
Income tax relating to components of other comprehensive income (X)
Other comprehensive income for the year, net of tax X
Total comprehensive income for the year X

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COMPANIES BASIC ADJUSTMENTS

TYPES OF SHARES
There are a number of different types of shares which companies may issue.

Ordinary shares
Preference shares

There are two types of preference share:

Irredeemable preference shares exist, much like ordinary shares. The amount issued in form of Irredeemable
preference shares is not payable after a fixed period.
Redeemable preference shares are issued for a fixed term. At the end of this term, the shareholder redeems their
shares and in return is repaid the amount they initially bought the shares for (normally plus a premium). In the
meantime they receive a fixed dividend.

ACCOUNTING FOR A SHARE ISSUE


The accounting entry to record the issue of shares is:

Dr Cash Proceeds received

Cr Share capital Nominal value of shares issued

Cr Share premium Premium on issue of shares.

ACCOUNTING FOR A RIGHTS ISSUE


A rights issue is an issue of new shares to existing shareholders in proportion to their existing shareholding. The issue
price is normally less than market value to encourage shareholders to exercise their rights and buy shares.

Dr Cash Proceeds received

Cr Share capital Nominal value of shares issued

Cr Share premium Premium on issue of shares.

ACCOUNTING FOR A BONUS ISSUE

A bonus issue is an issue of new shares at no cost to existing shareholders, in proportion to their existing shareholding.
An issue of this type does not raise cash, but is funded by the existing share premium account (or retained profits if the
share premium account is insufficient), and accounted for by:

Dr Share premium/Retained profits Nominal value of shares issued

Cr Share capital Nominal value of shares issued

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LOAN NOTES
A company can raise finance either through the issue of shares or by borrowing money.

An issue of loan notes is recorded by:

Dr Cash

Cr Loan notes (non-current liability)

Interest paid on the loan notes is recorded by:

Dr Finance cost (interest expense)

Cr Cash / accrual

Finance cost is charged on effective rate of interest


Cash paid is as per the nominal rate of interest
The differential amount becomes a part of the closing liability of loan

DIVIDENDS
Ordinary dividends = No. of shares x Per share dividend

Preference dividends = Amount of preference shares x % of dividend

PAST EXAMS ANALYSIS

Topic Exam Attempt Question


Dec. 15 Q.1 (iv), (vii)
June 15 MCQ.19 Q.3(i),(ii)
Dec. 14 Q.2(i)
June 14 Q.2 (iii),(v)
Basic adjustments Companies Dec. 13 Q.2 (v)
June 13 Q.2(v)
Dec. 12 Q.2(ii),(iii)
June 12 Q.2 (i)
June 11 Q.2 (i)

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IAS 16 PROPERTY, PLANT AND EQUIPMENT

Objective:
The objective of IAS 16 is to prescribe the accounting treatment for property, plant, and equipment.

Definitions:
Property plant and equipment are intangible assets that:
Are held for use in the production or supply of goods or services ,for rental to others, or for administrative
purposes; and
Are expected to be used during more than one years.

Carrying amount is the amount at which an asset is recognized after deducting any accumulated depreciation and
accumulated impairment losses

Depreciation is systematic allocation of the depreciable amount of assets over its useful life.

Depreciable amount is the cost of an asset less its residual value.

Residual Value is the estimated amount that an entity can obtain when disposing of an asset after its useful life has
ended. When doing this the estimated costs of disposing of the asset should be deducted.

Recognition:
PPE are recognized if
It is probable that future economic benefits associated with the item will flow to the entity; and
The cost of the item can be measured reliably.

Aggregation and segmenting This IAS does not provide what constitute an item of property, plant and equipment and
judgment is required in applying the recognition criteria to specific circumstances or types of enterprise. That is: -
i. It may be appropriate to aggregate individually insignificant items, such as moulds, tools dies, etc.
ii. It may be appropriate to allocate total expenditure on an asset to its component parts and account for each
component separately e.g. an aircraft and its engines.

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Initial measurement:
PPE are initially recognized at the cost.
Elements of costs comprise:

Its purchase price


Any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable
of operating,
The initial estimate of the costs of dismantling and removing the item and restoring the site on which it is
located (the present value of dismantling cost will be added to the cost of asset and provision will be created
and it will be unwinded at every year end and the amount will be recognized in statement of profit or loss as
finance cost and provision will be increased in statement of financial position).
Directly attributable cost of bringing the assets to the location and condition necessary for the intended
performance, e.g.

Costs of employees benefits arising directly from the construction or acquisition of property, plant and
equipment
The cost of site preparation
Initial delivery and handling costs
Installation costs
Cost of testing whether the asset is functioning properly after the net proceeds from the sale of any trial
production (samples produced while testing equipment)
Professional fees (architects, engineers)

Cost of self-constructed assets will be the cost of its production


If an asset is exchanged, the cost will be measured at the fair value unless
(a) The exchange transaction lacks commercial substance or

(b) 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.

Measurement Subsequent to Initial Recognition:

IAS 16 permits two accounting models:

Cost Model. The asset is carried at cost less accumulated depreciation and impairment.
Revaluation Model. The asset is carried at a revalued amount, being its fair value at the date of revaluation less
subsequent depreciation and impairment, provided that fair value can be measured reliably.

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Revaluation model:
Revaluations should be carried out regularly, so that the carrying amount of an asset does not differ materially
from its fair value.
If an item is revalued, the entire class of assets to which that asset belongs should be revalued.
Revalued assets are depreciated in the same way as under the cost model.
Gain in revaluation should be credited to other comprehensive income and accumulated in equity under the
heading "revaluation surplus" unless it represents the reversal of a revaluation decrease of the same asset
previously recognized as an expense, in which case it should be recognized as income.
A loss on revaluation should be recognized as an expense to the extent that it exceeds any amount previously
credited to the revaluation surplus relating to the same asset.
Each year, the amount by which the new depreciation exceeds the old depreciation should be transferred from
the revaluation reserve in the capital section of the statement of financial position to the retained earnings.
When a revalued asset is disposed of, any revaluation surplus may be transferred directly to retained earnings,
or it may be left in equity under the heading revaluation surplus.

Depreciation:

The depreciable amount should be allocated on a systematic basis over the asset's useful life.
The residual value and the useful life of an asset should be reviewed at least at each financial year-end.
The depreciation method used should reflect the pattern in which the asset's economic benefits are consumed
by the entity.
Depreciation should be charged to the statement of profit or loss.
Depreciation begins when the asset is available for use and continues until the asset is derecognized.

Impairment:
An item of PPE shall not be carried at more than recoverable amount. Recoverable amount is the higher of an asset's fair
value less costs to sell and its value in use.
Impairment is included in profit or loss when the claim for impairment becomes receivable.

De-recognition:
Remove from statement of financial position when disposed of or abandoned
Recognize any gain or loss in the statement of profit or loss.
PAST EXAMS ANALYSIS

Topic Exam Attempt Question


Spec. exam Sept. 16 MCQ.1
Dec. 15 Q.1 (iii)
June 15 MCQ.9,13 Q.3(iii)
Dec. 14 Q.2(ii)
June 14 Q.2(ii), Q.4
IAS 16
Dec. 13 Q.2(ii)
June 13 Q.2(ii)
June 12 Q.2 (ii)
Dec. 11 Q.2 (ii)
June 11 Q.2 (ii)

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IAS 38 - INTANGIBLE ASSETS

OBJECTIVE
The objective of this IAS is to prescribe accounting treatment for intangible assets.

DEFINITIONS
An intangible asset is an identifiable nonmonetary asset without physical substance held for use in the
production or supply of goods or services, for rental to others, or for administrative purposes.

IDENTIFIABILITY:
An intangible asset can be termed identifiable if it:

is separable or
Arises from contractual or other legal rights

Research is original and planned investigation undertaken with the prospect of gaining new scientific or technical
knowledge and understanding.

Development is the application 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.

RECOGNITION AND MEASUREMENT


The recognition of an intangible asset requires an entity to demonstrate that the item meets:-
a) The definition of an intangible asset
b) The recognition criterion that:-

It is probable that the expected economic benefits that are attributable to the asset will flow to the entity;
and
The cost of the asset can be measured reliably

An intangible asset shall be measured initially at cost.

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Separate rules for recognition and initial measurement exist for intangible assets depending on whether they were:

Acquired separately: At cost


Acquired as part of a business combination: At fair value
Acquired by way of a government grant: As per IAS 20
Obtained in an exchange of assets: At fair value
Generated internally

INTERNALLY GENERATED INTANGIBLE ASSETS


To assess whether an internally generated intangible assets meets the criteria for recognition, an enterprise classifies
the generation of the asset into:

RESEARCH PHASE
Recognised as expense in statement of profit or loss

DEVELOPMENT PHASE
An intangible asset arising from development (or from the development phase of an internal project) should be
recognized as asset if, and only if, an enterprise 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;
(d) How the intangible asset will generate probable future economic benefits. Among other things, the enterprise
should 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; and
(f) Its ability to measure the expenditure attributable to the intangible asset during its development reliably.

Internally generated brands, mastheads, publishing titles, customer lists and similar items should not be recognised as
intangible assets.

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MEASUREMENT AFTER RECOGNITION

COST MODEL
After initial recognition, an intangible asset shall be carried at its cost less any accumulated amortization and any
accumulated impairment loss.

REVALUATION MODEL
After initial recognition an intangible asset whose fair value can be determined with reference to the active market shall
be carried at revalued amount, less subsequent accumulated amortization and subsequent accumulated impairment
losses.

The depreciable amount of an intangible asset with a finite useful life shall be allocated on a systematic basis
over its useful life
The amortization period and the amortization method for an intangible asset with a finite useful life shall be
reviewed at least at each financial year end.
An intangible asset with an indefinite useful life shall not be amortized but will be tested for impairment at
every reporting date.
The useful life of an intangible asset that is not being amortized shall be reviewed each period
The recoverable amount of the asset should be determined at least at each financial year end and any
impairment loss should be accounted for in accordance with IAS 36.
Remove from statement of financial position when disposed of or abandoned. Recognize any gain or loss in the
statement of profit or loss.

GOODWILL
Goodwill is not normally recognised in the accounts of a business at all. The reason for this is that goodwill is considered
inherent in a business and it does not have any objective value.

PURCHASED GOODWILL
There is one exception to the principle that goodwill has no objective value, this is when a business is sold.

Purchased goodwill is shown in the statement of financial position because it has been paid for. It has no tangible
substance, and so it is an intangible non-current asset.
PAST EXAMS ANALYSIS

Topic Exam Attempt Question


Dec. 15 Q.1 (ii)
IAS 38 June 15 MCQ.2
June 14 Q.5(i)

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IAS 36 IMPAIRMENT OF ASSETS

OBJECTIVE
The objective of this IAS is to set rules to ensure that the assets of an enterprise are carried at no more than their
recoverable amount.

DEFINITIONS
Recoverable amount is the higher of an assets net selling price and its value in use.
Value in use is the present value of estimated future cash flows expected to arise from the continuing use of an
asset and from its disposal at the end of its useful life.
Net selling price the amount obtainable from the sale of an asset in an arms length transaction between
knowledgeable, willing parties, less the costs of disposal.
An impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable amount.
A cash-generating unit is the smallest identifiable group of assets that generates cash inflows from continuing use
that are largely independent of the cash inflows from other assets or groups of assets.
Corporate assets are assets other than goodwill that contribute to the future cash flows of both the cash-generating
unit under review and other cash-generating units.

IMPAIRMENT ASSESSMENT
An enterprise should assess at each reporting date: -

a) Whether there is any indication that an asset may be impaired;


b) Irrespective of any indication of impairment, an entity shall also: -
Test in case of intangible assets having indefinite life or under development; and
Test goodwill acquired in business combination for impairment annually

External sources of information include:


Decline in assets market value
Adverse effect in the technological, market, economic or legal environment in which the enterprise operates;
Increase in market interest rates

Internal sources of information include:


Obsolescence or physical damage
Significant changes with an adverse effect in the extent to which, or manner in which, an asset is used or is
expected to be used
Economic performance and expected net cashflows of an asset are worse than expected

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MEASURING RECOVERABLE AMOUNT
Net selling price is the price in Binding Sale Agreement less Disposal Cost
Value in Use is the present value of estimated the future cash inflows and outflows to be derived from continuing use of
the asset and from its ultimate disposal (The discount rate should be a pre-tax rate)

RECOGNITION AND MEASUREMENT OF IMPAIRMENT LOSS


An impairment loss should be recognized as an expense in the statement of profit or loss immediately, unless the asset
is carried at revalued amount (Recognized directly against any revaluation surplus. Any over and above amount as
expense in P&L)

CASH GENERATING UNIT


A cash generating unit (CGU) is the smallest identifiable group of assets for which independent cash flows can be
identified and measured. For example, for a restaurant chain a CGU might be each individual restaurant.

As goodwill acquired in a business combination does not generate cash flows independently
of other assets, it must be allocated to each of the acquirers cash generating units
A CGU to which goodwill has been allocated is tested for impairment annually. The
carrying amount of the CGU including the goodwill is compared with its recoverable amount.

The impairment loss on a CGU is allocated in the following order:

first to any asset that is impaired (e.g. if an asset was specifically damaged)
second, to goodwill in the cash generating unit
third, to all other assets in the CGU on a pro rata basis based on carrying value

When allocating an impairment loss the carrying amount of an asset should not be reduced below the higher of its fair
value less costs to sell, value in use or zero.

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REVERSAL OF IMPAIRMENT LOSS

The increased carrying amount of an asset due to a reversal on impairment loss should not exceed the carrying
amount that would have determined had no impairment loss been recognized for the asset in prior years.
It is recognized as income immediately in statement of profit or loss
Any reversal of an impairment loss on a revalued asset should be treated as a revaluation increase under that
other International Accounting Standard.

Considerations on reversal of an Impairment Loss for a cash generating unit:

First, asset other than goodwill on a pro-rata basis based on the carrying amount of each asset in the unit; and
An impairment loss recognized for goodwill shall not be reversed in a subsequent period.

PAST EXAMS ANALYSIS

Topic Exam Attempt Question


June 15 MCQ.4
IAS 36 Dec. 14 MCQ.12,18
June 12 Q.4

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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.

DEFINITIONS:
Investment property is property held to earn rentals or for capital appreciation or both, rather than for:
a) Use in the production or supply of goods or services or for administrative purposes; or
b) Sale in the ordinary course of business.

Owner-occupied property is property held (by the owner or by the lessee under a finance lease) for use in the
production or supply of goods or services or for administrative purposes.

The following are examples of investment property:


a) Land held for long-term capital appreciation
b) Land held for a currently undetermined future use
c) A building that is vacant but is held to be leased out under one or more operating leases.
d) Property that is being constructed or developed for future use as investment property

The following are examples of items that are not investment property:
a) Property intended for sale in the ordinary course of business
b) Property being constructed or developed on behalf of third parties
c) Owner-occupied property (see IAS 16), including (among other things) property held for future use as owner-
occupied property, property held for future development and subsequent use as owner-occupied property,
property occupied by employees (whether or not the employees pay rent at market rates) and owner-occupied
property awaiting disposal.

RECOGNITION:
Investment property shall be recognized as an asset 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.

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MEASUREMENT
Initial measurement
An investment property shall be measured initially at its Cost + Transaction costs.
The cost of a purchased investment property = Purchase price + any directly attributable expenditure.

SUBSEQUENT MEASUREMENT

IAS 40 permits entities to choose between

A fair value model, and


A cost model.

Fair value model


Under the fair value model the entity should:
Revalue all its investment property to 'fair value' (open market value) at the end of each financial year, and
Take the resulting gain or loss to profit or loss for the period in which it arises.

Fair value is the price that would be received to sell an asset or paid to transfer a liability, in an orderly transaction
between market participants at the measurement date.

Cost model:
Under cost model, investment property should be measured at depreciated cost, less any accumulated impairment
losses.

EXCEPTION:
All investment property must be valued under either one model or the other.

TRANSFERS:

Transfers to, or from, investment property should only be made when there is a change in use, evidenced by one or
more of the following

commencement of owner-occupation
commencement of development with a view to sale end of owner-occupation
commencement of an operating lease to another party end of construction or development

When an entity decides to sell an investment property without development, the property is not reclassified as
investment property but is dealt with as investment property until it is disposed of.

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RULES FOR TRANSFER:

For a transfer from investment property carried at fair value to owner-occupied property or inventories, the fair
value at the change of use is the 'cost' of the property under its new classification
For a transfer from owner-occupied property to investment property carried at fair value, IAS 16 should be
applied up to the date of reclassification. Any difference arising between the carrying amount under IAS 16 at
that date and the fair value is dealt with as a revaluation under IAS 16
For a transfer from inventories to investment property at fair value, any difference between the fair value at the
date of transfer and it previous carrying amount should be recognized in profit or loss
When an entity completes construction/development of an investment property that will be carried at fair
value, any difference between the fair value at the date of transfer and the previous carrying amount should be
recognized in profit or loss.

When an entity uses the cost model for investment property, transfers between categories do not change the carrying
amount of the property transferred, and they do not change the cost of the property for measurement or disclosure
purposes.

DISPOSAL
An investment property should be derecognized on disposal
The gain or loss on disposal should be calculated as the difference between the net disposal proceeds and the
carrying amount of the asset and should be recognized as income or expense
Compensation from third parties is recognized when it becomes receivable.

PAST EXAMS ANALYSIS

Topic Exam Attempt Question


IAS 40 June 13 Q.5

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IAS 2 INVENTORIES

Objective
The objective of this IAS is to prescribe the accounting treatment of inventories.

Definitions
Inventories are assets; -
a) Held for sale in the ordinary course of business
b) In the process of production for such sale; or (work in progress, finished goods awaiting to be sold)
c) In the form of materials or supplies to be consumed in the production process or in the rendering of
services
Net Realizable Value is the estimated selling price in the ordinary course of business less the estimated costs of
completion and the estimated cost necessary to make a sale.

Cost of Inventories
The cost of inventories will comprise all costs of purchase, costs of conversion and other costs incurred in bringing the
inventories to their present location and condition.

(a) Purchase cost comprise the;


i) Purchase price plus;
ii) Import duties and other non refundable taxes;
iii) Transport, handling and any other cost directly attributable to the acquisition of finished goods, services
and materials; less
iv) Trade discounts, rebates and other similar amounts

(b) Cost of conversion


i) Costs directly related to the units of production (direct labor); and
ii) Systematic allocation of fixed and variable production overheads that are incurred in converting
materials into finished goods. (Factory rent, depreciation of machinery, supervisor salary, power
consumption)

The allocation of fixed overheads to the costs of conversion is based on the normal capacity of the production facilities.

(c) Other cost incurred in bringing the inventories to their present location and condition (i.e. non production
overheads or costs of designing products for specific customers).

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The Standard excludes the following from the cost of inventories

a) The abnormal amount of wasted material, labor or other production cost;


b) Storage costs unless necessary for production before the further production process/stage;
c) Administrative overheads that do not contribute to bringing inventories to their present location and condition; and
d) Selling cost

Costs of Inventories of a service provider


The cost of inventories of service providers includes primarily the labour and other cost of the personnel directly
engaged in providing the service including supervisory personnel and directly attributable overheads.

Cost Formulas
First in first out (FIFO) or weighted average cost formula.

Measurement of inventory
Inventory shall be measured at the lower of cost and net realizable value.

Rule:

The write down of inventories would normally take place on an item-by-item basis but similar or related items may
be grouped together
The NRV should be based on the most reliable evidence available at the time of estimates are made.
NRV should be reassessed at each reporting date
Reversal of write down is limited to the original write down of inventories.

PAST EXAMS ANALYSIS

Topic Exam Attempt Question


Dec.14 MCQ.8
IAS 2 Dec. 11 Q.2 (iv)
June 11 Q.2 (v)

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IAS 41 AGRICULTURE

OBJECTIVE
The objective of IAS 41 is to establish standards of accounting for agricultural activity

SCOPE
Within scope are Biological assets, Agricultural produce at the point of harvest and Government grants related to
biological assets.

Excluded from scope are Land and Intangible assets related to agricultural activity

DEFINITIONS

ACTIVE MARKET:
Exists when; the items traded are homogenous, willing buyers and sellers can normally be found at any time and prices
are available to the public.

AGRICULTURAL ACTIVITY:
The management of the transformation of a biological asset for sale into agricultural produce or another biological
asset.

Biological asset: A living animal or plant.

Agricultural produce: The harvested produce of the entitys biological assets.

Biological transformation: The process of growth, degeneration, production, and procreation that
cause an increase in the value or quantity of the biological asset.

Harvest: The process of detaching produce from a biological asset or cessation of its life.

RECOGNITION
Biological assets or agricultural produce are recognised when:
Entity controls the asset as a result of a past event
Probable that future economic benefit will flow to the entity; and
Fair value or cost of the asset can be measurement reliably.

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MEASUREMENT
Biological assets within the scope of IAS 41 are measured on initial recognition and at subsequent reporting
dates at fair value less estimated costs to sell, unless fair value cannot be reliably measured.
If no reliable measurement of fair value, biological assets are stated at cost less accumulated depreciation and
accumulated impairment losses.

Agricultural produce is measured at fair value less estimated costs to sell at the point of harvest.
The gain on initial recognition of biological assets at fair value less costs to sell, and changes in fair value less
costs to sell of biological assets during a period, are included in profit or loss.
A gain on initial recognition (e.g. as a result of harvesting) of agricultural produce at fair value less costs to sell
are included in profit or loss for the period in which it arises.
All costs related to biological assets that are measured at fair value are recognised as expenses when incurred,
other than costs to purchase biological assets.
An unconditional government grant related to a biological asset is measured at fair value less estimated point-
of-sale costs is recognised as income when, and only when, the government grant becomes available
A conditional government grant, including where a government grant requires an entity not to engage in
specified agricultural activity, is recognised as income when and only when, the conditions of the grant are met.

PAST EXAMS ANALYSIS

Topic Exam Attempt Question


IAS 41 June 15 MCQ.10

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IAS-8

ACCOUNTING POLICIES, CHANGE IN ACCOUNTING ESTIMATES AND ERRORS

Objective:
The objective of this Standard is to prescribe the criteria for selecting and changing accounting policies, the accounting
treatment and disclosure of changes in accounting policies, accounting estimates and corrections of errors.

Definitions:
Accounting policies are the specific principles, bases, conventions, rules and practices applied by an entity in preparing
and presenting financial statements.

A change in accounting estimate is an adjustment of the carrying amount of an asset or liability, or related expense,
resulting from reassessing the expected future benefits and obligations associated with that asset or liability.

Material Omissions or misstatements of items are material if they could, influence the economic decisions that users
make on the basis of the financial statements.

Prior period errors are omissions from, and misstatements in, the entitys financial statements for one or more prior
periods arising from a failure to use, or misuse of, reliable information that:
Was available when financial statements for those periods were authorized for issue; and
Could reasonably be expected to have been obtained and taken into account in the preparation and presentation
of those financial statements.

Selection and application of accounting policies:


The accounting policy applied to the item shall be determined by the IFRS.
In the absence of an IFRS, management shall use its judgment in applying an accounting policy that results in
information that is relevant and reliable.

An entity shall select and apply its accounting policies consistently for similar transactions.

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Changes in accounting policies:
A change in accounting policy is permitted only if

Required by an IFRS or revised IAS


If a change in accounting polity results in the financial statements providing reliable and more relevant financial
information.
When a change in accounting policy is required by a new Standard, the Standard will often include specific
'transitional provisions'.
If transitional provision is not present applying to change required by standard, or the entity changes the policy
voluntarily then, it shall apply the change retrospectively. i.e.
The entity shall adjust the opening balance of each affected component of equity for the earliest prior period
presented and the other comparative amounts disclosed for each prior period presented as if the new accounting
policy had always been applied.

Changes in accounting estimates:

The effect of a change in an accounting estimate shall be recognized prospectively by including it in profit or loss in:

The period of the change, if the change affects that period only; or
The period of the change and future periods, if the change affects both

To the extent that a change in an accounting estimate gives rise to changes in assets and liabilities, or relates to an item

of equity, it shall be recognized by adjusting the carrying amount of the related asset, liability or equity item in the

period of the change.

Errors:

An entity shall correct material prior period errors retrospectively in the first set of financial statements authorized for
issue after their discovery by:
restating the comparative amounts for the prior period(s) presented in which the error occurred; or
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
PAST EXAMS ANALYSIS

Topic Exam Attempt Question


Dec. 14 MCQ.1
IAS 8 June 14 Q.5(i)
June 12 Q.2 (iii)

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IAS 23-BORROWING COST

OBJECTIVE:
To prescribe the accounting treatment for borrowing cost.

DEFINITIONS:
Borrowing costs are costs, for example interest costs, incurred by an entity in connection with the borrowing of funds in
order to construct an asset.

A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale.

ACCOUNTING TREATMENT:
RECOGNITION

An entity should capitalize the borrowing costs that are directly attributable to the acquisition, construction or
production of a qualifying asset as part of the cost of that asset and, therefore, should be capitalized.

Other borrowing costs are expensed in statement of profit or loss when occurred.
Return on any surplus funds invested is first deducted from the amount of interest and then the remaining amount
is capitalized.
Where funds are borrowed specifically, costs eligible for capitalization are the actual costs incurred less any income
earned on the temporary investment of such borrowings. Where funds are part of a general pool, the eligible
amount is determined by applying a capitalization rate to the expenditure on that asset. The capitalization rate will
be the weighted average of the borrowing costs applicable to the general pool.

PERIOD OF CAPITALIZATION
1. Commence capitalization when
Expenditure on asset being incurred
Borrowing cost being incurred
Activities to prepare asset for use/sale are in progress
2. Suspend capitalization if construction is suspended (due to bad weather, strikes etc).
3. Cease capitalization when substantially all activities necessary to prepare the asset for use/sale are complete.

DISCLOSURE
The accounting policy adopted.
Amount of borrowing cost capitalized during the period.
Capitalization rate used.

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FINANCIAL INSTRUMENTS

Introduction
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.

Financial assets
A financial asset is any asset that is:
cash
a contractual right to receive cash or another financial asset from another entity
a contractual right to exchange financial assets/liabilities with another entity under conditions that are potentially
favorable
An equity instrument of another entity.

Examples of financial assets include:


trade receivables
Investment in equity shares.

Financial liabilities
A financial liability is any liability that is a contractual obligation:
to deliver cash or another financial asset to another entity

Examples of financial liabilities include:


trade payables
debenture loans
redeemable preference shares

Initial recognition of financial instruments


An entity should recognise a financial asset or a financial liability in its statement of financial position:
when, and only when, it becomes a party to the contractual provisions of the instrument
at fair value of consideration given/received i.e. this is normally cost

FINANCIAL ASSETS
Initial measurement of financial assets
At initial recognition, all financial assets are measured at fair value. This is likely to be the purchase consideration paid to
acquire the financial asset and will normally exclude transactions costs.

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Subsequent measurement of financial assets
Subsequent measurement then depends upon whether the financial asset is an investment in a debt instrument or an
equity instrument, as follows:

Debt instruments:
Debt instruments would normally be measured at fair value through profit or loss (FVTPL), but could be measured at
amortised cost if the entity chooses to do so, provided the following two tests are passed:

The business model test where the objective is to collect the contractual cash flows
The contractual cash flow characteristics test that cashflows are solely payments of principle and interest on
the principle outstanding.

Where an entity changes its business model, it may be required to reclassify its financial assets as a consequence

Debt instruments: further detail


Even if a financial instrument passes both tests, it is still possible to designate a debt instrument as FVTPL if doing so
eliminates or significantly reduces a measurement or recognition inconsistency (i.e. accounting mismatch) that would
otherwise arise from measuring assets or liabilities or from recognising the gains or losses on them on different bases.

Equity instruments:
Equity instruments are measured at either:
fair value either through profit or loss, or
fair value through other comprehensive income

It is possible to designate an equity instrument as fair value through other comprehensive income, provided specified
conditions have been complied with as follows:

The equity instrument cannot be held for trading, and


There must be an irrevocable choice for this designation upon initial recognition.

FINANCIAL LIABILITIES
After initial recognition an entity should measure all financial liabilities (other than liabilities held for trading and
derivatives that are liabilities) at amortised cost using the effective interest rate method.

EQUITY AND LIABILITIES


An equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its
liabilities.

Compound instruments
The issuer of a financial instrument must classify it as a financial liability or equity instrument on initial recognition
according to its substance.

A compound instrument is a financial instrument that has characteristics of both equity and liabilities.

IAS 32 requires compound financial instruments be split into their component parts:
- a financial liability (the debt)
- An equity instrument (the option to convert into shares).
These must be shown separately in the financial statements.
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For example, a convertible bond:
The value of a convertible bond consists of a liability component - the bond - and
An equity component - the value of the right to convert in due course to equity.

To account for a convertible loan:


Calculate fair value of liability component first
- Based on present value of future cash flows assuming non-conversion
- Apply discount rate equivalent to interest on similar non-convertible debt instrument
Equity = remainder

The economic effect of issuing convertible bonds is substantially the same as the simultaneous issue of a debt
instrument with an early settlement provision and warrants to purchase shares.

If preference shares are irredeemable they are classified as equity


If preference shares are redeemable they are classified as a financial liability
Interest, dividends, loss or gains relating to a financial instrument claimed as a liability are reported in the
statement of profit or loss while distributions to holders of equity instruments are debited directly to equity (in
the SOCIE)
Offset of a financial asset and liability is only allowed where there is a legally enforceable right and the entity
intends to settle net or simultaneously
PAST EXAMS ANALYSIS

Topic Exam Attempt Question


Dec. 15
Q.1 (v)
June 15
Q.3
Dec. 14
MCQ.11
June 14
Financial instruments Q.2(iv)
Dec. 12
Q.2 (v)
Dec. 11
Q.2 (v), Q.5
Dec. 11
Q.2 (ii)
June 11

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IAS 37 PROVISONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS

OBJECTIVE
The objective of this IAS is to ensure that appropriate recognition criteria and measurement bases are applied to
provisions, contingent liabilities and contingent assets.

DEFINITIONS
A provision is a liability of uncertain timing or amount.
An obligating event is an event that creates a legal or constructive obligation that results in an enterprise having no
realistic alternative to settling that obligation.
A legal obligation is an obligation that derives from:

(a) A contract (through its explicit or implicit terms);


(b) Legislation; or
(c) Other operation of law.

A constructive obligation is an obligation that derives from an enterprises action where:

(a) By an established pattern of past practice, published policies or a sufficiently specific current statement, the
enterprise has indicated to other parties that it will accept certain responsibilities; and
(b) As a result, the enterprise has created a valid expectation on the part of those other parties that it will discharge
those responsibilities.

A contingent liability is:


(a) A possible obligation that arises from past events and whose existence will be confirmed only by the occurrence
or non-occurrence of one or more uncertain future events not wholly within the control of the enterprise; or

(b) A present obligation that arises from past events but is not recognized because:
(i) It is not probably 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.

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
enterprise.

An onerous contract is a contract in which the unavoidable costs of meeting the obligations under the contract
exceed the economic benefits expected to be received under it.

A restructuring is a program that is planned and controlled by management, and materially changes either:

(a) The scope of a business undertaken by an enterprise; or


(b) The manner in which that business is conducted.

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RECOGNITION

PROVISIONS
A provision shall be recognized when:
a) An entity has a present obligation (legal or constructive) as a result of a past event;
b) It is possible than an outflow of resources embodying economic benefits will be required to settle the obligation;
and
c) A reliable estimate can be made of amount of the obligation.

If these conditions are not met, no provision shall be recognized.

MEASUREMENT
The amount recognized as a provision shall be the best estimate of the expenditure required to settle the present
obligation at the reporting date. This means that:

Provisions for one-off events (restructuring, environmental clean-up, settlement of a lawsuit) are measured at the
most likely amount.
Provisions for large populations of events (warranties, customer refunds) are measured at a probability-weighted
expected value.
Both measurements are at discounted present value using a pre-tax discount rate that reflects the current market
assessments of the time value of money and the risks specific to the liability.

In reaching its best estimate, the enterprise should take into account the risks and uncertainties that surround
the underlying events.
In case of expectation of reimbursement of provision (some or all of the expenditure), the reimbursement
should be recognized when it is virtually certain that reimbursement will be received
In SOFP, reimbursement should be shown as an asset and provision should be shown at gross amount however,
in statement of profit or loss they can be netted off.

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RE-MEASUREMENT OF PROVISIONS
Review and adjust provisions at each reporting date
If outflow is no longer probable, reverse the provision to income statement.

APPLICATION OF RECOGNITION AND MEASUREMENT RULES


Some specific requirements on applying recognition and measurement rules are as follows:
Provisions shall not be recognized for future operating losses.
If an entity has a contract that is onerous, the present obligation under the contract shall be recognized and
measured as a provision.

RESTRUCTURING
The following are examples of events that may fall under the definition of restructuring:
Sale or termination of a line of business
Closure of business locations
Changes in management structure
Fundamental re-organization of company

Restructuring provisions should be accrued as follows:

Sale of operation: Accrue provision only after a binding sale agreement. If the binding sale agreement is after reporting
date, disclose but do not accrue

Closure or re-organization: Accrue only after a detailed formal plan is adopted and announced publicly. A board decision
is not enough.

Restructuring provision on acquisition (merger): Accrue provision for terminating employees, closing facilities, and
eliminating product lines only if announced at acquisition and, then only if a detailed formal plan is adopted 3 months
after acquisition.

A management or board decision to restructure taken before the reporting date does not give rise to a constructive
obligation at the reporting date unless the entity has, before the reporting date:

a) Stated to implement the restructuring plan; or


b) Announced the main features the restructuring plan to those affected by it in a sufficiently specific manner to
raise a valid expectation in them that the entity will carry out the restructuring.

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Restructuring provisions should include only direct expenditures caused by the restructuring, not costs that associated
with the ongoing activities of the enterprise such as: -

a) retraining or relocating continuing staff;


b) marketing; or
c) investment in new systems and distribution networks

CONTINGENT LIABILITIES
An enterprise should not recognize a contingent liability.
A contingent liability is disclosed in financial statements, unless the possibility of an outflow of resources
embodying economic benefits is remote.

CONTINGENT ASSETS
An enterprise should not recognize a contingent asset.
A contingent asset is disclosed in financial statements, where an inflow of economic benefits is probable.

PAST EXAMS ANALYSIS

Topic Exam Attempt Question


Spec. exam Sept. 16 MCQ.5
June 15 MCQ.16
Dec. 14 MCQ.17
IAS 37 June 14 Q.5(ii)
Dec. 13 Q.2(iii), Q.4(c)
Dec. 12 Q.5
Dec. 11 Q.4

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IAS 17 LEASES

Objective
The objective of IAS 17 is to ensure that leases are accounted for in the financial statements, of both lessees and lessors,
in accordance with their commercial substance.

Definitions

Lease
A lease is an agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right
to use an asset for an agreed period of time. Usually legal ownership is retained by the lessor.

Finance Lease
This is a lease that transfers substantially all the risks and rewards incident to ownership of an asset. Title may or may
not be eventually transferred.

Operating Lease
This is a lease other than a finance lease.

Lease Term
This is the non-cancellable period for which the lessee has contracted to lease the asset.

Inception of a lease (date of commitment)


This is the earlier of the date of the lease agreement and the date of the parties commitment to the lease's principal
provisions. This is the date at which the assets and liabilities to be recognised at the commencement of a finance lease
are determined.

Commencement of the lease term (date of initial recognition)


This is the date from which the lessee is entitled to exercise its right to use the leased asset and it is the date of initial
recognition of the lease assets and liabilities.

Minimum Lease Payments


The payments over the lease term that the lessee is expected or can be required to make plus:
for a lessee any amounts guaranteed by the lessee to the lessor,

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Guaranteed residual value
For a lessee, that part of the residual value which is guaranteed by the lessee or by a party related to the lessee.

Classification of Leases
The following are indicators would normally lead to a lease being classified as a finance lease:
1. The lease transfers ownership of the asset to the lessee by the end of the lease term;
2. The lessee has an option to purchase the asset at a price which is expected to be
3. sufficiently lower than fair value at the date the option becomes exercisable such that, at the inception of the lease,
it is reasonably certain that the option will be exercised (often referred to as a 'bargain purchase' option);
4. The lease term is for the major part of the economic life of the asset even if tide is not transferred;
5. At the inception of the lease the present value of the minimum lease payments amounts
to substantially all of the fair value of the leased asset;
6. The leased assets are of a specialised nature such that only the lessee can use them without major modifications
being made.

Leases of Land and Buildings


Under IAS 17 a lease of property comprises two parts; a lease on the land and a separate lease on the building.
Consequently the lease payments should be divided between payments on the land and payments on the building.

Because land has an infinite life, it is highly unlikely that substantially all the risks and rewards of ownership would be
transferred to the lessee; as a lease term is likely to be insignificant in comparison with the useful life of the land. As a
result the land element of such a lease would normally be classified as an operating lease.

The classification of the building element of such a lease will depend on the terms of the lease.
Where a company has an interest in the property and that property is leased to another party under an operating lease
then providing the property meets the definition of an investment property in IAS 40 (held to earn rentals and or for
capital appreciation), it should be measured in accordance with the rules of IAS 40 rather than IAS 17. The property
interest held by the lessor maybe a freehold interest or a leasehold interest. If the interest is freehold or the lease is a
finance lease the company has a choice under IAS 40 of accounting for investment properties at cost or fair value.
However, if the interest held is held under an operating lease and the lessor wishes to treat the interest held as an
investment property, the fair value model in IAS 40 must be adopted for all investment properties held.

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Accounting for Operating Leases
Operating leases are viewed as an annual expense of the business and should be charged to the
statement of profit or loss on a systematic basis (normally straight line basis).
The aggregate benefits of incentives in lease (costs incurred by the lessor) should be recognised by the
lessee as a reduction on the rental expense over the lease term on a straight-line basis, unless another
systematic basis is more representative of the time pattern of the lessee's receipt of benefit.

Accounting For Finance Leases


A finance lease allows the lessee use of the asset as if it was his/her own and creates a liability to the lessor for the
capital amount to be repaid.

The asset and initial liability should be recognised at the lower of the assets fair value and the present value of the
minimum lease payments.
The asset should be depreciated over the shorter of the lease term or the useful life of the asset.
Calculate the finance charge on the obligation under the finance lease so as to give a constant periodic rate of
charge on the outstanding liability using:
Actuarial method (based on rate implicit in the lease - most accurate)
Sum of the digits (good approximation)
Straight line

Rental payments should be allocated between interest and reduction of outstanding liability.

Double entry book keeping: Lessee's books


1) Debit PP&E: Assets held under Finance Lease - SOFP
Credit Obligations under finance lease - SOFP
Being initial recognition of asset and liability

2) Debit Obligations under finance lease - SOFP


Credit Bank
Being rental repayment recorded in full

3) Debit Interest expense - P&L


Credit Obligations under finance lease - SOFP
Being year end adjustment to recognise interest allocated to Income statement

4) Debit Depreciation expense - P&L


Credit Accumulated depreciation - SOFP
Being depreciation of assets held under finance lease

Note the interest expense in Journal 3 is normally adjusted for at the end of the period. In which case journals (2) and (3)
could be combined:

3a) Debit Obligations under finance lease - SOFP


Debit Interest expense - P&L
Credit Bank
Being rental repayment split between capital reduction and interest allocation

If the reporting period is different to the lease period then interest for the accounting period is calculated by time
apportioning interest determined for the relevant lease periods.

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Accounting for Sale And Leaseback Transactions
A sale and leaseback transaction arises when a vendor sells an asset and immediately re-acquires the use of the
asset by entering into a lease with a buyer
These transactions provide a means of raising
The seller/lessees treatment of the 'sale' depends on whether the resultant lease is classified as a finance lease
(not considered sold) or an operating lease (considered sold).
Where a sale and leaseback transaction results in a finance leaseback the standard states that any excess of sale
proceeds over the carrying amount should not be recognised immediately as income by a seller/lessee. Instead,
the excess is deferred and amortised over the lease term.

PAST EXAMS ANALYSIS

Topic Exam Attempt Question


Spec. exam Sept. 16 MCQ.3
June 15 Q.3(iii), (iv)
Dec. 14 Q.19
IAS 17
Dec.13 Q.2 (ii), Q.5
June 12 Q.2 (ii)
Dec. 11 Q.2 (ii)

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IFRS 13 FAIR VALUE MEASUREMENTS

NEED FOR FAIR VALUE GUIDANCE:


IFRS 13 provides a single source of guidance for all fair value measurements, clarifying the definition of fair value and
enhancing disclosures requirements about reported fair value estimates.

FAIR VALUE DEFINITION


Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date.

From the above definition, it can be inferred that fair value is an exit price.

IFRS 13 provides a new framework to estimate fair value in a consistent manner across standards. For a fair value
measurement, an entity has to determine:

The particular asset or liability that is the subject of the measurement


For an asset, the valuation premise that is appropriate for the measurement
The most advantageous market for the asset or liability and
The valuation technique appropriate for measurement

I. THE MOST ADVANTAGEOUS MARKET


It is assumed that transactions take place in the most advantageous market to which the entity has access. This means
that the entity is in a position to receive the maximum amount on sale of the asset or pay the minimum amount to
transfer a liability after considering transaction and transport costs.
While transaction and transport costs are relevant to identify the market, they are not considered in determining the
fair value.

II. MEASUREMENT ASSUMPTIONS


Fair value measurement of an asset or liability should use the assumptions that market participants would use in pricing
the asset or liability. These assumptions include:

buyers and sellers are independent of each other


they have knowledge about the asset or liability
they are capable of entering into a transaction
They are willing to enter into a transaction, rather than being forced or otherwise compelled.

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III. ASSET -SPECIFIC VALUATIONS
For a fair value measurement of an asset, it is assumed that the asset will be sold to a market participant who will use it
at its highest and best use.

IV. LIABILITY-SPECIFIC VALUATION


Fair value measurement of a liability assumes that the liability is transferred to a market participant at the measurement
date. Where there is no observable market price for the transfer of a liability, an entity would be required to measure
the fair value of the liability using the same methodology that the counterparty would use to measure the fair value of
the corresponding asset.

V. VALUATION TECHNIQUES
An entity uses valuation techniques appropriate in the circumstances and for which sufficient data are available to
measure fair value, maximising the use of relevant observable inputs and minimising the use of unobservable inputs.

Where fair value is determined using a valuation technique, IFRS 13 prescribes that the technique should be one of the
following.

i. Market approach: uses price and other relevant market information for identical or comparable assets or
liabilities
ii. Income approach: converts future amounts to a single discounted present value amount or
iii. Cost approach: amount that would currently be required to replace the service capacity of the asset
iv. Fair value hierarchy

IFRS 13 seeks to increase consistency and comparability in fair value measurements and related disclosures through a
'Fair Value Hierarchy'. The hierarchy categorises the inputs used in valuation techniques into three levels.

Level 1 Inputs
Quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity can access at the
measurement date.

Level 2 Inputs
Inputs other than quoted prices included in Level 1 that are directly or indirectly observable.

Level 3 Inputs
Inputs for the asset or liability that are not based on observable market data(unobservable inputs).

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RULES IN BUSINESS COMBINATION:
IFRS 3 sets out general principles for arriving at the fair values of a subsidiary's assets and liabilities only if they satisfy
the following criteria:

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. Vice versa for liabilities
In the case of an intangible asset or a contingent liability, its fair value can be measured reliably.
The acquiree's identifiable assets and liabilities might include assets and liabilities not previously recognised in
the acquiree's financial statements
An acquirer should not recognise liabilities for future losses or other costs expected to be incurred as a result of
the business combination.
The acquiree may have intangible assets which can only be recognised separately from goodwill if they are
identifiable. They must be able to be capable of being separated from the entity.
The acquirer should measure the cost of a business combination as the total of the fair values at the date of
acquisition
If part of the consideration is payable at a later date, this deferred consideration is discounted to present value
at the date of exchange.
In case of equity instruments as cost of investment, the published price at the date of exchange normally
provides the best evidence of the instrument's fair value.
Costs attributable to the combination, for example professional fees and administrative costs, should not be
included: they are recognised as an expense when incurred.
If an asset or liability has been recognised at fair value at acquisition, it must be recorded in the subsidiarys
statement of financial position at fair value consequently also
Some fair value adjustments are made on depreciable assets such as buildings, the assets with fair value
adjustment must be depreciated at its fair value so there will be an adjustment, which flows through to profit or
loss for this additional depreciation.

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IAS-20 GOVERNMENT GRANTS

Objective:
To prescribe the accounting for, and disclosure of, government grants and other forms of government assistance.

Definitions:

Government assistance is provision of economic benefits by government to a specific entity or range of entities which
meet specific criteria.

Government grants are transfer of resources to an entity, from government, in return for compliance with certain
conditions.

Accounting treatment:
Recognition
A government grant is recognized only when there is reasonable assurance that

The entity will comply with any conditions attached to the grant
The grant will be received.

Grant related to income are recognized over the period and matched with the related expenses.

Grant related to depreciable assets are recognized over the useful life of the assets in the proportion of depreciation
charge.

Grant related to non-depreciable assets are also recognized over the period in which related expenses are made.

Non-monetary grants are recognized at fair value.

Presentation:

A grant relating to assets may be presented in one of two ways:

As deferred income, or
By deducting the grant from the asset's carrying amount.

A grant relating to income may be reported separately as 'other income' or deducted from the related expense.

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Repayment:
A government grant that becomes repayable shall be accounted for as a revision to an accounting estimate (IAS
8).
Repayment of a grant related to income shall be applied first against any un-amortized deferred credit and if
repayment exceeds the deferred credit the rest will be recognized immediately as expense.
Repayment of grants related to assets shall be recorded by increasing the carrying amount of the asset or
reducing the deferred income balance by the amount payable. The cumulative additional depreciation that
would have been recognized to date as an expense in the absence of the grant shall be recognized immediately
as an expense.

If the conditions of a grant are breached, it may need to be repaid.

In case of Revenue grants recognize repayment immediately as an expense.


In case of Capital grant increase the carrying value of the asset by the amount of the repayment, or reduce deferred
income by the amount of the repayment.

Disclosure:

The following must be disclosed:

Accounting policy adopted for grants, including method of statement of financial position presentation
Nature and extent of grants recognized in the financial statements
Unfulfilled conditions and contingencies attaching to recognized grant

PAST EXAMS ANALYSIS

Topic Exam Attempt Question


June 15 MCQ.15
IAS 20 June 14 Q.5(iii)
Dec. 12 Q.5

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IAS 10 - EVENTS AFTER REPORTING DATE

Objective:
To prescribe:
When an entity should adjust its financial statements for events after the reporting period; and
The disclosures that an entity should give about the date when the financial statements were authorized for issue
and about events after the reporting period.

Definitions:
Event after the reporting period occurs between the end of the reporting period and the date that the financial
statements are authorized for issue. These include:

Adjusting events provide evidence of conditions that existed at the end of the reporting period.
Non-adjusting events are those that are indicative of conditions that arose after the reporting period.

Accounting treatment:

Adjust financial statements for adjusting events


Do not adjust for non-adjusting events
If an entity declares dividends after the reporting period, the entity shall not recognize those dividends as a
liability at the end of the reporting period. That is a non-adjusting event.
An entity shall not prepare its financial statements on a going concern basis if management determines after the
reporting period either that it intends to liquidate the entity or to cease trading.

Adjusting events examples


Adjusting events, as is evident by the name, require adjustments in the financial statements. Following are some
examples:

Invoices received in respect of goods or services received before the year end
The resolution after the reporting date of a court case giving rise to a liability
Evidence of impairment of assets, such as news that a major customer is going into liquidation or the sale of
inventories below cost
Discovery of fraud or errors showing that financial statements were incorrect
Determination of employee bonuses/profit shares
The tax rates applicable to the financial year are announced
The auditors submit their fee
The sale of a non-current asset at a loss indicates that it was impaired at the reporting date
The bankruptcy of a customer indicates that their debt was irrecoverable at the reporting
date

The sale of inventory at less than cost indicates that it should have been valued at NRV in the accounts
The determination of cost or proceeds of assets bought/sold during the accounting period indicates at what amount
they should be recorded in the accounts

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Non-adjusting events examples

Usually non-adjusting events do not require adjustments. However, if the event is of such importance that its non-
disclosure will affect the economic decision making of users it should be disclosed in the notes to the accounts. Some
examples of non-adjusting events are as follows:

Business combinations
Discontinuance of an operation
Major sale/purchase of assets
Destruction of major assets in natural disasters
Major restructuring
Major share transactions
Unusual changes in asset prices/foreign exchange rates
Commencing major litigation
A purchase or sale of a non-current asset
The destruction of assets due to fire or flood
The announcement of plans to discontinue an operation
An issue of shares

Disclosure:

Non-adjusting events should disclose the nature and financial effect of the event if its non-disclosure would affect the
judgment of users in making decisions.

Companies must disclose the following

When the financial statements were authorized for issue


Who gave that authorization
Who has the power to amend the financial statements after issuance

PAST EXAMS ANALYSIS

Topic Exam Attempt Question


IAS 10 June 15 MCQ.3

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IAS 12 INCOME TAXES

Objective
The objective of IAS 12 is to prescribe the accounting treatment for income taxes.

Definitions

Accounting profit
This is the net profit (or loss) for the reporting period before deducting tax expense.

Taxable Profit
This is the profit (or loss) for a period, determined in accordance with the local tax authority's rules, upon which income
taxes are payable.

CURRENT TAX
This is the amount of income tax payable (or recoverable) in respect of the taxable profit (or loss) for the period.

Accounting for Current Tax


Current taxes include tax payable for current period and adjustment of under/over provision of prior periods
Current taxes are to be treated as an expense
If the tax expense and the provision at the end of the year are greater than the payment, the shortfall in the
payment will be disclosed as a current tax liability and vice versa.

Tax Expense
Tax in the income statement may consist of three elements:
Current tax expense
Adjustments to tax charges of prior periods (over/under provisions)
Transfers to/from deferred tax.

DEFERRED TAX

Tax Base
This is the amount attributed to an asset or liability for tax purposes.

Tax base-Asset
The tax base of an asset is the amount that will be deductible for tax purposes against any future taxable benefits
derived from the asset.

Tax base-Liability
The tax base of a liability is its carrying amount, less any amount that will be deductible for tax purposes in respect of
that liability in future periods.

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Accounting for Deferred Tax
Deferred tax liabilities are the amounts of income taxes payable in future periods in respect of taxable temporary
differences.

Deferred tax assets are the amounts of income taxes recoverable in future periods in respect of:
deductible temporary differences
the carry forward of unused tax losses
the carry forward of unused tax credits

Temporary differences are differences between the carrying amount of an asset or liability in the SOFP and its tax base.

Temporary differences may be of two types:

i. Taxable temporary differences are temporary differences that will result in taxable amounts in determining taxable
profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled.
A taxable temporary difference occurs when:
Depreciation or amortisation is accelerated for tax purposes
Development costs capitalised in the statement of financial position deducted against taxable profit when the
expenditure was incurred
Interest income is included in the statement of financial position when earned, but included in taxable profit
when the cash is actually received
Prepayments in the statement of financial position deducted against taxable profits when the cash expense was
incurred
Revaluation/Fair value adjustment of assets with no adjustment of the tax base.
Deferred tax on impairment where these djustments are ignored for tax purposes until the asset is sold.

ii. Deductible temporary differences are temporary differences that will result in amounts that are deductible in
determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or
settled.

A deferred tax asset (DTA) shall be recognised for all deductible temporary differences to the extent it is probable that
taxable profit will be available against which the deductible temporary difference can be utilised.

Provisions, accrued product warranty costs for which the taxation laws do not permit the deduction until the
company actually pays the claims. This is a deductible difference as its taxable profits for the current period will
be higher than those in future, when they will be lower.

Measurement of deferred tax assets and liabilities


Measurement shall be at the tax rates expected to apply to the period when the asset is realised or liability is
settled.
The rates used shall be those enacted or substantially enacted by the end of the reporting period.
Measurement depends upon the expectations about the manner in which the recovery of tax asset or
settlement of tax liability will take place.
In the case of deferred tax assets and liabilities, the values are not to be discounted.
Deferred tax expense is recognized as an expense in statement of profit or loss. If the tax relates to items that
are credited or charged directly to equity, then this current tax and deferred tax shall also be charged or
credited directly to equity.

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Presentation

Current tax assets and current tax liabilities should be offset on the SOFP only if the entity has the legal right and the
intention to settle on a net basis.

Deferred tax assets and deferred tax liabilities should be offset on the SOFP only if the entity has the legal right to settle
on a net basis.

PAST EXAMS ANALYSIS

Topic Exam Attempt Question


Dec. 15 Q.1 (vi)
June 15 Q.3 (vi)
Dec. 14 Q.2 (iii)
June 14 Q.2 (vi)
Dec. 13 Q.2 (iv)
IAS 12
June 13 Q.2 (iv)
Dec. 12 Q.2 (vi)
June 12 Q.2 (iv)
Dec. 11 Q.2 (vi)
June 11 Q.2 (iv)

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SUBSTANCE OVER FORM

The principles of the framework would be applied to the following transactions.

Consignment inventory
Sale and repurchase agreements/sale and leaseback agreements
Factoring of receivables/debts

CONSIGNMENT INVENTORY:
Inventory is an arrangement where inventory is held by one party but is owned by another party.

Identify if the manufacturer has the right to require the return of the inventory and if that right is likely to be exercised
then the inventory is not an asset of the dealer.

If the dealer is rarely required to return the inventory then this part of the transaction will have little commercial
effect in practice and should be ignored for accounting purposes. The potential liability would need to be
disclosed in the accounts

SUMMARY OF INDICATORS - INVENTORY IS AN ASSET OF DEALER AT DELIVERY


Manufacturer cannot require dealer to return or transfer inventory
Financial incentives given to persuade dealer to transfer inventory at manufacturers
request
Dealer has no right to return or is commercially compelled not to exercise its right of
return
Dealer bears obsolescence risk e.g. Penalty charged if dealer returns to manufacturer,
or Obsolete inventory cannot be returned to the manufacturer and no compensation is
paid by manufacturer for losses due to obsolescence
Inventory transfer charged by manufacturer is based on manufacturers list price at
date of delivery
Dealer bears slow movement risk e.g. Dealer is effectively charged interest as transfer
price or other payments to manufacture vary with time for which dealer holds
inventory, or Dealer makes a substantial interest-free deposit that varies with levels of
inventory held.

SALE AND REPURCHASE AGREEMENTS:


These are the arrangements under which the company sells an asset to another person on terms that allow the
company to repurchase the asset in certain circumstances.

If the seller has the rights to the benefits of the use of the asset, and the repurchase terms are such that repurchase is
likely to take place, the transaction should be accounted for as a loan.

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SUMMARY OF INDICATIONS OF THE SALE OF THE ASSET:
Indications of sale of original asset to buyer , the seller may retain a different asset
No commitment for seller to repurchase asset call option where there is a real possibility the
option will fail to be exercised
Risk of changes in asset value borne by buyer such that buyer does not receive solely a lenders
return both sale and repurchase price equal market value at date of sale/repurchase
Nature of the asset is such that it will be used over the life of the agreement , and seller has no
rights to determine assets development or future sale

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 negotiated as a package

If the transaction results in a finance lease then it is in substance a loan from the less or to the lease with the
asset as security.
If the result is an operating lease and the scale price was below fair value, this may be being compensated for by
lower rentals in the future. If this is the case any loss should be amortised over the period for which the asset is
expected to be used.
If the scale price was above fair value any excess is deferred and amortised over the period for which the asset is
expected to be used.

FACTORING OF RECEIVABLES/DEBTS.:
This is where debts or receivables are factored the original creditor sells the debts to the factor.

If the seller has to pay interest on the difference between the amounts advanced to him and the amounts that the factor
has received, and if the seller bears the risk of non-payment by the debtor, then the indications would be that the
transaction is, in effect, a loan.

REQUIRED ACCOUNTING:
Where the seller has retained no significant benefits and risks relating to the debts and has no obligation to
repay amounts received from the factors, the receivables should be removed from its statement of financial
position
No liability should be shown in respect of the proceeds received from the factor
A profit or loss should be recognized, calculated as the difference between the carrying amount of the debts and
the proceeds received.
Where the seller does retain significant benefits and risks a gross asset should be shown in the statement of
financial position of the seller within assets, and a corresponding liability in respect of the proceeds received
from the factor should be shown within liabilities.
The interest element of the factors charges should be recognized as it accrues and included in profit or loss with
other interest charges.

PAST EXAMS ANALYSIS

Topic Exam Attempt Question


Dec. 15 Q.1 (i)
June 14 Q.2(i)
Substance over form Dec. 13 Q.4(b)
June 13 Q.2(i)
June 11 Q.2 (vi)

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IFRS 15 REVENUE FROM CONTRACTS WITH CUSTOMERS

IFRS 15 specifies how and when an IFRS reporter will recognise revenue.

THE FIVE-STEP MODEL FRAMEWORK


The standard provides a single, principles based five-step model to be applied to all contracts with customers.

STEP 1: IDENTIFY THE CONTRACT WITH THE CUSTOMER


A contract with a customer will be within the scope of IFRS 15 if all the following conditions are met:

The contract has been approved by the parties to the contract;


Each partys rights in relation to the goods or services to be transferred can be identified;
the payment terms for the goods or services to be transferred can be identified;
the contract has commercial substance; and
It is probable that the consideration to which the entity is entitled to in exchange for the goods or services will
be collected.

STEP 2: IDENTIFY THE PERFORMANCE OBLIGATIONS IN THE CONTRACT


At the inception of the contract, the entity should assess the goods or services that have been promised to the
customer, and identify as a performance obligation:

a good or service (or bundle of goods or services) that is distinct; or


A series of distinct goods or services that are substantially the same and that have the same pattern of transfer
to the customer.

A series of distinct goods or services is transferred to the customer in the same pattern if both of the following criteria
are met:

each distinct good or service in the series that the entity promises to transfer consecutively to the customer
would be a performance obligation that is satisfied over time; and
A single method of measuring progress would be used to measure the entitys progress towards complete
satisfaction of the performance obligation to transfer each distinct good or service in the series to the customer.

A good or service is distinct if both of the following criteria are met:

The customer can benefit from the good or services on its own or in conjunction with other readily available
resources; and
The entitys promise to transfer the good or service to the customer is separately identifiable from other
promises in the contract.

Factors for consideration as to whether a promise to transfer the good or service to the customer is separately
identifiable include, but are not limited to:

The entity does not provide a significant service of integrating the good or service with other goods or services
promised in the contract.
The good or service does not significantly modify or customise another good or service promised in the contract.
The good or service is not highly interrelated with or highly dependent on other goods or services promised in
the contract.

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STEP 3: DETERMINE THE TRANSACTION PRICE

The transaction price is the amount to which an entity expects to be entitled in exchange for the transfer of goods and
services. When making this determination, an entity will consider past customary business practices.

Where a contract contains elements of variable consideration, the entity will estimate the amount of variable
consideration to which it will be entitled under the contract.

However, a different, more restrictive approach is applied in respect of sales or usage-based royalty revenue arising
from licences of intellectual property. Such revenue is recognised only when the underlying sales or usage occur.

STEP 4: ALLOCATE THE TRANSACTION PRICE TO THE PERFORMANCE OBLIGATIONS IN THE CONTRACTS

Where a contract has multiple performance obligations, an entity will allocate the transaction price to the performance
obligations in the contract by reference to their relative standalone selling prices. If a standalone selling price is not
directly observable, the entity will need to estimate it. IFRS 15 suggests various methods that might be used, including:

Adjusted market assessment approach


Expected cost plus a margin approach
Residual approach (only permissible in limited circumstances).

STEP 5: RECOGNISE REVENUE WHEN (OR AS) THE ENTITY SATISFIES A PERFORMANCE OBLIGATION

Revenue is recognised as control is passed, either over time or at a point in time.

Control of an asset is defined as the ability to direct the use of and obtain substantially all of the remaining benefits from
the asset. The benefits related to the asset are the potential cash flows that may be obtained directly or indirectly. These
include, but are not limited to:

Using the asset to produce goods or provide services;


Using the asset to enhance the value of other assets;
Using the asset to settle liabilities or to reduce expenses;
Selling or exchanging the asset;
Pledging the asset to secure a loan; and
Holding the asset.

An entity recognises revenue over time if one of the following criteria is met:

The customer simultaneously receives and consumes all of the benefits provided by the entity as the entity
performs;
The entitys performance creates or enhances an asset that the customer controls as the asset is created; or
The entitys performance does not create an asset with an alternative use to the entity and the entity has an
enforceable right to payment for performance completed to date.

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If an entity does not satisfy its performance obligation over time, it satisfies it at a point in time. Revenue will therefore
be recognised when control is passed at a certain point in time. Factors that may indicate the point in time at which
control passes include, but are not limited to:

The entity has a present right to payment for the asset;


The customer has legal title to the asset;
The entity has transferred physical possession of the asset;
The customer has the significant risks and rewards related to the ownership of the asset; and
The customer has accepted the asset.

CONTRACT COSTS

The incremental costs of obtaining a contract must be recognised as an asset if the entity expects to recover those costs.

Costs incurred to fulfil a contract are recognised as an asset if and only if all of the following criteria are met:

The costs relate directly to a contract (or a specific anticipated contract);


The costs generate or enhance resources of the entity that will be used in satisfying performance obligations in
the future; and
The costs are expected to be recovered.

The asset recognised in respect of the costs to obtain or fulfil a contract is amortised on a systematic basis that is
consistent with the pattern of transfer of the goods or services to which the asset relates.

PAST EXAMS ANALYSIS

Topic Exam Attempt Question


Dec. 12 Q.2(i)
IFRS 15
Dec. 11 Q.2 (i)

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CASH FLOW STATEMENTS - IAS 7

Objective
The objective of IAS 7 - Cash-flow Statements is to ensure that enterprises provide information about the historical
changes in cash and cash equivalents by means of a cash flow statement which classifies cash flows during the period
according to operating, investing and financing activities for a period.

Cash & Cash Equivalents


Cash comprises cash in hand and deposits repayable on demand less overdrafts repayable on demand.

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. (Investments with a maturity of three months or less from
the date of acquisition)

Presentation of Cash Flow Statement


Operating Activities
Cash flows from operating activities are those that normally arise from transactions relating to trading activities.

Cash flows from operating activities can be calculated in two ways, using the direct method or the indirect method.

Direct method
The direct method shows operating cash receipts and payments directly. This is useful as it shows the actual sources,
and uses of cash flows by nature. The problem is that most businesses do not keep records in this way and so it can be
time consuming to gather the information. The information if available would be presented as follows:
$

Cash receipts from customers X

Payments to suppliers (X)


Payments in relation to employees (X)
Payments in relation to other operating expenses (X)
Cash flows from Operations X
Interest paid (X)
Income taxes paid (X)
Dividends paid (might be shown in financing activities) (X)
Net cash flows from operating activities X
Whilst IAS 7 encourages the use of this method it is not mandatory.

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Indirect Method
This method starts with profit before tax and adjusts for non-cash items to arrive at cash flows from operations. Non
operating items such as interest paid, tax paid are deducted to arrive at net cash flows from operating activities. This
method allows users to assess the quality of earnings as a comparison of profit and cash flows can easily be made.
Additionally, this method is popular with preparers, as it does not give away such sensitive information as the direct
method.

Investing Activities
Investing activities are the acquisition and disposal of long term assets, and other investment that are not considered to
be cash equivalents but have been made to generate future income and cash flows.

Financing Activities
Financing activities are activities that alter the equity capital and borrowing structure (gearing) of the entity and will
comprise receipts and payments of capital/principal from or to external providers of finance.

Proforma single Entity Cash Flow Statement


$'m $'m
Net cash inflow from operating activities
Profit before tax X
Adjustments for:
Add back interest expense X
Deduct investment income (X)
Add back depreciation X
Add back Loss on disposal of PP&E X
Add back Goodwill impairment X
Add back increase in provisions X
Deduct amortisation of government grants (X)
Operating profit before working capital changes X
(Increase) in inventory (X)
(Increase) in receivables (X)
Increase in payables X
Cash generated from operations X
Interest paid (X)
Tax paid (X)
Dividends paid (might be shown in Financing instead) (X)
Net cash flow from operating activities X/(X)

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Cash flows from investing activities
Purchase of PP&E (X)
Purchase of non-current investments (X)
Receipts from sale PP&E X
Receipts from sale of investments X
Dividends received X
Interest received X
Receipt of government grant X
Cash used for investing activities X/(X)
Cash flows from Financing activities
Issue of ordinary share capital X
Issue of loan notes X
Payment of finance lease liabilities (X)
Cash from financing activities X/(X)
Net increase/(Decrease) in cash and cash equivalents
Opening balance for cash & cash equivalents X

Closing balance for cash and cash equivalents X

PAST EXAMS ANALYSIS

Topic Exam Attempt Question


June 15 Q.3(e)
Dec. 14 MCQ.9
Dec. 13 Q.3(a)
IAS 7 June 13 Q.3(a)
June 12 Q.3 (a)
Dec. 11 Q.3 (a)
June 11 Q.3 (a)

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IFRS 5-NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS

OBJECTIVE
The objective of this standard is to specify the accounting for Non-current assets held for sale, and presentation and
disclosure of discontinued operations.

Non-Current Assets Held For Sale

HELD FOR SALE


This term refers to a non-current asset whose carrying amount will be recovered principally through a Sale transaction
rather than through continuing use.

DISCONTINUED OPERATION
A discontinued operation includes the following criteria:
is a separately identifiable components
must represent a major line of the entitys business
is part of a plan to dispose of a major line of business or a geographical area
is a subsidiary acquired with a view to resell

DISPOSAL GROUP
This is a group of assets and possibly some liabilities that an entity intends to dispose of in a single transaction.
Non-current assets or disposal groups that meet the criteria to be classified as held for sale are measured at the lower
of:
their carrying amount and
fair value less costs to sell,

ACCOUNTING TREATMENT:
Non-current assets that meet the criteria are presented separately on the Statement of Financial Position within
current assets.
If the held for sale item is a disposal group then related liabilities are also reported separately within current
liabilities.
Discontinued operations and operations held for sale must be disclosed separately in the statement of financial
position at the lower of their carrying value less costs to sell.

CLASSIFICATION OF NON-CURRENT ASSETS AS HELD FOR SALE


For an asset to be classified as held for sale:
a) It must be available for immediate sale in its present condition allowing for terms that are usual or customary;
b) Its sale must be highly probable {expected within 1 year of reclassification);
c) It must be genuinely sold, not abandoned.

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For a sale to be highly probable it must be significantly more likely than probable. In addition the standard sets out the
following criteria to be satisfied:

Management, at a level that has the authority to sell the assets or disposal group, is committed to a plan to sell;
An active program to locate a buyer and complete the sale must have begun.
The asset or disposal group must be actively marketed at a price that is reasonable compared to its current fair
value.
The sale of the asset is expected to be recorded as completed within time, ear from the date of classification.
The actions required to complete the plan should indicate that it is not likely that there will be significant changes
made to the plan or that the plan will be withdrawn.

MEASUREMENT
They are measured at the lower of:
Fair value less costs to sell; and
Carrying amount (in accordance with the relevant Standard).

Any impairment loss on initial or subsequent write-down of the asset or disposal group to fair value less cost to sell
is to be recognised in the statement of profit or loss.
Any subsequent increase in fair value less cost to sell can be recognised in the statement of profit or loss to the
extent that it is not in excess of the cumulative impairment loss that has been recognised in accordance with the
IFRS 5 or previously in accordance with IAS 36.

SUBSEQUENT REMEASUREMENT
Whilst a non-current asset/disposal group is classified as held for sale it should not be depreciated or amortised.
At each reporting date where a non-current asset or disposal group continues to be classified as held for sale it
should be re-measured at fair value less costs to sell at that date.
This may give rise to further impairments or a reversal of previous impairment losses. In either case recognise in the
income statement.
PAST EXAMS ANALYSIS

Topic Exam Attempt Question


June 15 MCQ.17
Dec.14 MCQ. 14
IFRS 5
June 13 Q.2(ii) Q.2(a)
June 11 Q.4 (b)

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IAS 21 THE EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATES

Objective of IAS 21
The objective of IAS 21 is to prescribe how to include foreign currency transactions (As per scope of F7)

Key definitions

Functional currency:
The currency of the primary economic environment in which the entity operates.

Presentation currency:
The currency in which financial statements are presented.

Foreign currency:
It is a currency other than the functional currency of the entity.

Exchange difference:
The difference resulting from translating a given number of units of one currency into another currency at different
exchange rates.

Closing rate:
It is the spot exchange rate at the end of the reporting period.

Exchange difference:
It is the difference resulting from translating a given number of units of one currency into another currency at different
exchange rates.

Exchange rate:
It is the ratio of exchange for two currencies.

Monetary items:
They are units of currency held and assets and liabilities to be received or paid in a fixed or determinable number of
units of currency.

Spot exchange rate:


It is the exchange rate for immediate delivery.

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Foreign currency transactions
A foreign currency transaction should be recorded initially at the rate of exchange at the date of the transaction (use of
averages is permitted if they are a reasonable approximation of actual).
At each subsequent reporting date:

Foreign currency monetary amounts should be reported using the closing rate
Non-monetary items carried at historical cost should be reported using the exchange rate at the date of the
transaction
Non-monetary items carried at fair value should be reported at the rate that existed when the fair values were
determined
Exchange differences arising when monetary items are settled or when they are translated at different rates
from initial recognition or previous financial statements are reported in profit or loss in the period
If a gain or loss on a non-monetary item is recognised in other comprehensive income (for example, a property
revaluation under IAS 16), any foreign exchange component of that gain or loss is also recognised in other
comprehensive income.

PAST EXAMS ANALYSIS

Topic Exam Attempt Question


IAS 21 Spec. exam Sept. 16 MCQ.6

Dynamic Publishers Page 63 of 88


IAS 33 - EARNINGS PER SHARE

INTRODUCTION
Earnings Per Share (EPS) is an unusual accounting ratio in that it has a whole standard devoted to its calculation and
presentation.

USES OF EPS
The uses of EPS as a financial indicator include:
The assessment of management performance over time.
Trend analysis of EPS to give an indication of earnings performance.
An indicator of dividend payouts. The higher the EPS the greater the expectation of an increased dividend compared
to previous periods.
An important component in determining the entity's price/earnings (P/E) ratio.

DEFINITIONS
Ordinary shares: an equity instrument that is subordinate to all other classes of equity shares.
Potential ordinary shares: a financial instrument or other contract that may entitle its holder to ordinary shares.
Examples of potential ordinary shares include:
Convertible debt
Convertible preference shares
Share warrants
Share options

Warrants or options: financial instruments that give the holder the right to purchase ordinary shares.
Dilution: a reduction in EPS or an increase in loss per share resulting from the assumption that convertible instruments
are converted, the options or warranties are exercised, or that ordinary shares are issued upon the satisfaction of
specified conditions.

Antidilution: an increase in EPS or a reduction in loss per share resulting from the assumption that convertible
instruments are converted, the options or warranties are exercised, or that ordinary shares are issued upon the
satisfaction of specified conditions.

BASIC EPS
The basic EPS should be calculated by dividing the net profit or loss attributable to ordinary equity shareholders by the
weighted average number of ordinary shares outstanding during the period.

The net profit is profit after tax and preference dividends.

CHANGES IN THE CAPITAL STRUCTURE


The four most common reasons for adjusting shares in issue at the beginning of the period are:
Issue of new shares during the period (fully or partly paid)
Bonus issues
Rights issues;
Potential ordinary shares (resulting in calculation of diluted EPS)

Dynamic Publishers Page 64 of 88


Issue of new shares during the period (Fully paid)
Shares should be included in the weighted average calculation from the date consideration is receivable

Issue of new shares during the period (Partly paid)


Shares should be included in the weighted average calculation from the date consideration is receivable. Partly paid
shares are treated as fractions of shares; based on payments received to date as a proportion of the total subscription
price.

Bonus issue, share split and share consolidation


IAS 33 requires that the bonus shares are treated as if they had occurred at the beginning of the period. The EPS from
the previous period should also be recalculated using the new number of shares in issue to allow comparison with the
current year's EPS, as if the issue had taken place at the beginning of that period as well.

When calculating the prior period EPS comparator then multiply last year's EPS by the factor:

Number of Shares before bonus issue


Number of Shares after bonus issue

When calculating the weighted average number of shares then the bonus factor to apply is the inverse of the above, i.e.
Number of Shares after bonus issue
Number of Shares before bonus issue

Similar considerations apply where ordinary shares are split into shares of smaller nominal value or consolidated into
shares of higher nominal value.

RIGHTS ISSUE
With a rights issue additional capital is raised by the issue of the shares. Then when dealing with a rights issue at a
discount, calculation of EPS should mark adjustment for the two elements:
A bonus issue (reflecting the fact that the cash received would not pay for all the/shares issued if based on fair
values, rather than being discounted).
An assumed issue at full price (reflecting the fact that new shares are issued in return for cash);
Consequently the number of shares outstanding at the beginning of the year should be adjusted for the bonus factor to
give a deemed number of shares in issue before the rights issue. This should be weighted for the period up to the date
of the rights issue.

The bonus factor is equal to: Fair Value before rights issue
Theoretical ex - rights Price after rights issue

Additionally the number of shares actually in issue after the rights issue is weighted for the period after the rights issue.
As in the section on bonus issues, the prior period EPS should be adjusted for the bonus factor. This is achieved by taking
the reciprocal of the bonus factor (turn fraction Upside down) and multiplying by last year's EPS.

DILUTED EARNINGS PER SHARE


An entity may have in issue at the reporting date a number of financial instruments that give rights to ordinary shares at
a future date. IAS 33 refers to these as potential ordinary shares. Examples of potential ordinary shares include:

Convertible debt;
Convertible preference shares;
Share warrants
Share options

Dynamic Publishers Page 65 of 88


Where these rights are exercised they will increase the number of shares. Earnings may also be affected. The overall
effect will tend towards lowering (or diluting) the EPS.

So that existing shareholders can see the potential dilution of their present earnings, IAS 33 requires that a diluted EPS is
calculated.
The calculation is performed as if the potential ordinary shares had been in issue throughout the period. If the rights
were granted during the reporting the period, then time apportion.

The diluted EPS is:


Earnings as per basic eps + Adjustment for dilutive potential ordinary shares
Weighted Average number of shares per basic EPS + Adjustment for dilutive potential ordinal

Convertible Financial instruments

CALCULATION OF EARNINGS
Adjust:

1. Profits
There will be a saving of interest. Interest is a tax-deductible expense and so the post-' tax effects will be
brought into the adjusted profits.
There will be a saving of preference dividend. There is no associated tax effect

2. The number of shares


The potential ordinary shares are deemed to be converted to ordinary shares at the start of the period unless
they were issued during the reporting period.

SHARE WARRANTS AND OPTIONS


A share option or warrant gives the holder the right to purchase or subscribe for ordinary shares. IAS 33 requires that
the assumed proceeds from these shares should be considered to have been received from the issue of shares at fair
value. These would have no effect on EPS.

The difference between the number of shares that would have been issued at fair value and the number of shares
actually issued is treated as an issue of ordinary shares for no consideration. This bonus element has a dilutive effect
with regard to existing shareholders.

PAST EXAMS ANALYSIS

Topic Exam Attempt Question


Spec. exam Sept. 16 MCQ.7
June 15 Q3.(d)
Dec. 14 MCQ.2, 13
June 14 Q.2(d)
IAS 33
June 13 Q.2(b)
June 12 Q.2 (b)
June 11 Q.4(b)
Dynamic Publishers Page 66 of 88
CONSOLIDATED FINANCIAL STATEMENTS

A group is formed when one company, known as the parent, acquires control over another company, known as its
subsidiary.

The subsidiary and the holding company are considered separate legal entities. Group accounts are presented as if the
parent company and its subsidiary were one single entity an application of the substance over form concept.

DEFINITIONS
Group of Companies arises when one company (Parent) takes control of another company (subsidiary).

Subsidiary is a company controlled by another company.

Parent is a company that controls one or more subsidiaries.

Non-Controlling Interest is a collective representation of the shareholders that normally own 49% or less of equity.

Consolidated Financial Statements means F/S of whole Group presented as a single set of accounts.

CONTROL
According to IFRS 10 Consolidated Financial Statements an investor controls investee when it is exposed, or has rights, to
variable returns from its involvement with the investee and has the ability to affect those returns through its power over
the investee.

Existence of parent subsidiary relationship


Parent subsidiary relationship exists when:

The parent holds more than one half of the voting power of the entity
The parent has power over more than one half of the voting rights by virtue of an agreement with other
investors (common control)
The parent has the power to govern the financial and operating policies of the entity under the articles of
association of the entity
The parent has the power to appoint or remove a majority of the board of directors
The parent has the power to cast the majority of votes at meetings of the board

1.1 EXEMPTION FROM PREPARING GROUP ACCOUNTS


A parent need not present consolidated financial statements if the following stipulations hold:

The parent itself is a wholly-owned subsidiary or it is a partially owned subsidiary of another entity Its securities
are not publicly traded
The parents debt or equity instruments are not traded in a public market
The parent did not file its financial statements with a securities commission or other regulatory organisation
The ultimate parent publishes consolidated financial statements that comply with International Financial
Reporting Standards.

Dynamic Publishers Page 67 of 88


GENERAL RULES

Same accounting policies should be used for both the holding company and the subsidiaries. Adjustments must
be made where there is a difference
The reporting dates of parent and subsidiary will be the same in most cases. In case of difference, the subsidiary
will be allowed to prepare another set of accounts for consolidation purposes (if the difference is of more than
three months).

Accounting for subsidiaries in separate financial statements of the holding company

The holding company will usually produce its own separate financial statements. Investments in subsidiaries and
associates have to be accounted for at cost or in accordance with IAS 39. Where subsidiaries are classified as held for
sale then the provisions of IFRS 5 have to be complied with.

PAST EXAMS ANALYSIS

Topic Exam Attempt Question


Spec. exam Sept. 16 MCQ.9
Consolidation rules June 15 MCQ.8
Dec.14 MCQ.10
Spec. exam Sept. 16 MCQ.2
IFRS 3
June 11 Q.1 (b)

Dynamic Publishers Page 68 of 88


CONSOLIDATED STATEMENT OF FINANCIAL POSITION

1. At the date of acquisition, the investment by the parent company in the subsidiary company is cancelled of
against the equity (share capital, state premium, retained earnings of subsidiary company. Any excess remaining
is known as goodwill.

2. All assets and liabilities of subsidiary company are than added on a line by line basis with the assets and
liabilities of the parent company.

3. If the parent contacts less than 100% of a subsidiary, the remaining investment is known as non-controlling
interest and a portion of equity shall now beattributable to NCI.

4. Consideration might be paid in the following ways:

By cash

By share for share exchange

By deferred consideration

By contingent consideration

By loan notes

5. Contingent consideration: At times, the parent Co. agrees to pay the consideration only if some specified
conditions are met such conditions are contingent events and IFRS 3 requires to measure such consideration at
fair value

Initial recognition:

Dr. Cost of investment


Cr. Provision for contingent consideration

Deferred consideration: is recorded at present value at the date of acquisition.

Initial recognition:

Dr. Cost of investment


Cr. Provision for contingent consideration

Subsequent recognition Unwinding of discount

Dr. Consolidates retained earnings

Cr. Provision for deferred consideration

Dynamic Publishers Page 69 of 88


6. Intra-group balances: Such intra-group balances shall be removed from consolidated statement of financial
position (CSOFP) only if the balances reconcile.

Dr. Payables

Cr. Receivables

7. If balances do not reconcile:

Make the adjustments for in transit items

Cash in transit
DR Cash
CR Receivables

Goods in transit
DR Inventories
CR Payables

8. Intra-Group unrealized profits

Downstream transactions: if P Co has sold goods to S Co and these goods remain the in inventory at the year
end, the profit recognized by the parent Co. Shall be eliminated (No impact on NCI)

Dr. Consolidated Reserves

Cr. Inventory

Upstream transaction: If the S Co. has sold goods to the P.Co. the profits have been earned by the S.Co. and shall
be eliminated not only from group reserve but also from NCI

Dr. Consolidated Reserves

Dr. NCI

Cr. Inventories

9. FV Adjustment

Gain or loss adjusted in the calculation of goodwill. Additional depreciation is deducted from retained earnings.

FV of net assets.

10. Intra-group loans: The portion of loan given by the P.Co to its subsidiary is an intra-group receivable,
payable and shall be eliminated as such.

Dr. Loan liability

Cr. Loan Asset

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Any interest receivable payable on such loans shall also be eliminated but only to the extent related to the parent

Dr. Interest payable

Cr. Interest receivable

If the P.Co has not recorded interest receivable on loans given to the sub Co. the first treatment is to record the
interest receivable.

Dr. Interest receivable

Cr. Consolidated reserves

After this an intra-group interest receivable payables exists which shall be eliminated

Dr. Interest payable

Cr. Interest receivable

If P.Co. has recorded the receivable but subsidiary company has not included a payable in its own financial
statements, first treatment is to record the interest payable.

After this an intra-group interest receivable, payable asset which shall be eliminated.

11. Intra-group dividiends: If the parent Co has not recorded the dividend recoverable the first treatment is to
record the receivables.

Dr. Dividend receivable

Cr. Consolidated reserve

After this an intra-group, dividends receivable/payable exists which shall be eliminated:

Dr. Consolidated reserves

Dr. NCI

Cr. Dividend payable

12. Redeemable Preference Shares: Treat like any other long-term loani.e. eliminate as an inter-company loan and
adjust for any interest accrual.

Dynamic Publishers Page 71 of 88


13. Full or fair value of NCI: IFRS-3, allows/requires goodwill to be stated at full value i.e. a part of goodwill shall now
be attributable to NCI.

Now goodwill impairment shall be charged not only to be parent company but also to NCI

Dr. NCI

Dr. Consolidated Reserves

Cr. Goodwill

Goodwill in consolidated Statement of Financial Position:

Acquisition-datefair value of consideration transferred by parent X


Plus:Fair (or full) value of the N-CI at date of acquisition X
Less:Fair value of subsidiary's identifiable net assets at date of acquisition
(X)
Equals: Total Goodwill X

Impairment Of Goodwill
Under this approach the goodwill appearing in the consolidated Statement of Financial Position is the total goodwill. The
accounting treatment will be:

Dr Group retained Earnings X


Dr Non-controlling interest X
Cr Goodwill X

PAST EXAMS ANALYSIS

Topic Exam Attempt Question


Spec. exam Sept. 16 MCQ.10,15
Dec. 15 Q.3a
June 15 MCQ.5,11,12,14
Dec. 14 MCQ.16 Q.3(a),(c)
Consolidated SOFP
Dec. 13 Q.1(a)
June 13 Q.1
June 12 Q.1
Dec. 11 Q.1

Dynamic Publishers Page 72 of 88


CONSOLIDATED STATEMENT PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME

The basic idea is to show the results of the group as if it were a single entity.
The majority of figures are simple aggregations of the results of the parent and all the subsidiaries (line by line)
down to profit after tax.
In aggregating the results of the parent and subsidiaries, intra-group transactions such as dividend income,
interest income and unrealised profits are eliminated.
Any non-controlling interest is ignored until profit after tax. Their interest in profits after tax is then subtracted
as a one-liner to leave profits attributable to members of the parent.

P group plc - Pro-forma Consolidated statement of profit or loss


For year ended 30 November 20X6
$'m
Sales revenue (P+S less intra-group sales) X
Cost of Sales (P+S less intra-group purchases plus unrealised profit in inventory) (X)
Gross Profit X
Distribution Costs (P+S) (X)
Administrative Expenses (P+S) (X)
Group operating Profit X
Interest and similar income receivable (P+S less intra group interest income) X
Interest expenses (P+S less intra-group interest expense) (X)
X
Share of Profits of Associate (PAT) X
Profit before tax X
Income tax expense (P+S) (X)
Profit for the period X
Profit attributable to :
Owners of the parent X
Non-controlling interest X
X

Dynamic Publishers Page 73 of 88


OTHER ADJUSTMENTS

If the subsidiary is acquired during the current accounting period it is necessary to apportion the profit for the
period between its pre-acquisition and post-acquisition elements. This is dealt with by determining on a line-by-
line basis the post acquisition figures of the subsidiary.
After profit after tax in consolidated statement of profit or loss, total profits are divided between profits
attributable to group and profit attributable to NCI
Any dividends receivable by the parent must be cancelled against dividends paid from the subsidiary
undertaking.
Where group companies trade with each other one will record a sale and the other an equal amount as a
purchase. These items must be removed from the consolidated statement of profit or loss by cancelling from
both sales and cost of sales.
The unrealized profit adjustment is to increase cost of sales. In case of upstream transaction, the unrealized
profit is deducted from profit attributable to NCI also.
Investment in loans means an intra-group finance cost as well as inter-group dividends.
These will cancel out in basically the same way as for dividends.
Impairment of goodwill is treated as an administration expense unless otherwise stated
There is no impact of fair value adjustment on acquisition at the statement of profit or loss. However, any
additional depreciation related to such fair value adjustment must be charged by adding to cost of sales and
deducting from profit after tax of subsidiary while calculating profit attributable to NCI

DISPOSAL OF INVESTMENT

Subsidiaries are consolidated until the date control is lost therefore profits need to be time-apportioned.

Disposal occurs when control is lost over subsidiary. F7 syllabus includes only full disposal i.e. all the holding is
sold (say, 70% to nil)
The effective date of disposal is when control is lost
Following is the accounting treatment for full disposal
In case of Statement of profit or loss and other comprehensive income, consolidate results and non-
controlling interests to the date of disposal.
Show the group profit or loss on disposal
In case of Statement of financial position, there will be no non-controlling interests and no
consolidation as there is no subsidiary at the date the statement of financial position is being prepared.

Parent company's accounts

In the parent's individual financial statements the profit or loss on disposal of a subsidiary will be calculated as:

Sales proceeds X

Less: Carrying amount (cost in P's own statement of financial position) (X)

Profit (loss) on disposal X/(X)

Dynamic Publishers Page 74 of 88


Group accounts Gain/loss on disposal of subsidiary

In the group financial statements the profit or loss on disposal will be calculated as:

$ $

Proceeds X

Less: Amounts recognised prior to disposal:

Net assets of subsidiary X

Goodwill X

Non-controlling interest (X)

Profit / loss X/(X)

If the disposal is mid-year:


- A working will be required to calculate both net assets and the non-controlling interest at the disposal date.
- Any dividends declared or paid in the year of disposal and prior to the disposal date must be deducted from the
net assets of the subsidiary if they have not already been accounted for.
Goodwill recognised prior to disposal is original goodwill arising less any impairment to date.

PAST EXAMS ANALYSIS

Topic Exam Attempt Question


Spec. exam Sept. 16 MCQ.8
June 15 Q.1
Dec. 14 Q.3(b)
Consolidated P&L June 14 Q.1
Dec. 13 Q.1(b)
Dec. 12 Q.1
June 11 Q.1

Dynamic Publishers Page 75 of 88


IAS 28 INVESTMENTS IN ASSOCIATES

SCOPE
This Standard shall be applied in accounting for investments in associates.

DEFINITIONS
The following terms are used in this Standard with the meanings specified:-
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.
The equity method is a method of accounting whereby the investment is initially recognized at cost and adjusted
thereafter for the post-acquisition change in the investors share of net assets of the investee. The profit or loss of
the investor includes the investors share of the profit or loss of the investee.
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. Investments of 20% to 50% in voting power of companies lead to
existence of significant influence. Significant influence by an investor is usually evidenced in one or more of the
following ways:-

a. Representation on the board of directors or equivalent governing body of the investee.


b. Participating in policy making process, including participation in decisions about dividends or other distributions.
c. Material transactions between the investor and the investee
d. Interchange of managerial personnel; or
e. Provision of essential technical information.

1.1 ACCOUNTING OF ASSOCIATE


Associate should be accounted for in consolidated financial statement using equity method; i.e. investment is

Initially recorded at cost;


Adjusted for post acquisition change in net assets (investor share); Or post acquisition profits/losses (investor share);
The profit or loss of the investor includes the investors share of the profit or loss of the investee.
Dividend paid or distributions made will reduce the investment.
On acquisition any difference between the cost of investment and investors share of net fair value of associates
identifiable assets, liabilities and contingent liabilities is accounted for in accordance with IFRS-3.
Goodwill relating to an associate is included in the carrying value of investment
Any excess of the investors share of net fair value of the associates assets, liabilities and contingent liabilities
over the cost of investment is excluded from the carrying value of investment and is included in the income
statement of the year of acquisition.

Adjustments in investors share of profit and loss after acquisition are made in respect of depreciation based on Fair
Value.
If different reporting dates, adjust the effect of significant events between reporting dates;
The investors financial statements shall be prepared using uniform accounting policies for like transactions and
events in similar circumstances.

Dynamic Publishers Page 76 of 88


If the investors share of losses exceeds or equals its interest in associate, the investor will discontinue the
recognition of further losses. Additional losses can only be recognized if there exist any legal or constructive
obligation
Impairment test will be applied on the entire amount of investment under IAS -36 and the impairment loss will be
recognized.
In case of trading between group and associate, the profits or losses resulting from these transactions are
recognized in the investors financial statements only to the extent of un-related investors interest in associate.
No netting-off is done between receivables and payables

1.2 EXCEPTIONS TO THE EQUITY METHOD

An investment in an associate shall be accounted for using the equity method except when:
1) There is an evidence that the investment is acquired and held exclusively with a view to its disposal within twelve
months from acquisition date (Then apply IFRS -5).
2) All of the following apply:
a. The investor is a wholly-owned subsidiary its other owners do not object if the investor does not apply the
equity method;
b. The investors debt or equity instruments are not traded in a public market
c. The investor did not file its financial statements with securities commission, and
d. The ultimate parent of the investor produces consolidated financial statements.
Some noteworthy points include:
Investment described in 1 above shall be classified as held for trading and accounted for in accordance with
IFRS-5.

Dynamic Publishers Page 77 of 88


EQUITY METHOD
Statement of profit or loss
Dividend income from associates (reported in the investor's books) is replaced by the profit after tax of the
associate.

1.3 STATEMENT OF FINANCIAL POSITION


Initially the Investments in Associates is shown at cost (same as in the individual accounts), identifying any goodwill
included in the cost.
In subsequent years the Investor's accounts will show:

the investment at cost


Plus group share of associate's post acquisition reserves.
Less any impairment of investment to date.

On the bottom of the balance sheet consolidated reserves will reflect the other side of these adjustments.

Method $
Cost of Investment X
Plus group share of post acquisition reserves X
Less impairment of investment (X)
INVESTMENT IN ASSOCIATES X

PAST EXAMS ANALYSIS

Topic Exam Attempt Question


Spec. exam Sept. 16 MCQ.11
Dec. 15 Q.3b
Associates
June 15 MCQ.18
Dec. 11 Q.1

Dynamic Publishers Page 78 of 88


RATIO ANALYSIS

Ratio analysis is a technique whereby complicated information is summarised to a common denominator so that a
meaningful comparison of the company's performance and financial position can be made, or comparison be made with
another similar company

ANALYSIS AND INTERPRETATION

Calculation of key ratios from Explanation of ratios to


financial statements establish strengths and
weaknesses

PURPOSE
Depends on USER

Management Lender / analyst Investors / analyst


Cost control Lending Buy/Hold/Sell shares
Profitability analysis Security Quality of management
Investment decisions Credit worthiness

Comparison required with:


Previous years
Predetermined forecasts
Industry averages

LIMITATIONS

Availability of information Consistency Historic cost accounting


Cost/difficulty of obtaining Changes in accounting policies Inherent limitations of HCA in
Information between years periods of price level
changes
Different policies used by
different companies

Dynamic Publishers Page 79 of 88


LIMITATIONS OF RATIO ANALYSIS
1. It is an oversimplification of a harsh business world
2. Ratios are based on highly subjective accounting figures
3. Historical cost accounts do not take into account the impact of inflation
4. Ratios do not make allowances for external factors: economic or political
5. Users are more interested in future prospects rather than past events

WHAT IS THE OBJECTIVE OF FINANCIAL STATEMENTS?


To provide information about the financial position, performance and financial adaptability of an enterprise that is
useful to a wide range of users for assessing the stewardship of management and for making economic decisions

PROVIDE USEFUL INFORMATION ON

Who
Financial Performance Financial are
Position adaptability these
users
Statement of Statement of profit or Statement of Resources, solvency & and
Financial Position loss Financial Position financial structure what
infor
Statement of Income Performance & matio
Changes in equity Statement Distributions n do
they
Statement of Cash Statement of Realised gains/losses & want?
flows changes in equity unrealized gains losses
(reserve movements)
Cash flow Amounts of cash flow
statement Timings of cash flow
Quality of profits
Shareholders (investment decisions) Profit and dividend prospects
Loan creditors {lending decisions) Creditworthiness and liquidity

Employees (safety of employment) Wage bargaining and future prospects

Suppliers (credit decisions) Ability to pay on time and short term liquidity
Note that most users will be interested in what has happened in the past, and what may happen in the future!

Dynamic Publishers Page 80 of 88


OVERVIEW

DIVISION OF RATIOS

PERFORMANCE LIQUIDITY EFFICIENCY STOCK MARKET

ROCE% SHORT Stock t/o in days ROE%


TERM
Profit margin% Current ratio Debtors t/o in days EPS
Creditors t/o in days Dividend yield%
Gross profit% Acid-test ratio

Net profit% LONG TERM Asset turnover


Gearing Dividend cover

Interest cover

EXAM TECHNIQUE:
RATIO ANALYSIS-----------use appendices to show calculations / always show formula used

COMMENTS (cause) & CONSEQUENCES (effect)


3 steps

- The gearing ratio has moved from......}

- The gearing ratio measures.................} What is the overall picture?

- The move may be due to................}

Dynamic Publishers Page 81 of 88


STYLE OF REPORT

FORMAT STRUCTURE BE CONCISE

Formal: External Use sub-headings: Keep it simply and short


Introduction Avoid
Informal: Internal Separate paragraphs
Conclusion

Dynamic Publishers Page 82 of 88


PERFORMANCE RATIOS

Profitability and asset utilization


Primary ratio Return on Capital Employed
(ROCE)

Profit before interest and tax (PBIT) Comments on how


Share capital + reserves + long term efficiently capital has been
liabilities employed by management
OR
Fixed assets + current assets current
Liabilities (1 yr.)

Profitability Asset utilization

Profit margin Secondary ratios Asset utilization

PBIT Sales
Sales Non CA + CA - CL

Comments on how profitable are sales Measures performance of


and control of operating costs company in generating
sales from assets at their
disposal

Gross profit margin Tertiary ratios Non-current asset


utilization

GP Sales
Sales Non CA (ex investments)

Measures margin earned Measure turnover


Indicates changes in margin and generated by Non CA
product mix Indicates spare
capacity

Operating cost margin


Distribution / Administration
Sales

Indicates whether costs are being


controlled

Dynamic Publishers Page 83 of 88


LIQUIDITY AND EFFICIENCY RATIOS

Short term solvency, working capital management and gearing

Short term solvency


Can business pay its creditors / employees on time and service its assets

Current ratio (current ratio) Acid ratio (quick ratio)

Current assets Current assets inventory


Current liabilities Current liabilities

Indicates any potential Indicates real short-term


liquidity problems liquidity

Working capital management /


efficiency
Inventory and credit control

Stock control Credit control

Raw materials: Debtors turnover in days


Average RM stock x 365 Trade debtors x 365
RM consumption Credit sales
Indicates inventory holding policy Indicates number of days taken to collect
Work-in-progress: debts
Average x x 365
Cost of production Creditors turnover in days
Indicates production cycle Trade creditors x 365
Finished goods: Credit purchases
Average FG x 365 Indicates number of days to pay debts
Cost of sales
Indicates shelf life

Dynamic Publishers Page 84 of 88


Gearing and long term financial strength
Risk business takes from using debt capital

Gearing: debt / equity ratio Interest cover gearing

Fixed interest capital* x 100 PBIT


Ordinary share capital + Interest payable
Reserves

Indicates how vulnerable Indicates safety of interest


company is to lenders of payments
long term finance or how
reliant it is on external
finance

* Loans + redeemable preference shares payments


+ deferred tax + obligations under finance leases

Dynamic Publishers Page 85 of 88


STOCK MARKET / INVESTOR RATIOS

Return on equity capital (ROE)

Profit after tax and preference dividends Indicates how efficiently company is
Ordinary share capital + reserves employing funds provided by equity
shareholders

Earnings per share (EPS)

Used as measure of profitability; higher


Profit after tax and preference dividends the EPS, the higher the shareholders
Number of equity shares in issue expectation re dividend payout

Price earnings ratio (P/E)


Market price of equity share Measures of a companys market rating;
EPS higher the PER, the higher the markets
confidence in companys future
prospects

Dividend cover
Indicates how many times current years
profit covers dividends appropriated,
Profit after tax and preference dividends and retention policy
Ordinary dividends appropriated in period

Dividend yield
Measure of return on investment
Ordinary dividends appropriated in period
Market price of equity shares

Dynamic Publishers Page 86 of 88


PAST EXAMS ANALYSIS

Topic Exam Attempt Question


Spec. exam Sept. 16 MCQ. 12,14
Dec. 15 Q.2
June 15 MCQ.7,20 Q.2
Dec. 14 Q.1
June 14 Q.3
Interpretation of ratios Dec. 13 Q.3(b)
June 13 Q.3(b)
Dec. 12 Q.3
June 12 Q.3 (b)
Dec. 11 Q.2 (iii), Q.3 (b)
June 11 Q.3 (b)

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NOT-FOR-PROFIT AND PUBLIC SECTOR ENTITIES

Not-for-profit and public sector entities are not expected to show a profit but must ensure that they have
managed their funds efficiently
Not-for-profit and public sector entities do not exist to make profits, but they do have a diverse range of
stakeholders, many of whom have a legitimate interest in the bodys financial stewardship.
The corporate objectives of businesses are very different from those of not-for-profit and public sector entities.
Companies exist largely to make profits.
In practice, the accounting policies adopted by not-for-profit and public sector entities are increasingly similar.
Not-for-profit and public sector entities include government agencies, healthcare agencies, schools, colleges and
charities
Even though not-for-profit entities do not report to shareholders, they must be able to account for the funds
received and the way they have been allocated
Their objective is to provide goods and services to various recipients and not make a profit
A public sector entity such as local government will have the aim of providing services to its local community
such as fire services, refuse collection, libraries, theatres and sports facilities
A charity will have the aim of providing assistance to a particular cause, for example poverty aid in developing
countries, child protection, animal rescue

Performance measurement
The performance of a public sector or not-for-profit entity will be in terms of measuring whether its stated Key
performance indicators have been achieved
One measure of performance for public sector entities is the 3 Es economy, efficiency and effectiveness
Another performance consideration is whether the entity has achieved value for money
Charities must focus on demonstrating that they have made proper use of the funds received and whether they
have achieved their stated aims

PAST EXAMS ANALYSIS

Topic Exam Attempt Question


Not-for-profit entities Dec. 14 MCQ.15

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